Neogenomics Inc (NEO) 2016 Q3 法說會逐字稿

Greetings, and welcome to the NeoGenomics' third-quarter 2016 financial results call.

At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (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 Chief Executive Officer. Thank you. You may begin.

Thank you, Audrey. Good morning. I'd like to welcome everyone to NeoGenomics' third-quarter 2016 conference call and introduce you to the NeoGenomics team that's here with us today.

Joining me in our Fort Myers headquarters is Steve Jones, our Executive Vice President; George Cardoza, our Chief Financial Officer; Fred Weidig, our Controller and Principal Accounting Officer; Jessica King, our Manager of SEC Reporting; Rob Shovlin, President of our Clinical Services Division; and Steve Ross, our Chief Information Officer. Dr. Maher Albatar, our Chief Medical Officer and Director of R&D, is joining us from our Alisa Viejo lab in California.

Before we begin our prepared remarks, Steve Jones will read the standard language about the 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 statements speak only as of today, and we undertake no obligation to update any such statements to reflect events or circumstances after today.

Thanks, Steve. In this morning's conference call, I'll comment on our third-quarter performance, the status of the integration of Clarient, our current management focus, and conclude with a look-forward to growth and value-creation opportunities for our Company in 2017 and beyond.

We're pleased with our third-quarter performance. I referred to it as a solid quarter in our Board review last week, but solid is actually outstanding, when considering the amount of change our business has successfully navigated during this time. It's also outstanding when you consider the overall numbers.

Revenue was up over 140% from last year. That was due largely to the Clarient acquisition, but also to organic growth even during the integration process. In terms of clinical genetic test volume, we believe base NeoGenomics grew approximately 25%, and legacy Clarient started to grow again, with a year-over-year increase of about 3%, although measuring the relative contribution is getting harder as the businesses combine.

Profitability was excellent, as we generated $9.1 million of adjusted EBITDA. This was 3.2 times greater than last year's level. Even though we are still operating two different labs in Orange County, using two different lab systems, and are managing through a transition from 2 to 1, we still drove reductions in cost per test. We increased productivity and maintained excellent service levels. In fact, we actually recorded the lowest cost per test in our history.

We're particularly pleased with the amount of cash flow generated from operations. Our billing and cash management processes are strong. The record $9.6 million of cash flow from operations in quarter-three now brings our total year-to-date cash flow from operations up to $21.7 million. This cash flow strengthened our balance sheet and gives us financial flexibility to pursue strategic and recapitalization initiatives. Steve will cover all the numbers in more detail in a few minutes.

Let's talk about the integration of Clarient. I'll use the same description as I did last quarter -- so far, so good. Here is what we have accomplished so far and what to expect over the next few months.

We took over every back-office function that GE previously provided, including payroll, payables, accounting, information systems, Human Resources, et cetera, and now we are largely done with all GE transition services. This amounts to annualized savings of about $4.4 million compared with the beginning of the year.

We completely restructured the Clarient billing process, eliminated outsourced vendors, hired our own team, and got the billing process under good management. Our combined DSOs are now down to 76 days, cash collections are excellent, and clients are not complaining any longer about the Clarient billing process. We expect to have all clients using the legacy NeoGenomics billing system by the end of this year.

We identified the best practices of each company on a detailed basis, reprogrammed our laboratory information system, tested the heck out of the system, and rolled out the new LIS in about four months. We are now providing the best of the best for migrating clients. The system is functioning well, and we are now rolling it out to all of our clients.

We restructured the sales team, eliminated duplicative territories, added specialty teams, and installed a new compensation and management structure. We've had outstanding retention in our sales team, kept all of our top-performing people, added selectively to our geographic coverage, and are growing the Clarient base once again.

We think we have an extremely professional and productive team that is hungry and ready to grow. We segmented the Clarient customer base, identified client-specific requirements and pricing, trained clients on new capabilities, and began migrating them to our new one-company LIS lab processes and billing system. We now have about half of all Clarient accounts fully transitioned, and expect to finish this process in the next six to eight weeks.

