Neogenomics Inc (NEO) 2014 Q2 法說會逐字稿

Greetings and welcome to the NeoGenomics second-quarter 2014 financial results conference call. (Operator Instructions). As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Doug VanOort, Chairman and CEO of NeoGenomics. Thank you, Mr. VanOort. You may begin.

Thank you, Danny, and good morning. I would like to welcome everyone to NeoGenomics' second-quarter 2014 conference call and introduce you to the NeoGenomics team that is here with us today.

Joining me in our Fort Myers headquarters, we have Steve Jones, our Executive Vice President for Finance; George Cardoza, our Chief Financial Officer; Steve Ross, our Chief Information Officer; and Jerry Dvonch, our Director of External Reporting. Dr. Maher Albitar, our Chief Medical Officer and Director of R&D, is joining us from our Irvine, California, lab.

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

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 fact 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 uncertainties 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.

Okay, thanks, Steve. We will begin our call today with some brief remarks about performance in the second quarter of 2014 and then provide an update of some key initiatives, including our recently announced acquisition of Path Logic. Steve will then discuss our financial results in more detail.

We were very pleased with NeoGenomics' performance in the second quarter of 2014. Test volume growth was 40%, revenue growth was 32%, gross margin improved by 360 basis points, cash flow from operations was a record $4.3 million, and a number of important growth initiatives were readied for launch. In addition, just after the end of the quarter we completed our first acquisition.

Our teams are committed and working hard to position NeoGenomics as one of our industry's premier cancer testing laboratories.

Steve will describe the financials in more detail in a few minutes, but I would like to provide some context for you. The 40% volume growth compared with last year's second quarter actually exceeded our own expectations. The growth was broad based and was nearly equally split between each of the three sales regions across our country. Also noteworthy is that nearly one-third of the growth versus last year came from new clients that started with us in the first half of 2014. We are really proud of our sales team for that strong performance.

We believe the cancer testing market is growing, but that our growth primarily reflects market-share gains in the hospital and pathology markets as a result of our comprehensive cancer testing menu and particularly because of our innovative molecular testing product line. In fact, molecular testing volume increased by 61% compared with last year and now represents our second-largest testing department.

Clearly, innovation continues to be an important factor driving our performance.

Volume growth also reflects our commitment to deliver consistently strong service levels, so while customer acquisition rates were strong, customer retention rates also continued to be very high.

Revenue growth was 32%, despite an approximately $1 million reduction in revenue recorded as the result of the National Correct Coding Initiative, or NCCI, matter relating to the billing for Medicare FISH tests. The governmental agency responsible for clarifying this rule, CMS, has still not provided any guidance, and so we recorded revenue based on what we believe to be the most conservative interpretation of this rule.

Had we used a different interpretation, revenue growth would have been reported as 39% compared with last year.

Despite a 5% reduction in average price per test, all from the NCCI matter, we were pleased that incremental gross profit was strong. Gross margins were up to 49.5%, an increase of 360 basis points from the second quarter of last year. Cost per test declined by about 12% compared with last year's second quarter, and productivity metrics improved once again, as the number of tests processed per lab employee increased by over 10% in the second quarter compared with last year. In fact, cost of goods sold per test hit a record low in the quarter.

We are extremely proud of our operating teams for that performance. Indeed, it is a testament to the commitment to excellence that all of our employees display on a daily basis.

Selling, general, and administrative costs increased significantly, as they grew by 45% compared with last year. This is a far greater increase in spending than we are typically comfortable with. However, we believe that about half of the increase in spending in SG&A relates directly to specific growth or cost reduction initiatives. For example, on the growth side, we increased sales and marketing expense by 60% compared with last year as we expanded our sales team and invested in better sales and marketing infrastructure to drive growth on a sustainable basis.

We also invested to build an infrastructure and capability for clinical trials, develop our next-generation sequencing platform, develop and launch our next generation of digital pathology products, and develop our new proprietary prostate cancer test. We also invested to position ourselves for future cost reductions with additional spending for information technology for lab automation and other activities. So, while the SG&A cost increase was high, we believe the payback on these investments will be very strong.

Profit was $274,000, or $0.01 a share. Incremental profit versus the prior year was obviously impacted by the $1 million reduction caused by the unresolved NCCI matter and by investments in growth initiatives that we believe will bear fruit in coming quarters. Given the sizable investments we made and expensed, we are very pleased with the level of profit we recognized in the quarter.

During the quarter, we fully completed a comprehensive renovation of our Fort Myers lab and it looks great. Our new old lab now provides us with both increased capacity and a more efficient and cost-effective workflow.

