Neogenomics Inc
NASDAQ:NEO

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Earnings Call Transcript

Earnings Call Transcript
2017-Q4

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Operator

Greetings, and welcome to NeoGenomics’ Fourth Quarter and Full Year 2017 Earnings Conference Call. [Operator Instructions]

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Doug VanOort, Chairman and Chief Executive Officer for NeoGenomics. Thank you, Mr. VanOort. You may begin.

D
Doug VanOort
Chairman and CEO

Thank you very much. Good morning everyone. I’d like to welcome you all to NeoGenomics fourth quarter 2017 conference call. Joining me from our Fort Myers headquarters is Steve Jones, our Executive Vice President; George Cardoza, our Senior Vice President and Chief Financial Officer; Bill Bonello, our Treasurer and Director of Corporate Development; Rob Shovlin, President of our Clinical Services Division; Kathryn McKenzie, our Vice President of Finance and Principal Accounting Officer; and Jessica King, our Director of External Reporting. Dr. Maher Albitar, our Senior Vice President, Chief Medical Officer and Director of R&D is joining us from our Aliso Viejo Lab in California.

Before we begin our prepared remarks, Steve Jones will read the standard language about forward-looking statements.

S
Steve Jones
Executive Vice President

This conference call may contain forward-looking statements, which represent our current expectations and beliefs about our operations, performance, financial condition and growth opportunities. Any statements made on this call that are not statements of historical facts are forward-looking statements. These statements by their nature involve substantial risks and uncertainties, certain of which are beyond our control. Should one or more of these risks or certainties materialize or should the underlying assumptions prove incorrect, actual outcomes and results could differ materially from those indicated in the forward-looking statements. Any forward-looking statement speaks only as of today, and we undertake no obligation to update any such statements to reflect events or circumstances after today.

Before turning it back to Doug, I want to let everyone know that we will be making a copy of our transcript for this morning’s call available on the Investor Relations section of our website shortly after the call is completed. We also want to let everyone know that we are going to limit the number of questions to two per person in order to give more people a chance to ask questions within the one hour that has been allotted for this call.

D
Doug VanOort
Chairman and CEO

Thank you, Steve.

I’d like to briefly review our quarter four performance, comment on some underlying trends and our business and share with you our key plans for 2018. Let’s begin with our financial performance.

NeoGenomics fourth quarter performance was very good and we are especially pleased with the underlying growth momentum in our business. Consolidated revenue of $67.8 million was up 12.1% from last year’s fourth quarter, adjusting for the sale of pathologic revenue increased by 15%. We grew test volume in our clinical division by a very strong 18.7% and the product mix was healthier. Our sales team is getting back to its former levels of high productivity and obviously we are winning market share.

Pharma division revenue increased by 69% compared with last year’s fourth quarter. We had reported large gains in the backlog of signed contracts in previous quarters and although revenue conversion can be uneven from quarter-to-quarter, we are pleased to have had many projects convert to revenue in quarter four. Our backlog of signed contracts increased once again and ended the year 81% higher than last year.

We also were able to drive better profitability on those revenue increases. Adjusted EBITDA reached a record high $10.5 million. This improvement in profitability was achieved despite lower price per test. As we lowered cost per test once again by over 10% and our laboratory employees operated at record levels of productivity.

Although, we had strong levels of cash collection, the record high adjusted EBITDA included elevated bad debt expense, as we made sure that some billing challenges experienced earlier in the year are behind us.

Importantly, we ended quarter four with net accounts receivable expressed in terms of days sales outstanding for our clinical division at their lowest levels since mid-2016. All-in-all fourth quarter financial performance was very strong and we are pleased to see the positive underlying fundamentals we told you about during our last call bear fruit in improved financial results.

I’d like to comment now on some of those underlying fundamental dynamics affecting our business and start by reviewing our clinical division. Fourth quarter volume growth of nearly 19% was by far the best of the year. Importantly, that growth was more balanced with accelerating momentum in our core testing disciplines.

As we explained previously, NeoGenomics has performed much of the country’s PD-L1 testing, ever since that biomarker was identified as a companion diagnostic test in the fourth quarter of 2016. While our high-level of PD-L1 testing resulted in higher overall volume growth earlier in the year, at an average price of about $100 per test, PD-L1 testing did not result in much higher revenue and it drove very little profit growth.

When we analyze fourth quarter volume growth trends, excluding PD-L1, we see that growth in our core test areas excluding PD-L1 was up nearly 19% or 17%, excuse me, compared with a year ago. This reflects a more successful balanced commercial sales effort.

We reported in the last quarter’s call that our sales forces has once again focused on winning new business. In fact, their efforts yielded the highest levels with quarterly growth of the year for molecular, FISH and flow cytometry testing.