We drew up construction plans to completely renovate the 78,000 square foot Alisa Viejo lab facility and are into Phase II of the three-phase construction process. We're investing over $3 million in this facility and it's going to be a fabulous lab. Construction will be complete in January, and we will have the Irvine lab fully consolidated into the AV lab by the end of February.

Other than the inevitable few-week delays here and there, we have executed these plans in a disciplined manner on time and within budget. Now we're much further down the road, and the integration risk is much lower. Planning is done, execution is well underway, and client retention levels are extremely high.

The remaining integration activities are under good solid management. As one of our key leaders remarked last week, integration doesn't feel like a project anymore; now it's just part of our management process.

We want to tell you about how we're now managing the Company. We've organized the management of our Company into two divisions: a Clinical Services division and a Pharma Services division. I mentioned that Rob Shovlin is here with us today as President of the Clinical Services division.

There is significant collaboration between the divisions because we're still a small company and share critical resources, but clinical clients have different requirements than pharmaceutical clients. We now have focused resources necessary to pursue these distinct customer requirements.

And we are reporting our revenue in two business segments -- the Clinical Service site and the Pharma Services segment. I'll make a few comments about each of them.

Today, the Clinical Services business comprises over 90% of our revenue. This division had a strong quarter, despite the focus on integration. In geographic areas with lower levels of integration activity, like the Northeast, revenue growth and new account activity was terrific, well ahead of our aggressive goals.

In other areas of the country with higher concentrations of migrating clients, growth rates were lower. Our sales teams are looking forward to completing the integration process and pivoting back to market share-driven growth. In fact, they can hardly wait.

Just last week, we reviewed a long list of large account opportunities that are on our radar screens. It was quite exciting. We also added significantly to our managed care and hospital contract network with a number of new payer contracts, a large hospital system agreements -- and large hospital system agreements -- signed so far this year, and many more of those are in our pipeline.

Our operating teams are working really well together, and have a good operating rhythm and momentum. Service levels are excellent, the costs are beginning to come down, and the opportunities are very clear. With a customer migration process completed by year-end, followed by the full facility consolidation early next year, we expect major improvements in costs, productivity, and efficiencies in 2017.

We are making the Clinical Services division the clear leader in oncology diagnostic testing with the most comprehensive test menu and the highest quality and lowest cost in our industry. Quarter-three results were exactly as we expected and we are well on our way to achieving our goals.

The Pharma Services division comprises about 10% of our revenue today, but we expect that percentage to increase. After an exceptionally strong quarter-two, we were not particularly surprised by the pullback in revenue in quarter-three. The revenue reduction of $1.8 million is partially a result of contract timing, but also because we are rebuilding the pipeline. We recognize that revenue in the Pharma Services segment can fluctuate from quarter to quarter, but we expect revenue to bounce back nicely from quarter-three levels.

Our management team has a fair amount of experience in the Pharma Services business and we know we can be successful. As an example, although the Neo legacy Pharma business was much smaller, it grew by over 100% in quarter-three. However, most of the current Pharma business was acquired as a result of the Clarient acquisition. That Clarient legacy business was down about 20% in quarter-three and we're not very happy about that.

On the other hand, we are encouraged that, at the end of quarter-three, our total division revenue backlog was up significantly compared with the beginning of the year. We've added a number of new clients and just signed a long-awaited project with a major pharmaceutical company using a new technology called MultiOmyx developed by GE. We have the exclusive rights to use that knowledge for in vitro diagnostic testing services.

We also know that we can be successful, because the Clarient legacy business had great people and great client relationships from which to build. For example, development of new immunotherapies in oncology is increasing at a rapid pace, and we have extensive experience with PD-1 and PD-L1 testing for immunotherapy. Also, we have a unique capability with our comprehensive test offering, and scientific and medical expertise.