In order to accommodate our rapid growth, we also opened a small lab in Fresno, California, as we have increased our cytogenetic technologist team. In addition, we are currently expanding our large Irvine lab facility to allow for continued growth in molecular test volume.

In previous investor calls, I described our key areas of focus. We continue to make good progress achieving our objectives, and this morning I will briefly review a few of these, as well as comment on our recent acquisition.

As you know, one of our key areas of focus for 2014 is to get lean. We continue to make -- we are pleased that as a result of a variety of initiatives, we drove our cost of goods sold per test down by 12% in this past quarter.

However, frankly, we were a little disappointed that we were unable to implement several cost-reduction initiatives that we had planned to execute during the second quarter. These were delayed for several reasons, one of which was that we had to keep up with the record volumes while maintaining our high service levels.

The good news is that we have a number of process improvements that haven't yet been implemented. We're looking forward to executing them now in the third quarter, particularly in our FISH and molecular departments, and we expect to realize gains from these activities as the year progresses. We also expect to continue to drive additional volume of testing through our labs and to realize the economies of scale that will result from this and from continued workflow improvements.

Our goal is to reduce our cost of goods sold per test by 8% to 10% for the full year 2014 and 2015, and we continue to believe that we will be successful in reaching this goal.

Growth is another key focus area for our Company. We were obviously pleased with the volume growth of 40% in Quarter 2 and especially pleased that no one client or group accounted for the bulk of that growth, as it was widespread. We don't want to promise that we can continue to sustain that rate of growth forever, but we do believe that our targeted 20%-plus growth rate is quite achievable through 2015.

Our sales team has continued to perform very well and their productivity is strong. On average during the second quarter, we had 27 sales professionals in the field and we added training, managed care, and product management resources as a way to help sustain the high rates of productivity.

New products continued to be an important driver for growth. So far this year, we have added 30 new molecular and FISH-based tests to our already comprehensive testing menu. Just last week, we announced a significant expansion of our product line with 23 new and different cancer profiles, based on next-generation sequencing. These eight hematologic profiles and 15 solid tumor profiles are very compelling. The profiles contain both molecular tests, as well as FISH tests, when appropriate.

As many of you know, molecular testing and cancer therapeutics are evolving quickly and it is difficult for many physicians to keep current with the literature. Our profiles, which we've branded as NeoTYPE profiles, are an up-to-date panel of tests targeted to specific diseases. These profiles include those driver genes our medical team considers to provide actionable information to clinicians.

We believe this approach is also the most cost-effective approach for our healthcare system. Of course, our molecular tests can also be ordered individually.

We believe that our innovative product suite will have important benefits for physicians and their patients, including better information about potential response to currently approved drugs and investigational therapies and the ability to test using smaller amounts of tissue or fluids. Importantly, we believe use of this technology will also allow us to become more efficient as our volume of testing increases.

We just launched this new line of next-generation sequencing services and it is too early to forecast the demand. However, we think this is an important and growing area of oncology testing and we intend to be a leader in this area.

Importantly, we have also invested significantly in digital pathology and immunohistochemistry and plan to launch a substantially improved digital pathology service in the next several weeks. This product is important as we continue to round out our service offering to be a one-stop shop for our pathology and hospital clients around the country. It also helps us in the important clinical trials area, as we can read and interpret results from around the world in any of our locations.

Diversifying our business is also an important area of focus as we balance our risk profile and take advantage of new opportunities, and building a clinical trials business is one of our important initiatives in this regard.

As part of our exclusive strategic alliance with Covance's Central Laboratory, we are jointly bidding on a number of requests for proposal and are building our book of business. Although we realized only a small amount of revenue from clinical trials this past quarter, we expect that to ramp up smartly over the coming quarters. We continue to be on track to expand our capabilities to jointly provide anatomic pathology, histology, and specialty lab testing services on a worldwide basis as we help install capabilities later this year at Covance locations in Shanghai, China, and Geneva, Switzerland.

We are also engaging directly with several pharmaceutical firms, particularly in the area of molecular testing, based on our next-generation sequencing testing platform. These relationships take time to develop, but we feel like we're making good progress in this area as well.

Innovation offers us a number of interesting diversification opportunities. One of the more exciting of these opportunities is our development of a proprietary prostate cancer test. As you may remember, this is a molecular test performed on blood plasma and urine, instead of prostate tissue biopsies.

The two goals for this test are to distinguish the presence of cancer versus BPH in patients and to distinguish high-grade from low-grade cancer in those patients with prostate cancer. We believe our test can help make this determination without the patient having to undergo a painful and invasive biopsy procedure.

We have decided to rebrand this test as NEOLAB Prostate. LAB is an acronym for liquid alternative to biopsy.