Our strategy to offer a one-stop shop for all oncology testing needs is paying off as new clients are requesting many tests in our comprehensive service offering.

Our sales team is confident, experienced and well-trained. We recently added five talented people to our sales team and now have 50 people focused on sales efforts across the country for our clinical division.

The sales team’s efforts were aided by over three dozen new managed care and strategic partnership agreements signed during 2017, and these helped us to continue to gain new hospital clients across the country.

In addition, we are adding capacity to meet customer expectations with the construction of a small lab in Atlanta, Georgia, focused primarily on providing rapid turnaround flow cytometry services to clients in that area. We believe that our market share gains are based on our scale, our test offering, which we believe is the most comprehensive test offering for oncology in the industry and our focus to consistently deliver high levels of service.

These high levels of service are evidenced by very strong response rates and scores from our regular customer surveys, and are also demonstrated by very high levels of customer retention. In our recent analysis of customer retention, we found that our overall customer retention rate during the past year was 97.5% and about half of the number of lost customers was due to either our decision not to provide services or to their retirement or acquisition.

Adjusting for losses within our control, customer retention is nearly 99%. Of course, even one customer loss is unacceptable to us and our teams are working to get those few lost customers back.

Let’s turn our attention now to the Pharma Services division. Once again we reported a record quarter in this division, with revenue up 69% year-over-year to $8.7 million. The health of this business is also demonstrated by $18 million of newly signed contracts during the quarter and ending backlog of 81% to $67 million.

The Pharma Services business is strategically important to us for a variety of reasons. It gives us a window into what new oncology drugs, the leading, most innovative pharma and biotech companies are developing. And it allows us to partner with those innovators as we discover and test new biomarkers to help them with their drug development programs. These advances will also help fuel growth in our clinical division, as those drugs are approved and put into clinical practice. In addition the business diversifies our company into another high growth market segment.

As a result, we are investing in building this firm of business by adding capacity. As promised, we opened our first European lab in November located just outside Geneva, Switzerland in Rhône. And we are now in the process of constructing a new lab in Houston, Texas to replace an older facility that came to NeoGenomics as a result of the Clarient acquisition.

Clearly, we have very strong growth momentum and many opportunities in both our clinical and pharma business units. However, there are challenges in any business and NeoGenomics is no exception. One of our continuing challenges has to do with reimbursement in the clinical division. And this year, there are several issues we are dealing with. Our entire industry is dealing with reimbursement headwinds as a result of the implementation of PAMA in 2018.

In our case, with less than 30% of our test mix subjected to the clinical lab fee schedule, the effect of this particular headwind is relatively minor, is expected to be less than $1 million of impact amounting to less than 0.4% of clinical revenue. Many of our tests, specifically FISH, flow cytometry and immunohistochemistry are reimbursed by CMS using the physician fee schedule.

Based on new reduced rates for certain immunohistochemistry and flow cytometry tests in 2018, we expect the impact from physician fee schedule changes to be less than $2 million, amounting to less than 0.7% of clinical revenue.

On our last call, we discussed the potential impact of increasing requirements by certain payers, or prior authorization of test orders. We have set up ordering and billing processes to deal with this new requirement, and at this time we do not see a major impact on test volume or reimbursement levels as a result of this requirement.

Another very recent reimbursement challenge is caused by changes in the so-called 14-day rule. This longstanding rule required non-hospital reference labs like NeoGenomics to bill hospital clients directly instead of Medicare for any laboratory tests performed within 14 days of sample procurement in a hospital setting.

Under the new rule in effect for 2018, certain molecular pathology tests performed in hospital outpatient settings are now excluded from this 14-day rule and non-hospital reference labs such as NeoGenomics can bill Medicare directly for these tests.

Although details of this rule are quite complex, the implication is that NeoGenomics will now bill Medicare for many single gene molecular tests that have historically been billed to hospital clients. We believe this is a poor policy change by CMS as it does the opposite of policy shifts of recent years and will result in less accountability for ordering and additional cost to the government.

However, a few smaller labs lobbied for this change and it was enacted even despite concerns expressed by NeoGenomics and the American Clinical Laboratory Association. While difficult to estimate exactly what this impact will be, we expect greater complexity and confusion among clients and difficulty collecting for some newer and innovative molecular tests.

Based on the information we have available today, we estimate the impact of recent changes to the 14-day rule to reduce reimbursement by about $2.5 million to $3 million in 2018 or approximately 1% to 1.25% of clinical revenue.

There are also other potential reimbursement challenges for NeoGenomics and other labs in our industry caused by other proposed Medicare coverage determinations, but these rule determinations are not final, are ambiguous and are potentially harmful to patient care. Cancer patients are among the most vulnerable patients and getting access to key test results quickly is critical to get the right treatments and the best chance in their fight to survive. We are keeping a close watch on these potential coverage limitations and commenting along with many in our industry.