This business will take time to build and we are trying to invest thoughtfully. We've begun to invest in the sales team. Our sales leadership and half of the sales team, while very experienced in the market, are new to our Company in the last five months. We're also investing in infrastructure, both internal resources and lab infrastructure.

In response to the request of several of our pharma clients, we are currently in the planning phase to expand internationally and expect to announce the European facility in the next several months. The bottom line here is that we believe this business has great long-term growth potential and we are investing in it.

I'd like to change the conversation now to look ahead to our Company's key growth and value creation opportunities. We are fundamentally a growth company, but we try to distinguish ourselves uniquely among other growth companies in our industry by also generating cash and profit. We've been very fortunate, and this has translated to a ten-fold increase in our stock price over the past eight years.

That success has been driven by market share-driven growth as a result of innovation and great service. It's also been driven by operating discipline that has translated that revenue growth into earnings and cash flow growth.

With that backdrop, here are 10 key growth and profitability drivers for NeoGenomics over the next few years: One, continuing to take market share in a growing market. Two, cross-selling the strong Clarient products to Neo clients and vice versa. Three, partnering with oncology groups who choose to internalize some pathology services. Four, growing the Pharma services business in an era of precision medicine. Five, capturing the cost synergies from the Clarient acquisition. Six, developing and commercializing liquid biopsy tests, including our prostate cancer test. Seven, automating our laboratories. Eight, developing information products based on our vast oncology database. Nine, adding testing for early detection, predisposition testing and monitoring. And ten, further consolidating the industry.

Each one of these 10 areas are opportunities that we are actively pursuing, and we think that, individually and collectively, they will help us to create a lot of value for our clients and the patients they serve, and for our investors.

Now we're going to turn the floor over to Steve Jones, our Executive Vice President and Director of Investor Relations, to review third-quarter results in more detail and lead us through a Q&A session.

Thanks, Doug. Before we open it up for questions, I would like to briefly touch on a few financial highlights from the quarter. We are pleased to report $60.8 million of revenue in quarter-three, 142% increase over the prior year, driven primarily by the inclusion of Clarient in the test results, but also by strong growth in the base NeoGenomics clinical test volume. Approximately $53.9 million of this revenue was derived from the core clinical genetic testing business, $1.9 million from PathLogic, and $5 million from the Pharma Services division.

Consolidated gross margin was 45%, a 50 basis point increase from the 44.5% reported in Q3 2015. This increasing gross margin was driven by the 6.2% year-over-year decrease in average cost of goods sold for clinical genetic tests to $204. As Doug mentioned, this is the lowest level we have ever reported for this metric, and this is before we unlock the additional cost synergies from having all clients on one laboratory information system, and all of our Orange County, California employees in the same facility.

Consolidated SG&A costs increased by $14.9 million or 135% from Q3 2015. However, as we discussed in the press release, $2.5 million of this increase was due to non-cash variable stock based compensation and non-cash amortization of intangibles directly related to the Clarient acquisition. SG&A as a percentage of total revenue fell to 42.7% from 44% in Q3 2015.

Given the reductions in cost per test and the economies of scale we achieved on the cash portion of our SG&A expenses, consolidated adjusted EBITDA increased by 224% to $9.1 million as compared to the prior year, and adjusted EBITDA margin grew by 380 basis points year-over-year to a record 15%.

Importantly, adjusted EBITDA in quarter-three was just $59,000 below the level reported in quarter-two, despite the $2.4 million sequential reduction in revenue as a result of the lumpy nature of our Pharma Services revenue stream. This speaks volumes about the incremental efficiencies we are unlocking each quarter.