We made good progress during this past quarter as we held two advisory board meetings, published an abstract based on data from 319 patients, and formed a team of academic advisors to consult with us on furthering the test development.

We have now made the test available for ordering with the condition that the ordering physician must provide clinical utilization and follow-up data to us as part of the testing process. We are targeting to test another 600 to 800 patients in this manner and add another 200 patients as part of a trial underway in Europe.

Overall, this new NEOLAB Prostate cancer test continues to be the most promising proprietary test development initiative we have underway.

Yet another growth and diversification initiative is now being implemented with the acquisition of Path Logic. This was the first acquisition for NeoGenomics, and we're excited about it. As you read in our press release a couple of weeks ago, Path Logic has a strong reputation for specialized anatomic pathology services and is a great complement to NeoGenomics' specialized cancer genetic testing.

Path Logic has many tests that are complementary to NeoGenomics and NeoGenomics has many tests that are complementary to Path Logic. We plan to offer Path Logic tests to NeoGenomics' existing client base and to offer NeoGenomics tests to Path Logic's existing client base. We are particularly excited about offering our world-class molecular menu and industry-leading FISH and cytogenetics services to Path Logic's existing client base.

The team of pathologists at Path Logic is excellent. And we're excited about combining the skills of our medical teams for the benefit of existing clients, as well as for our emerging clinical trials initiatives.

While this is the first acquisition that NeoGenomics has executed, I personally have quite a bit of experience acquiring and integrating laboratories, having completed many acquisitions over the past 30 years. I have learned firsthand what works and what doesn't work in integrations, and we plan to integrate this business with deliberacy and thoughtfulness.

We are keeping the main Path Logic laboratory in West Sacramento, California, open and hope to retain all of the talented employees working in that facility. We believe that lab is significantly under capacity and can handle more volumes at relatively low levels of increased cost. While there will be some cost-related synergies, we believe the main upside is the cross-selling and revenue opportunity and the opportunity to fill up the West Sacramento laboratory.

Path Logic is currently operating at a small monthly loss as the result of being underutilized, but we are committed to making this business profitable by early 2015. This acquisition was not very large and was both opportunistic and strategic. We're genuinely excited about the opportunities this new capability offers to our employees, clients, and shareholders.

Before I conclude my remarks, I want to comment about the NCCI FISH edit matter. We had hoped for some clarification so that we could provide you with an update on this NCCI FISH edit matter. As background, the National Correct Coding Initiative, a department within CMS, issued a new guideline in December of 2013 concerning FISH reimbursement that has created significant confusion in the laboratory industry.

We tried very hard to explain the issue to CMS, and on March 5, the ACLA and the industry received assurance from CMS that a clarification would be provided shortly. After repeated follow-up, unfortunately, as of today, over four months later, we're still waiting.

The impact of this confusing rule is significant. Had we billed and accounted for FISH testing as before, we would have realized an additional $1.05 million in revenue and an additional $870,000 in net profit in Quarter 2. But because the rule is confusing and contradictory, we have chosen to bill and account on a conservative basis. We believe this is the right thing to do, given the situation. We hope there is clarification soon and we will issue an update as soon as CMS provides clarification to the industry.

In summary, we are very pleased with the Company's performance in Quarter 2 and we are equally excited about the opportunities that lie ahead for NeoGenomics. In fact, our team has never been so excited about the possibilities. NeoGenomics is growing and gaining market share. We are getting leaner through good process management and control and we are developing new products and businesses for the future.

This is an exciting time for precision medicine in general and for the benefits for cancer patients and for our healthcare system, and an even more exciting time for us at NeoGenomics as we continue to carve out a reputation for leadership in our field.

I will now turn it over to Steve to comment more fully on our financial results.

Thanks, Doug. I will start by reviewing some of our financial and operating metrics for the second quarter, and then we want to open it up for questions.

Second-quarter revenue was $20.7 million, a 32% increase from Q2 last year. Test volume increased by 40% and average revenue per test declined by 5.3% to $455. The NCCI FISH matter reduced average revenue per test by $32, but other mix changes increased it by $7. Thus, we only netted a $25 reduction for the quarter.

For those of you that follow these things closely, we believe the NCCI FISH edits are now pretty well fully baked into our average unit price, and absent any further changes to our test mix or a reversal of the NCCI FISH edits, and excluding the impact of the Path Logic acquisition, we expect the average revenue per test to settle in around $450 for the balance of the year.