In total, we expect that known reimbursement headwinds will impact approximately 2% to 2.5% of clinical revenue. While reimbursement has been and continues to be a challenge for us and other industry participants, this reimbursement reduction is consistent with our previously disclosed expectations.

Fortunately, only about 15% of our total 2017 revenue was billed to Medicare, as approximately 65% of our bills were sent directly to hospitals under our individual contracts with them. Contracting directly with hospitals is a more preferable solution and situation for us. Our hospital clients deal directly with the cancer patients, they clearly see the value in the testing we provide for them and they pay for what they order.

I will conclude my prepared remarks by sharing with you our plans and expectations for 2018 As a purpose driven and values based company, one of our critical success factors, is to continue building a world-class culture. In 2018, we are focusing on significant initiatives to further develop the careers of our teammates and to create even better teamwork and rewards for high performance.

We are also focusing even more of our attention this year on providing uncompromising quality to our clients. Our initiatives here will require leadership and training for all employees. As we believe that high quality leads to lower cost, our process focus on automation initiatives are intended to lower cost for test by at least 5% to 7% and to once again raise the bar on productivity.

Our third area of focus in 2018 is about growth. We intend to engage clients in a process to further set ourselves apart from our competitors with exceptionally high levels of client satisfaction. We are also focusing on reimbursement and legislative initiatives to deliver profitable growth. We expect to invest $4 million to $5 million in a variety of mid to long-term growth initiatives.

Our plans for 2018 are expected to generate growth rates for both the clinical and pharma divisions that are consistent with our long-term financial goals of mid-teens volume growth for our clinical business, 20% volume growth in our pharma business - a 20% revenue growth in our pharma business, and with 25% to 35% incremental EBITDA contribution on our company wide revenue growth.

Clearly the demand for complex oncology testing in this exciting area of precision medicine continues to increase. As the market-leading, full-service oncology-focused laboratory we are uniquely positioned to meet that demand and we are aggressively pursuing our growth opportunities. We remain confident in our ability to grow and to build an even more exciting business.

I’ll now turn the floor to Steve Jones to review fourth quarter results in more detail and then Bill Bonello will review our 2018 guidance.

S
Steve Jones
Executive Vice President

Thanks Doug.

Fourth quarter consolidated revenues were $67.8 million, a 12.1% increase from last year. After adjusting for the sale of PathLogic, total revenue grew by 15% year-over-year. Clinical genetic testing revenue increased 9.8% and Pharma Services revenue increased 69.2%. Average revenue per clinical genetic test was $338, a 7.6% reduction from the prior year.

Consolidated gross profit increased by $5.9 million or 21.6% from the prior year. This increase represents more than 80% of the incremental $7.3 million of revenue growth from the prior year. Gross margin improved by 380 basis points from the prior year to 48.9%, the highest level since the second quarter of 2014. This improvement was driven by a 10.9% decrease in clinical cost per test as well as a 750 basis point increase in our Pharma Services gross margin from the prior year.

As mentioned in the press release, consolidated SG&A expenses decreased by $1.5 million or 5% from last year, because 2016’s fourth quarter included a $3.5 million non-cash impairment charge to write-off certain intangible assets. Excluding the effects of this 2016 impairment charge, SG&A expenses increased by $1.9 million or 7.2%, which was driven by a $2 million increase in bad debt versus the prior year.

Total bad debt in quarter four was $5.6 million, but for those of you who look at such things closely, I am pleased to report that write-offs in quarter four were only $2.9 million. Thus, we were able to increase our allowance as a percentage of gross receivables up to 18.5%.

On a full year basis, bad debt expense increased by $6.8 million to $18.6 million. For context, we estimate that approximately half of this increase was the result of the Clarient integration and that the overall level of bad debt will decrease in 2018. Adjusted EBITDA was to $10.5 million, an increase of $2.4 million or 28.9% compared to 2016’s fourth quarter. This increase in adjusted EBITDA represented 32.2% of the incremental $7.3 million of revenue growth from the prior year.

Fourth quarter GAAP net income available to common shareholders was $2.3 million compared to a net loss of $14.2 million in the fourth quarter of 2016, and diluted income per share was $0.03 versus a loss per share of $0.18 in the prior year.

However, as mentioned in the press release, quarter four 2017, net income includes a $3.1 million tax benefit in connection with the Tax Cuts and Jobs Act, and quarter four 2016 net income includes a $3.5 million impairment charge and a $3.9 million charge associated with the refinancing of our bank debt. We believe that in order to compare the net income related to the true operations of the company on a more consistent basis across periods, it is appropriate to adjust across periods.