Third-quarter GAAP net loss available to common shareholders was negative $5.6 million and GAAP diluted EPS was negative $0.07 per share. This compares to GAAP net loss available to common shareholders of $125,000 and diluted EPS of $0.00 per share in Q3 last year. However, as we discussed in the press release and in previous earnings calls, we believe 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 the GAAP net income or loss available to common shareholders to exclude -- one, the non-cash amortization of intangibles; two, the non-cash stock-based compensation expenses that are partially driven by changes in the Company's underlying stock price in any given quarter; three, the non-cash deemed preferred stock dividends required by GAAP accounting; four, the non-cash amortization of the beneficial conversion feature related to the preferred stock that is also required by GAAP accounting; and five, other one-time or nonrecurring income or loss items, of which there were none in quarter-three.

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 of how this is calculated in our earnings release.

In the third quarter, adjusted net income was $3.4 million, a 302% increase over the $855,000 in last year's third quarter; and adjusted diluted EPS was $0.04 per share compared to $0.01 per share in quarter-three 2015. We finished the second quarter with 947 full-time equivalent employees, contract doctors and temps versus 925 as of June 30th, and 896 as of December 31st last year.

Of the 51 people we added to our payroll since year-end, at least 12 were related to the internalization of previously outsourced GE functions. Adjusting for this, we've added 39 people or 4% to our workforce, while our volume has increased by 14%.

Before opening up for questions, I would like to comment briefly on our plans with respect to the Series A redeemable preferred stock that we issued to GE as part of the consideration for the Clarient acquisition.

As we have discussed before, we have the option to redeem all or a portion of this at any time while it is outstanding, and it does not become convertible into our common stock until 2019. GE has provided us with ample incentives to redeem all or part of these preferred shares early, including a 9.1% discount for any portion redeemed this year, and a 6.8% discount next year.

Given the acceleration in our adjusted EBITDA and cash flow from operations over recent quarters, we are deleveraging our balance sheet at a rapid pace. In fact, our adjusted EBITDA over the last 12 months is up over 50% from the end of last year, and continues to accelerate. In addition, we have paid down approximately $10.5 million of the debt we incurred to finance the transaction with internally-generated funds since year-end, and our cash balance has still grown by $5.5 million.

A very important measure when analyzing the senior debt capacity of the Company is the ratio of funded indebtedness to LTM adjusted EBITDA. On the day we closed the Clarient acquisition, we started with funded debt equal to 3.5 times LTM adjusted EBITDA. At the end of quarter-three, our funded debt was just under two times LTM adjusted EBITDA.

As a result, we are currently in discussions with banks to refinance our current senior debt facilities. Barring any unforeseen circumstances or acquisition opportunities that may arise in the next few months, we believe we have the ability to redeem up to $50 million of the preferred stock by year-end of this year with a combination of incremental bank debt and cash on-hand.

Importantly, we believe we can accomplish this and still not exceed funded indebtedness of three times LTM adjusted EBITDA. When completed, this will result in a 50% reduction in the number of Series A preferred shares outstanding or a reduction of 7.33 million shares.

At this point, I would like to close down our formal remarks and 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.

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

(Operator Instructions) Bill Bonello, Craig-Hallum.

A couple of questions. So I'm wondering if you can give us a sense of how much total cost saving has been realized from the acquisition synergies thus far? In other words, reflected thus far in the numbers, versus how much incremental savings we could see in future quarters?

Sure, Bill. Thanks for the question. So I think at the beginning of the year, we said that we expected about $6 million of cost synergies in 2016; I think we raised it to about $6 million to $8 million of cost synergies. And we think that that's about the number for 2016. And we expect next year that -- we said that we should have $20 million to $30 million of total synergies as a result of the Clarient acquisition, and we think we're right on track for that.

Okay. And do you think -- do you catch most of the remainder next year? Or how should we think about that?

Well, I think that we're going to -- by the end of next year, we will have a run rate where we have captured a significant portion of that, yes. What will happen next year, Bill, is the productivity increases will start to kick in as a result of people being in a combined facility and all clients being on one laboratory information system.