Gross profit was $10.2 million, a 43% increase over Q2 last year. As Doug discussed, we improved our average cost of goods sold per test by 11.7% versus last year by increasing lab productivity, realizing leverage from higher volumes, and from a variety of cost-reduction initiatives. This more than offset the 5.3% reduction in average revenue per test, which in turn allowed us to expand our gross margin to 49.5% in the quarter.

We drove 60%, or $3.1 million, of the incremental $5.1 million of revenue on a year-over-year basis to the gross profit line.

Turning now to SG&A, total sales and marketing expenses increased by $1.2 million, or 60%, versus last year as a result of investments in more sales and marketing personnel and the incremental commissions on the strong increase in revenue. General and administrative and R&D expenses increased by $1.8 million, or 39%, versus last year, primarily as a result of more personnel and personnel-related costs for billing and information technology, increased depreciation, and additional bad debt reserves on the incremental revenue.

Net income for the quarter was $274,000, or $0.01 a share, and adjusted EBITDA was $2.1 million, up 16% from last year.

We finished the second quarter with 364 full-time equivalent employees and contract doctors. The Path Logic acquisition added an additional 65 employees in early July, thus we now have approximately 430 employees.

Our accounts receivable balance, net of allowance for doubtful accounts, was $18.8 million at June 30, which is $500,000 less than where it was at March 31. If you are scratching your head right now, that's because this is definitely unusual, given our growth. We grew revenue by $2.5 million, or 14%, sequentially from Q1 and still managed to collect more than we have booked in revenue. This is truly an awesome accomplishment by our billing department and we're deeply thankful for having such an extraordinary team of dedicated professionals.

As a result, our AR balance expressed in terms of days sales outstanding was 83 days as of June 30, down from 95 days at March 31 and from 103 days earlier in the year. This superior level of collections allowed us to generate $4.3 million of cash flow from operations in just one quarter, which is almost double our previous record in a quarter.

This, in turn, allowed us to fund around half of the recent Path Logic acquisition with cash generated in the quarter.

We had $5 million of cash on June 30 and $8 million of availability under our working capital line of credit, for a total liquidity of $13 million at June 30 versus $10.5 million at March 31. We used $5.9 million of this liquidity on July 8 to fund the Path Logic acquisition.

We purchased $2.7 million of property, plant, and equipment in the quarter; however, we were able to lease finance approximately $1.6 million, or 60%, of this amount, thus the net use of cash from investing activities was only $1.1 million. Now that the Fort Myers laboratory's renovation is completed, we expect CapEx to return to more normal levels.

At this point, I'd like to close down our formal remarks and open it up for questions. Incidentally, if you are listening to this conference 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.

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

(Operator Instructions). Amanda Murphy, William Blair.

Just a quick question on FISH. Thanks for all the info on the NCCI edits. That was helpful. Obviously, there has been some positive proposals around FISH for next year, so I am just curious. I know they were reviewing that code. Do we know where we stand with that? Is that something that they punted to next year at this point or are we basically -- once we get through this year, do we have pretty decent visibility then going forward into what the FISH rates might be?

That's a great question. Thanks, Amanda. There was a 609-page proposed rule that came out of CMS on July 3 that we've studied in a fair amount of detail and there's a lot to like in the rule, except for one or two items of concern.

If the proposed changes to the practice expense relative value units remain in the actual final rule that will get published later this fall that are in the proposed rule, then it would suggest about a 30% increase per billing unit for the technical component FISH testing performs for Medicare beneficiaries and, similarly, about a 5% increase in the technical component of flow cytometry testing for Medicare beneficiaries.

They also stated they were not going to try to impose a cap on any of the rates in the physician fee schedule or the rates in the ambulatory payment classification schedule that is in place for hospitals, which was the subject of the proposed rule last year.

So net net, we feel very good about the proposed rule that has come out of Medicare. It is impossible to say that it will go through exactly as drafted in the final rule, but generally speaking, a lot of thought goes into Medicare rule makings and they generally do try to get it right. And so, we feel like we got the wind at our back on this one, but until we see the final rule, we won't know for sure.

Got it, okay. And then in terms of the guidance, I am just curious how you are thinking about the puts and takes on the revenue line. Obviously, you've got Covance, which is ramping up potentially, and then some new next-gen panels that are out. Just curious how you are thinking about those versus the base business within the revenue guidance.

We don't like to break out our guidance by product line because these things generally tend to -- the egg gets a little scrambled as you move forward.

We do believe we're going to see meaningful increases in CRO revenue as the year progresses as a result of some of these contracts we have previously awarded -- been awarded start to ramp up. But we're really just not at a place where we are ready to comment on that specifically.

The next-gen sequencing test is a week old now and we need to get some more traction in the industry. We have stated publicly on a number of occasions that molecular is our fastest-growing component of our revenue stream, and indeed the molecular panels are growing faster than molecular as a whole.