It is appropriate to adjust GAAP net income or loss available to common shareholders, to exclude certain non-cash items, and if applicable, one-time costs. We refer to this measure as adjusted net income, and on a per share basis, adjusted diluted earnings per share. And we have included a table with how those are calculated in our earnings release.

In the fourth quarter, adjusted net income was $4.4 million, compared to $4.4 million reported in the prior year. And adjusted diluted EPS was $0.05 per share, unchanged from the $0.05 per share reported in the quarter four 2016. We finished the fourth quarter with 1,009 full-time equivalent employees, contract doctors and temps versus 977 as of September 30, 2017, and 969 as of December 31, 2016.

The majority of these increases were additions to laboratory personnel to deal with increased testing volumes. As many of you know, I’ve had an operating role at Neo since 2002, and that 14 months ago, I began a process to transition my day-to-day duties to other team members.

Over the next six to eight weeks, I will be handing off my duties as Director of Investor Relations to Bill Bonello, our Vice President and Director of Corporate Development, who will take over this role in April. After that time, I’ll remain as a part-time consultant and board member.

I would like to take this opportunity to thank each and every one of our Neo employees and clients for their outstanding dedication and support in building one of the premier cancer testing labs in the United States.

I feel incredibly blessed to have been part of the team that grew the company from $90,000 in revenue in our first year to over $258 million in just 15 years. It has also been a high honor to work with investors and analysts over this period. I know I speak for all our employees and board members when I say that we are deeply appreciative of your confidence and support of our vision.

Indeed, we couldn’t have done it without you. Since Bill will be taking over this role shortly, we felt it was appropriate to have him present the 2018 guidance and answer any questions that may arise.

And thus I will now turn the floor over to Bill.

B
Bill Bonello
Treasurer and Director, Corporate Development

Thanks Steve.

Let me briefly review the 2018 guidance we issued this morning. For 2018, we expect revenue to be in the range of $260 million to $272 million. This guidance reflects the adoption of ASC 606. Under this new accounting standard, all bad debt expense will be accounted for as a reduction to revenue where it was previously reported separately as expense in the general and administrative section of our income statement. As a result, we expect the adoption of ASC 606 to reduce reported revenue by $15 million to $16 million in 2018.

Now, that the issues related to the Clarient billing integration are behind us, this level of expected bad debt represents a 16% to 17% decrease from 2017 levels. Our 2018 revenue guidance equates to 10% to 15% growth over 2017 on a pro forma basis, assuming adoption of ASC 606 effective January 1, 2017 and excluding the contribution of PathLogic for all of 2017.

For 2018, we expect adjusted EBITDA to be in the range of $39 million to $43 million, which equates to year-over-year growth of 13% to 24%, excluding the 2017 EBITDA deficits from PathLogic.

Importantly, the adoption of ASC 606 will not have a material impact on adjusted EBITDA We would remind everybody that revenue in our Pharma Services division can vary considerably from quarter-to-quarter.

We do expect that Pharma Services revenue and gross margin will be lower in Q1 than in Q4, but still up on a year-over-year basis. Our press release this morning includes a more comprehensive summary of our 2018 guidance, including EPS and adjusted EPS ranges and a reconciliation of non-GAAP measures to GAAP.

I will now hand get back to Steve to lead us through Q&A.

S
Steve Jones
Executive Vice President

At this point, we would like to open it up for questions. Incidentally, if you are listening to this conference call via webcast-only and would like to submit a question, please feel free to email us at sjones@neogenomics.com during the Q&A session, and we will address your questions at the end if the subject matter hasn’t already been addressed by our call-in listeners. As mentioned, at the beginning of this call, we would like to ask each person to limit their questions to two, so that we may hear from everyone and still keep within the hour allotted for this call.

Operator, you may now open up the call for questions.

Operator

[Operator Instructions] Our first question comes from the line of Drew Jones with Stephens, Inc. Please proceed with your question.

J
James Rutherford
Stephens, Inc.

This is James Rutherford in for Drew. Thanks for taking the questions. The first one is kind of a model related question, just what is the interest rate assumption that you’re using for your 2018 EPS guide. And you know can you give us some commentary on your interest rate risk and exposure there in a rising rate environment?

D
Doug VanOort
Chairman and CEO

For the fourth quarter, our interest expense averaged out to about 4.75%, again that’s taking the interest you see on the income statement and subtracting, there was amortization of debt costs. $50 million of our region’s debt is actually fixed through a hedge instrument and all of our capital leases are hedged as well. So, we don’t expect that 4.7%, 5% number to move up very much in 2018.

J
James Rutherford
Stephens, Inc.