And so, we feel like we're really positioned extraordinarily well with the next-gen sequencing panels we rolled out. They are -- based on the feedback we have gotten and compliance, they are exactly what clients were looking for, and so we're pretty excited about it, but I think we want to demure for another quarter before we talk specifically about what's possible there.

Got it. Just last one on Path Logic. Obviously, that's a little bit of a different business than you have historically been in, so how do you think about longer-term revenue synergies and competing in hands-on pathology vis-a-vis [somatic] pathology?

We feel very good about it, Amanda.

As you know, Path Logic's primary business is located in northern California. We do not have -- did not have a lot of clients in that area, so we are looking forward to growing in that area.

What we're also looking forward to, frankly, is leveraging Path Logic's product line for the benefit of our clients. They have some terrific specialized pathology services that many of our clients do not offer, and we believe that they would like to utilize those services. They also offer a number of other products that our clients have been asking for.

So we believe there is some nice revenue synergy on that side, and as we said in our remarks, offering our molecular and FISH-based test to existing Path Logic clients, we think, is something that we could do very, very quickly.

So, we are looking forward to integrating their product line with ours in the marketplace.

Got it. Thanks very much.

Drew Jones, Stephens.

Thanks for taking the question. Doug, you talked a little bit about a lot of the growth coming from new clients here over the past -- the first six months of the year. Can you give us some characteristics of what those new accounts look like? And is it global? Is it still primarily tech only where these guys are showing interest?

Yes, Drew, thanks for the question. As I mentioned, the growth was fairly broad based, and it was -- as I said, exceeded our expectations.

There was a fair amount of hospital growth in there where we were able to penetrate a number of hospital systems throughout the South. There was some big pathology client growth, both in the central part of our country, as well as in the west, and surprisingly, some of our biggest territories, even in the Northeast, also grew pretty dramatically. So it was very broad based.

I think our sales representatives are having a good time getting into clients and talking about the new testing that we are offering them. So our molecular testing menu is opening a lot of doors for us. We have got new tests that we are introducing literally every two or three weeks, and our clients are interested in our capabilities and the new testing technology.

So we are able to penetrate a lot of new clients, and frankly, there are a number that we are just waiting to bring on board as soon as we have a digital pathology platform that we feel very confident about, and that should be pretty soon.

And then, you talked a lot about the investments you're making. 2014, obviously, a year of investment. Can you give us a look out to maybe where we exit 2015 and what the EBITDA profile might look like at that point in time?

We generally as a policy don't give guidance until the February timeframe for each year.

There is just so many variables. We have got to get our arms around the Path Logic integration and see just what exact kinds of revenue synergies we can squeeze out of that. Get some better feel for where the prostate test is going to shake out and some of these new molecular panels.

There is a lot of really interesting new stuff coming down the horizon, and we are as excited as we have ever been about the growth prospects for NeoGenomics, but it would be remiss of us to try to quantify this at this particular time.

I would just maybe add to that, build on what Steve said, is that we have placed a lot of bets. None of these are huge bets, none of these are bet-the-farm bets, but each one of them could be pretty significant.

So next-generation sequencing, digital pathology, prostate cancer tests, clinical trials, we have a lot of very interesting things going on. And that's why we feel pretty confident in talking about the growth rates. The other thing I think you can count on, Drew, is that we are very process driven and that we plan to drop a fair amount of that under normal circumstances to the bottom line.

Great. Thanks, guys. Congrats.

Bill Bonello, Craig-Hallum.

Congratulations on a fantastic quarter. Can you just give us a little bit more color about the enhanced digital pathology offering, what -- how that is different than what you might have today? How it is different than what else is on the market, et cetera?

Yes, so Bill, we have never really been a Company that focused a lot on immunohistochemistry and digital pathology. As I think you know, we have been focusing more on molecular and FISH and cytogenetics and flow cytometry.

So this is a product line that many of our clients use and many of our clients use as an anchor for sending all of their testing to the provider that has the best digital pathology platform. And so, we have been working on this literally for years.

We believe that we made some breakthroughs recently, and the platform that we have allows clients to perform an interpretation for certain tests using our digital pathology platform where they can actually do the interpretation. And so, it is a very good complement to our tech-only platform.

We're actually pretty excited about it for the use in clinical trials as well. We intend to have clinical trials being done around the world in which our pathologist will do the interpretation, and in the future, we think pathologists will be more confident in interpreting results at least preliminarily based on the image, as opposed to looking at the glass.

So this is an important area for our growth in the future, and we think that not only will we gain direct digital immunohistochemistry business, but as a one-stop shop, then, we will be able to pull through other business with it.