And then just - thanks for the extra detail on the clinical volume growth, excluding PD-L1, that’s very helpful. Just digging into the 2018 guidance, what are you expecting for that non- PD-L1 volume growth, and then what are you assuming for PD-L1? I’m assuming pricing deceleration given the comp, but what are you thinking there?

D
Doug VanOort
Chairman and CEO

We would expect James our 2018 volume growth to be consistent with our long-term guidance for mid-teens volume growth in our clinical division. We haven’t historically broken out PD-L1 from other testing. We did so this quarter just to give you confidence that we are having balanced growth across all of our divisions, but we are probably not going to continue to do that in the future and not going to get into that level of specificity in terms of our guidance.

Operator

Our next question comes from the line of Kevin Ellich with Craig-Hallum. Please proceed with your question.

K
Kevin Ellich
Craig-Hallum

And Steve, congratulations and best of luck in the future. It’s been great working with you. I guess starting off, could we talk a little bit about bad debt, I appreciate the comments you made in your prepared remarks, it’s good to know that half of it came from the Clarient integration, and you expect that that to improve in 2018. Can you give us a little bit more color as to how much improvement we should expect and I guess will we get back to normalized levels pre-Clarient in 2018?

D
Doug VanOort
Chairman and CEO

Well, I’ll take the first thing, and you can talk about the next. So if you look at the full year bad debt we had in 2017 was $18.6 million. And if you just take the delta between the pre ASC 606 guidance and the post ASC 606 guidance, you’ll see its $15 million to $16 million range, which the mid-point of that would be $15.5 million.

So, the reduction in bad debt is estimated to be somewhere on the order of $3 million in 2018 on a moving forward basis.

K
Kevin Ellich
Craig-Hallum

And then I guess reimbursement, you know Doug you went through all of the moving pieces first as PAMA, physician fee scheduled 14-day rule. Do your assumptions in the 2018 guidance include any impact from changes to Nextgen sequencing reimbursement, was that included as well?

D
Doug VanOort
Chairman and CEO

Yes, all the known changes are included, there are like a - there are a few things that are yet unknown. I mentioned one of those Kevin is this so-called national coverage determination for certain next generation sequencing tests. That rule is not finalized as you know, but all of the other rules that I described are known challenges for us, and we have tried to quantify those for you.

Operator

Our next question comes from the line of Nick Jansen with Raymond James. Please proceed with your question.

N
Nick Jansen
Raymond James

In terms of just the non-PD-L1 growth, I know you’ve mentioned you’re not going to be providing that level of detail every quarter. But still if I get a sense of how that progressed throughout ‘17, is it safe to assume that the sales force going back on offense really help accelerate that through the year and that gives you the confidence as we think about the mid-teens projection for 2018?

D
Doug VanOort
Chairman and CEO

That’s exactly right, Nick. I think we tried to tell you during the year that at the beginning of 2017, our sales team was really involved in retaining clients as we were going through that that very difficult integration time.

And as that integration was completed at the end of quarter one, as our labs were put together, the sales team got back into selling mode and you’ll see - we have seen the result of that each quarter as we have gone through the year, and quarter four was by far the best quarter of volume growth excluding PD-L1 as they get back to selling our core testing disciplines. So that growth did accelerate excluding PD-L1 each quarter but it really jumped up nicely in quarter four.

N
Nick Jansen
Raymond James

And then a thing about Pharma Services. Certainly, the backlog numbers are encouraging. The revenue growth in ‘17 also been ahead of expectations. How do we think about the intermediate term trajectory there, the level of investment necessary? The European opportunity opening in terms of the lab in 4Q. Maybe just take a step back and think about that business today, roughly $27 million of revenue and where that ultimately could go as you think about the synergies associated with your existing clinical testing business?

D
Doug VanOort
Chairman and CEO

We like that business very much and we are investing in it. You’re right, it was about a $27 million revenue business for us in 2017 and we expect that to grow, you’ve seen the increases in backlog. We are investing in capacity in this business.

So we as you know started the laboratory facility in November of 2017 and that’s - and investment in 2018 as well, because we don’t have a lot of projects yet going into that lab, but the prospects for projects there is very, very strong. But that’ll happen as the year progresses. We are also investing in our Houston facility and that would be a net expense investment for us in the beginning of 2018.

We are also investing in people, we are investing in instrumentation in that business. We have got a lot of growth opportunities. The growth that we have had has come from our proprietary technology in MultiOmyx, which is terrific really for pharmaceutical companies who are investing in immuno-oncology drugs.

We also had growth in molecular and in immunohistochemistry, but we have opportunities in other disciplines as well. So we are very bullish on the pharma business long-term.

N
Nick Jansen
Raymond James

And if I could squeeze a third one, and just in terms of your M&A appetite, now that you’re 2 years post-Clarient. Do you feel like you’re now on a solid standing where tuck-in transactions could be a bigger role in ‘18 and ‘19?

D
Doug VanOort
Chairman and CEO

Yes. We are interested in M&A.

Operator

Our next question comes from the line of Paul Knight with Janney Montgomery Scott. Please proceed with your question.

P
Paul Knight
Janney Montgomery Scott

Do you have any obligations in the foreseeable future on the GE pick products?

D
Doug VanOort
Chairman and CEO

Thanks for the question, Paul. Steve, you want to deal with it?

S
Steve Jones
Executive Vice President

So, Paul, as you know, the GE preferred, is actually not convertible on their opt - at their option until 2019, so we have another year where we have basically the option to redeem it at our choosing.

Now having said all that, GE is on our board and we are very respectful of what GE’s wishes are and we are in dialogues from time to time with GE about what their wishes are and we don’t have any definitive plans on anything just yet. But when and if we do it, it’s not a foregone conclusion that we would do anything other than incremental debt or internal cash flow.

So we don’t really have an obligation to redeem it this year, but we will be respectful of GE’s desires if it comes up to be that way. And at the end of the day, we still have a 4.5% discount, if we take it out this year, so there are some incentives this year that go down little bit further next year.

P
Paul Knight
Janney Montgomery Scott

And then I notice your basic share count has obviously risen with the share price increase. What’s your assumption on 2018 guidance for share count?

S
Steve Jones
Executive Vice President

The share count rose in Q4 because we were profitable, effectively, again, if we are in a loss position, you don’t add in the preferred shares and the other shares. When you flip to a profit position, which obviously was largely driven by the Tax Cut and Jobs Act, you do have to bring those shares into your share count calculation.

D
Doug VanOort
Chairman and CEO

And I would think something for your diluted adjusted EPS number, I look to something around the $91 million mark or so.

P
Paul Knight
Janney Montgomery Scott

And then lastly regarding competition in the market, the solid tumor tests we hear out at FMI. What do you see as real risk out there to you guys? Is it FMI, who is it and what is it?

D
Doug VanOort
Chairman and CEO

Well as you know this is a very competitive industry and we have a lot of very strong competitors and we have had for quite some time. The big players, the big labs are very strong competitors. FMI has a strong competitor in the molecular area and there are others as well. And I would say traditionally we have competed pretty well with all those players. We are interested in exploring potentially some FDA type investments.

In 2018 we have included those in our expense guidance numbers that we provided to you and we think that there’s a lot of movement by the FDA in terms of their potential oversight of our laboratory developed test and we are keeping close watch on that, but we may invest in some FDA approvals for our own tests.

P
Paul Knight
Janney Montgomery Scott

And then lastly 606 affects the clinical line not the, the diagnostics line not the clinical services line, correct?

D
Doug VanOort
Chairman and CEO

606 affects the clinical division, Paul, it doesn’t really affect the Pharma Services division very much at all on the revenue side. George, do you want to elaborate?

G
George Cardoza
Senior Vice President and CFO

It can affect the timing of some contracts. But we are doing a full retrospective method. So we will have a little bit more of a deferred revenue balance, but that goes back basically to the beginning of time. So if you really look at the net impact in 2017 it would have been very small.

Operator

Our next question comes from the line of Raymond Myers with The Benchmark Company. Please proceed with your question.

R
Raymond Myers
The Benchmark Company

Let me first ask you about the Clarient acquisition, it’s been a bit over two years now since you acquired Clarient. Do we still expect Clarient synergies in 2018 or in the future?

D
Doug VanOort
Chairman and CEO

Yes, Ray, we will expect and embedded in our guidance for 2018 are some synergies as a result of the Clarient acquisition. As you know, we completed the integration of the labs, the merging of the labs in quarter one of 2017.

So there is some carryover impact in 2018 relative to 2017. So that will be synergy comparatively year-to-year. We also continue to have some cost synergies that are resulting from that acquisition in various labs, but I think more, and more importantly though at this point, what the Clarient acquisition is providing us is scale.

So we have a lot of scale, it’s helping us to win new accounts, new hospital accounts, as these hospitals groups are becoming larger and larger. They want to deal with a laboratory that can provide service to all of their member hospitals.

And so there are a lot of benefits of the Clarient acquisition. A lot of the cost synergies are tailing down now. But the scale benefits and other benefits are very much real and with us.

R
Raymond Myers
The Benchmark Company

And let me ask you about unusual issues in the fourth quarter. In the third quarter, we had hurricanes and the QNS testing effect. Is that completely resolved, did that affect the fourth quarter at all or indeed anything else affect the fourth quarter?