And in terms of just clients sending to the lab with the best digital pathology platform, what defines that? Is it the quality of the image or is it tools around the image? What makes a product the best digital pathology product?

It's a lot of things. It's the speed at which they can perform the interpretation. It's the image quality. It's some of the other tools that will help them provide that interpretation, ease of use, all of those kinds of things.

Okay, excellent. And then, just a clarification on the guidance. I think I know the answer, but I want to be crystal clear. Does it assume that you continue to interpret the NCCI edits as you have been, so the guidance assumes no change?

Yes, that's correct. As we stated in our Q1 conference call, should the NCCI edits be resolved favorably or overturned, it would add somewhere on the order of $3 million, probably a little bit more than that now, based on our volume growth, to revenue for the year and $0.04 or so a share of net income.

If they are overturned and they are overturned within the window where we can go back and bill for the pieces we never billed for originally, we would immediately go back and bill for all those pieces. And we have one year to do that under Medicare regulations.

Okay, that's perfect. And then, just the last thing, and I know you just did your first acquisition, but what are your thoughts on acquisitions in general going forward? Do you need a considerable amount of time to digest this and see how you did with your first one before you do anything else, or how should we think about that opportunity?

This Path Logic acquisition was important for us, but it was also quite small and contained. So we believe that the industry will consolidate and we believe that we will be a good consolidator and we're going to be pretty active in looking at possible opportunities, just as we have talked about in the past.

Okay, great. Thank you.

Debjit Chattopadhyay, ROTH Capital Partners.

Good morning, gentlemen, and thank you for taking the question. Congratulations on the quarter once again. When you think about the Path Logic acquisition, you mentioned on the call they are running at a small operating loss per month. What is the gross margin for that revenue segment that is coming in and how does it compare with yours right now?

Currently, they are operating around a 30% gross margin, which is not too far outside the norm for that particular business. We believe that by filling that up with capacity, additional capacity utilization, that we can get those into the high 30%s and possibly into the 40% range.

But this is, generally speaking, a lower margin business than our core business, but what it is is it's a gateway for us. It opens the door to a whole lot of specimens that we can get that maybe are going to other labs right now. So all of Path Logic's clients who have molecular cytogenetics, FISH testing, we think we can pull that through, and the pullthrough of the higher-margin work will get their margins on a collective basis up more in line with where we are.

Let me just build on that just very briefly by saying that the acquisition of Path Logic effectively doubles our pathology staff, and we really needed to add to our pathology staff as we consider what's going to happen with clinical trials.

We think our staff is going to be very busy interpreting results for these clinical trial projects around the world, and we simply needed more pathologists and more specialized pathologists, and that's going to be very helpful, I think, and carry decent margins.

Great. On the next-gen sequencing, you had mentioned in your molecular testing was also a growing segment, and within that, the panels are doing better than expected. So as you migrate the panels over to NGS, how do you see the gross margin shake out for the business? I would assume the gross margin should be going higher if you go -- move the NGS lab work?

That's the theory, and I think we're going to have a lot of data to determine that we proved that theory out or that we maybe didn't prove it out.

But generally speaking, next-generation sequencing has much better batching efficiencies than Sanger sequencing. When we run a panel using Sanger sequencing, we're running a bunch of individual Sanger reactions. When we run a profile using next-generation sequencing, we can generally run the molecular piece of the panel all in one batch. And so, you got efficiencies on supply cost. You got efficiencies on technologist time and whatnot.

Now, it's important to understand that all of our profile panels have some component of individualized test with them. There is not a profile that we have where it is just one NGS run. I know a lot of other companies in the industry are trying to sell that.

We really believe that you need to add FISH when it's appropriate to do so, even flow cytometry when it's appropriate to do so. And in some cases, there will be other molecular modalities, like fragment length analysis, that are necessary to run in addition to next-generation sequencing.

Is there anything that you would add to that, Dr. Albitar?

No, but just to point out that volume is very important for the efficiency, and we're at the point that our volume justify utilizing the [aging] sequencing. You remember we always say in the next gen, you can use many genes for one patient or two patients at the same time you can use many patients for fewer genes.

We're at the point where we [examined] the genes, the [next] genes, multiple times a week and still be very cost effective due to our current volume.

Great. Then on the prostate cancer test, you mentioned that you're going to make it available. Do you have a handle on what -- are you going to be charging for the specimens or -- to run the test, or this is going to be part of the clinical trial -- the trial that you plan to run, the 600 to 800 patients? I wasn't particularly clear on that.

We have a formal clinical trial, which is a blinded study going on in Europe, which will be a couple hundred patients, we hope, by the end of the year or so.

But we also have an open enrollment going on right now, which is part of a US-based clinical trial activity where doctors who want to participate can send samples in and we will run the samples. We actually issue a test report. We are not charging for that right now, but we are asking that in consideration for getting a test report back that gives patient follow-up data so that we can get at the clinical utility data, which, as you probably know, is just essential to convincing the payers to do this.

So the 600 to 800 patients we're going to do in the open enrollment study are -- it's not a blinded study, per se, but it does get at the clinical utility, and we think the combination of these two aspects of where we go next will be very helpful for us to further position the product and get the kinds of data we need to have the payer discussions ultimately.

And one last question before I jump off. In terms of your operating leverage, you are basically at a point where with the 40% volume growth that you had in the quarter, that a lot of this should [start] from the bottom line, or do you think 2014, you still see continued increase in G&A and really position it for 2015?

I think we feel like we're on the edge of being at the place where we are comfortable in terms of how much we are spending on SG&A.

As Doug mentioned, we generally like to see higher incrementals on a year-over-year basis dropping to operating profit. These were conscious decisions that we made to ramp up sales fast, to ramp up IT fast, to ramp up a lot of these other new product initiatives because there's opportunity in the marketplace.

We are not somebody -- not the kind of company that just lets everything flying for extended periods of time. We will keep investing where there is very good growth opportunities, but at some point after you make the upfront investments, you get a lot of leverage back on that, and we're expecting to see a lot of leverage on those investments here beginning in Q3 and Q4.

Having said all that, we got to get through the year here before we can really fully assess what 2015 is going to look like.

Thank you so much and congratulations once again.

Jack Wallace, Sidoti.

Great quarter, guys. Thanks for taking my questions here. In terms of the client acquisition, that was one-third of the growth here in the first half of the year, you said. Why our clients coming to NeoGenomics? Is it the menu of [passes], the quick turnaround times? Just help me understand what's getting them to come in the door and what's getting them to stick?

What's getting them to come in the door is a whole number of different things. One is our comprehensive menu, which we keep growing.

The second is specifically the molecular testing menu, which is pretty innovative and, we think, the most comprehensive for cancer testing in the market.

Third is our tech-only platform for FISH and flow cytometry in particular, which we think is among the best, if not the best, in the industry. We've certainly been at it the longest of anyone in the industry.

I think another key factor is the consistency of our service levels. We are really rigorous about maintaining very high service levels, and that primarily is turnaround time, but it is also picking up the phone when someone calls. It is jumping on an issue when there is an issue, all of that sort of thing.

So it is a variety of factors. In our business, this is a service business. You have to do 100 things right every single day in order to have a good service. And so, we tend to be very process oriented to make sure that we are consistently improving each of those 100 things all the time.

And then, for the very few clients that seem to be not returning, are those you are seeing to peel off from an in-sourcing standpoint or is that just the nature of having to balance 100 balls in the air?

Jack, we look at this really closely and we tend to look at retention rates in the larger clients, and I can tell you that when we looked at it for 2013, we lost four larger clients. Two of those were because their parent companies entered into contracts that required them to start sending somewhere else, one of those because it went out of business, and the fourth was a legitimate service issue.

When we look at this, we generally have 96% to 98% client retention rates on the larger clients, and the reason for that is our interests are totally, perfectly strategically aligned. Usually the larger clients are participants in at least some aspect of our tech-only program, and that we're enabling the pathologists to expand their own menu of services that they can offer to their oncology -- community-based oncology clients.

And so, we really work very hard to be the kind of laboratory that can extend our clients' menu of services into their client base, and that has worked very well for us. It has been the same strategy for the last 10 years and we're seeing continued traction with that same strategy, and that's why so many competitors are now starting to imitate us with their own tech-only offerings.

Thank you, and then lastly here, just to go back to the operating leverage question. Just going forward, you are going to have some variable expense in selling, obviously. And then, once you have gone ahead and filled up the majority of your molecular testing menu, you can continue next-gen sequencing, then essentially from a process, you're going to see likely the research and development figure be a bit variable, as well.

Is the most fixed portion of the operating-cost level going to be coming from G&A, and if so, what is a good level to think about as a plateauing level?

We have looked at this a lot of different ways. We think at around $150 million of revenue, you can really begin to optimize your levels, and we believe that SG&A and R&D as a percentage of revenue at $150 million of revenue should be in the mid to maybe a little bit high 30s. And so, it would be our goal to get the Company into that level.

Between now and then, we are investing in a lot of growth initiatives and we're going to have lumpy quarters. There are no such thing as smooth trends when it comes to when you're investing, when you're not investing.