D
Doug VanOort
Chairman and CEO

Well, thankfully we had no hurricanes in the fourth quarter, and none are forecast in the next few I guess. But the QNS issue is completely behind us, and we have fully recovered really from that - those quarter three events.

G
George Cardoza
Senior Vice President and CFO

The only unusual item in quarter four was the $3.1 million tax benefit from the new Tax Cuts and Jobs Act. It’s a one-time benefit.

Operator

Our next question comes from the line of Joe Munda with First Analysis. Please proceed with your question.

J
Joe Munda
First Analysis

A couple here, real quick. Steve or George or Bill, you guys talked about payer mix and the 14-day rule, roughly 15%. You had talked about - I think, you had said 15% from Medicare in 2017. Can you give us some sense of what the DSOs look like on that 15% from Medicare? Were they higher than the overall business?

S
Steve Jones
Executive Vice President

Medicare is typically in line with what we see in terms of the overall business and also it’s how we also put reserves aside from things as they age out. So, now our aging formula based on how we calculate the Medicare DSOs, it is comparable with our overall mix.

J
Joe Munda
First Analysis

So I guess, Doug, in response to that, I mean, you talked about confusion amongst customers. I mean, how do you see this playing out? Or how do you plan on preparing for this, when it comes to dealing with customers and guiding them through the reimbursement landscape?

D
Doug VanOort
Chairman and CEO

Dealing with that right now Joe, what we are doing is, educating clients about new requirements, more rigorous requirements about defining whether a patient is an inpatient or an outpatient or a non-patient and trying to make sure that everyone understands what the rules are, so that we can bill appropriately.

So there is some confusion in the marketplace. As a high volume laboratory, these changes in processes are very important that we get right the first time. So when our requisition in order for comes in, if it’s not correctly identified in terms of patient demographics and all of that sort of thing then we have to go through more processes to try to get that build appropriately.

And so that’s causing some confusion for us and for our clients. The impact of the 14-day rule is both process oriented as I just described, but also there will be some reimbursement impact because Medicare frankly does not pay for some innovative molecular tests.

And we have the benefit of billing hospitals directly is that they know what they order, they know what’s important for patient care. And since they order it and they’re accountable for it, they pay for it. And that’s one of the issues that we are dealing with in 2018.

J
Joe Munda
First Analysis

Okay. A couple more if you will?

D
Doug VanOort
Chairman and CEO

No, we got limit it to just one more if you don’t mind.

J
Joe Munda
First Analysis

Sure, no problem. So the backlog, you talked about $18 million. I was just wondering, how much of that is tied to Europe and the new lab that you opened up there?

D
Doug VanOort
Chairman and CEO

Yes. The new contracts…

J
Joe Munda
First Analysis

$18 million in new contracts…

D
Doug VanOort
Chairman and CEO

Just $18 million in new contracts, the backlog is a quite a bit higher. I don’t think we typically disclose the sort of the nature of the new bookings, but clearly some of that $18 million relates to projects in Europe. And we have good - our former clients are reacting very favorably to the added capacity that we have to perform studies across Europe, as well as the U.S.. So, I think the prospects there are a good.

Operator

Our next question comes from the line of Jeff Bernstein with Cowen. Please proceed with your question.

J
Jeff Bernstein
Cowen

Steve, just wanted to say thanks for all the help over time and congratulations and good luck in your future pursuits. Just a real quick one. On the clinical growth, do you have that number sans pathologic, just revenue growth?

D
Doug VanOort
Chairman and CEO

You’re talking about just genetic - clinical genetic testing?

J
Jeff Bernstein
Cowen

Just year-to-year.

G
George Cardoza
Senior Vice President and CFO

Yes. Excluding pathologic, total revenue grew 9.8% on the four quarter.

Operator

Our next question is a follow-up from the line of Kevin Ellich with Craig-Hallum. Please proceed with your question.

K
Kevin Ellich
Craig-Hallum

So I wanted to back to - Doug, you made some comments in your prepared remarks on the - I think it was $45 million of mid to long-term investments. Is that really related to the new lab you’re building in Atlanta, in Houston or you know, can you provide a little bit more color as what you’ll be investing that money into?

D
Doug VanOort
Chairman and CEO

Yes, Kevin. Some of that $4 million to $5 million is investments in facilities. So we have continued investment in Rolle, we have got a continued investment in Houston, we are really expanding the Houston facility which will serve our clinical division. But more importantly, will become one of our key labs for our Pharma Services division, and we are looking forward to that, that’s a fair amount of the $4 to $5 million investment that we spoke of for mid to long term strategy.

The other piece of that is investments in our tests and in one of the big pieces of investments in testing and new testing technologies and tests itself is the FDA initiatives that I spoke of briefly. So in that sense you know we have got a fair amount of work that we need to undertake in terms of processes and systems to make sure that we can meet the FDA you know particular standards and requirements there. So that’s the nature of that $4 to $5 million investment that we spoke of.

K
Kevin Ellich
Craig-Hallum

And then you know average revenue per test was a little bit lower than we were expecting. In the press release you talked about you know some molecular tests being affected, should we the same sort of impact throughout 2018? And then also I guess on top of that you have been able to reduce your cost per test really nicely, how much more runway is there for you guys to keep lowering your cost of services?

D
Doug VanOort
Chairman and CEO

Let me take the cost side and then maybe I’ll ask Bill or Steve to comment on the average unit price. We have been pretty fortunate and been pretty successful in lowering our cost per test historically and I think in 2017, that number was 10% or 11% cost for test reduction.

In 2018, we are targeting in the 5% to 7% range as some of the synergies that we were able to realize from Clarient are now behind us and we are operating on more of a normalized kind of cost reduction approach.

Now those reductions in 2018, we believe will come from automation initiatives, and really technology investments as we continue to explore new ways to perform the next generation sequencing or digital pathology or other kinds of testing technologies. And we think that 5% to 7% is doable and we think we have got runway to continue to reduce cost per test into the future as well. Bill?

B
Bill Bonello
Treasurer and Director, Corporate Development

Kevin, baked into our guidance is some assumption of a little bit more pressure on the revenue per test. We would think to be in a range of 300 to 310 after the adoption of ASC 606 which equates to approximately $320 to $330 per test prior to the adoption of ASC 606.

Remember as Doug walked through there isn’t a - be it modest, but there is an impact from the implementation of PAMA which took effect on January 1. There is an impact from the physician lab fee schedules which took effect on January 1, and then some of the other issues we have tried to kind of encompass a broad range of potential outcomes here to be responsible with our guidance.

Operator

Our next question is a follow-up question from the line of Drew Jones with Stephens, Inc. Please proceed with your question.

J
James Rutherford
Stephens, Inc.

This is James again in for Drew. You spoke about signing those - some more of those preferred relationships with the national healthcare organizations. Can you just remind us what the nature of those deals is and just perhaps help us understand how important those are to your growth going forward?

D
Doug VanOort
Chairman and CEO

There are a number of national type plans that we engage in, some of those are hospital plans where we’ll sign agreements with large hospital systems or purchasing organizations. Some of those are managed care plans that are national plans. And I would say that in both cases, those are very important to our growth.

They allow us to be sort of in network or to establish fee schedules where our people can walk into a hospital, for example and say, we have already been through the process with the group purchasing organization or the hospital system and here is the fee schedule and you know us because we have - we provide very good service and we have essentially been vetted already with these - with the corporate level people.

And I think it helps as well to have managed care penetration in various geographies, so that we are able to bill insurance companies when it’s appropriate. So these are very important to us. I mentioned that we continue continued to sign quite a few of these agreements in 2017, and we have a terrific team and we are looking to continue to sign more in 2018.

Operator

Our next question comes from the line of Brett Johnson with First Light Asset Management. Proceed with your question.

M
Mathew Arens
First Light Asset Management

This is Matt in for Brett. Just a comment and I’ll drop off the line here. I want to echo some of the previous comments. Steve, I know you’ll continue to be involved with the company going forward, but as you sunset your operating position, I just wanted to comment that for those of us who’ve been around the story for many years we know that Neo wouldn’t be the special company that it is if not for your many contributions. So, I just wanted to thank you for that and wish you all the best going forward.

S
Steve Jones
Executive Vice President

Thank you very much Matt, that’s very kind of you.

Operator

There are no further questions in the queue. I’d like to hand the call back to management for closing comments.

D
Doug VanOort
Chairman and CEO

Thank you. And I’d like to take you back a little bit on Matt’s comment. Before we end the call, I do want to recognize Steve for his really great work and dedication to our company over the past 15 years. Steve really did start with NeoGenomics when the company was just about nothing, it had very little revenue, and Steve has been a trusted colleague for me for these past nine years and we are very fortunate that Steve is going to continue to help us as a consultant and certainly as a board member. So, we are not letting him go too far.

I also want to recognize the approximately 1,000 NeoGenomics team members around the country for their dedication and commitment to building a world class cancer genetics testing company. On behalf of our entire NeoGenomics team, I want to thank you for your time joining us this morning and let you know that our first quarter 2018 earnings call will be held on or around May 1, 2018, which will be our first quarter under the new ASC 606 accounting rules.

For those of you listening that are investors or are considering an investment in NeoGenomics, we thank you for your interest in our company. Goodbye.

Operator

Ladies and gentlemen, this does conclude today’s teleconference. Thank you for your participation. You may disconnect your lines at this time. And have a wonderful day.