So we generally like to talk about those things as generalized areas over the course of a year and manage everybody's expectations about what the incremental profitability is in one quarter versus the next quarter, because of the lumpy nature of the investments.

Okay, thank you. That will be all for me.

[Frederick Copti], Private Investor.

Congratulations on the quarter. A quick question, going back to the plasma prostate test you mentioned. You spoke about domestic and global trial activity and the conditional launch, and I was just wondering if there has been a reassessment for the final launch that is anticipated for that.

And two other things. The SVM-based Cytogenetics Analysis System and the SVM-based Automated FISH Analysis System, v2, do you anticipate implementing them to gain substantial cost savings and an opportunity for sublicensing revenue in the future? Thank you.

We are going to ask Dr. Albitar to take the first of those questions about where we are on prostate cancer. And then, we will come back and pick up the other two after that.

For the prostate cancer test, Steve and Doug mentioned we are planning in the domestic the 600 to the 800 samples testing, that we are offering the test as lab developed test. So as the test literally is launched, but it is conditional launching so in that we are asking the physicians who are ordering these tests to give us feedback on two things. One is the performance of the test. The second one is the utilization.

We are collecting data on both, and frankly, we haven't started to announce this kind of conditional launching, but we already started getting samples. So we anticipate that the 600 to 800 samples to be done in very short period, and after that, we will evaluate the details and make the argument for why the test is good. And it is better offering for helping clinicians in these field. Until that time, really we cannot say anything more at this time.

Okay, thank you.

And with respect to the other questions, we licensed -- it was an early prototype for SVM-based Cytogenetics Analysis System when we entered into a license agreement with Health Discovery Corp. two and a half years ago. We have spent quite a considerable amount of time and money further developing that.

We do have what I would call an advanced beta version of that that we are using internally to get feedback from our technologists. This is quite a complex piece of software. We still have pretty good hopes for it, but until we get our techs to embrace it and tell us it helps them do their job faster and better, it is not something that we would even begin to start having any kind of sublicensing discussions on.

We do have the rights to sublicense it under our agreement with Health Discovery Corp. and that would certainly be interesting if we can prove out the functional utility of the software in a high-volume working laboratory. But we really just haven't commented any further on that.

With respect to the SVM FISH system, we did file a patent on that. It is not something we're using currently. It is something that we think there is some application for, but it's a question of resource for us. We are working on the SVM Cytogenetic System first, and then I think we want to get quickly into an SVM flow cytometry system.

At some point, we will probably come back to FISH and see if we can help it make us more efficient in that area as well. Dr. Albitar, would you like to add anything to that?

No, you covered it all.

Thank you.

I have a couple of other questions that have come in via email here that I just want to clean up before we wrap up. Can you tell us what Medicare is as a percentage of your payor mix after factoring in the NCCI FISH edits?

This is a great question. This is actually a nice silver lining for us. Medicare is now down to 18% to 20% of our total payor mix as a result of our conservative accounting for this NCCI issue. Keep in mind that two years ago, the expiration of the TC grandfather clause sharply reduced our billing mix. It literally moved 19% of our billing mix from Medicare into client pay. This appears to be moving around 5% to 6% of our billing mix over to -- or out of Medicare as well.

When you consider that just three years ago Medicare was 43%, 44% of our total paying mix and they are 18% to 20% now, it effectively means that Medicare's reimbursement policies will no longer be able to have anywhere near as big an impact on us as we have moving forward.

Next question is we understand that the guidance you issued this morning was exclusive of any transaction-related costs. Can you give us an idea of how much these costs were?

We have not received the final invoices for our services yet, but in any acquisition, you incur a fair amount of legal and accounting expense to do due diligence. I think we're looking at somewhere on the order of $250,000. The actual costs of completing the acquisition have to be expensed in the current period, and I need to be very clear with everybody that our guidance is exclusive of any impacts of deal-related costs that we incurred, and we are expecting a fairly substantial amount of deal-related costs that will ultimately be in the Q3 numbers.

With that, that's the last question I have. Operator, you can go ahead and wrap us up.

You confused me for a minute there, Steve.

As we end the call, I want to recognize all 430 NeoGenomics team members around the country for their dedication and commitment to building this world-class cancer genetics testing program, and on behalf of all of our NeoGenomics team, I want to thank you for your time in joining us this morning for our Quarter 2, 2014, earnings call and let you know that our Quarter 3, 2014, earnings call will be on or around October 23 of this year.

So for those of you listening that are investors are thinking about investing in NeoGenomics, we thank you for your interest in our Company. Goodbye.

Thank you.

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time and thank you for your participation.