So you can sort of lump the cost synergies, if you will, into two buckets -- the hard cost synergies, and we're a good way of the part through that, and then you have the productivity increases that come from having people on combined systems and all in one facility. And the piece that we'll pick up a lot more on next year is the productivity and efficiency increases.

Okay. That's helpful. And as you've progressed through the process, have you identified any new opportunities that weren't part of that original $20 million to $30 million plan?

Well, I think some of the opportunities are clearer than they were before. I'll just give you an example -- we did an analysis the other day, and there are over 100 Clarient accounts that only use Clarient for immunohistochemistry. And we -- as you know, Bill, we've grown in the past a lot by being a one-stop shop for our clients, and we think that we have a lot of opportunity to provide FISH and flow site cytometry and molecular testing to all of those clients.

So, I think that the general buckets of synergy that we identified early on are exactly where the synergy is, but they are much clearer to us now.

Okay. That's very helpful. And then just finally, you mentioned -- in your list of growth drivers, you mentioned the potential on liquid biopsy including prostate. Any kind of update that you can give us on prostate timing going forward?

Yes. Thanks for that question, Bill. I would say that the results of our work -- Dr. Alvatar has done a fantastic job there -- are very encouraging, and the performance characteristics are very strong. The feedback from the urology community, as we've gotten out there and talked with the community about our tests, are very positive. And we've just submitted a paper, and we expect to have that published.

And when it's published, we'll talk about a bit more about the test. And I think we would like to report that to our investors when we have a little bit more feedback on our results when we get into the marketplace. But we're encouraged.

Great. Thank you.

Amanda Murphy, William Blair.

This is Aurko in for Amanda. Just a couple of questions. We've heard some weakness in the broader space for utilization trends, and we were wondering if you're seeing any of that? And piggybacking on that question, have you seen -- what percentage of your growth -- organic growth -- is due to market share gain?

Well, thank you for the question. We don't really see a reduction in utilization. So, I would say that the market in general is very concerned about utilization. And I would say that we've always been fairly good working with our pathology clients, and providing testing that's very important to our clients and patients. And there's not been any sort of overutilization at all. So I think in terms of our utilization, it's about the same as it has been.

There's an interesting statistic that we publish every quarter called the average number of tests per case, and if you look going back five years, it's hovered between 1.5 and 1.6 test per case. And even after acquiring it, it's right smack at 1.55. So we really haven't seen any trends to suggest that, in the oncology sector at least, there is less utilization.

In fact, look at what's really driving oncology in America. It's just pure demographics. There's 25% more people turning 65 in America than there was six years ago, and that's something that we think will continue to drive a lot of utilization in coming years.

I'd just add one thing. I was talking with a client this week at a major oncology group and they said we need to do more testing, not less. Because we offer a lot of value when it comes to trying to provide better outcomes for patients at lower cost.

Got it. Thanks. And I guess another follow-up question to that is, is there any risk you see towards utilization and reimbursement under Hillary or Trump? Is an area perhaps an election for the question?

Gosh, you know, the truthful answer is I don't know. I don't think we will. But we are not expecting any meaningful disruptions to 2017 reimbursement. Medicare published the preliminary rule in July. The only time the preliminary rule deviates from the final rule is when new codes are introduced in the intervening period. That happened once two years ago. That's probably the only time I can remember in 10 or 15 years where that ever happened.

There's been no new codes introduced since July. We expect the final rule to be in line with where it was in July. And if that's the case, we'll see a little bit further reduction in flow cytometry, but the rest of our business is sort of just roughly flat with a little bit up in digital pathology. So overall, we are expecting a very stable year for reimbursement next year.

Yes, I think most people do know that, today, about 16% of our revenue is reimbursed by Medicare. The bulk of our business is reimbursed under contract directly with hospitals. So, that provide some level of protection for us.

Yes. And then if I can sneak one more in, you said barring any acquisitions, what kind of asset would you consider? And what kind of timeframe in the longer-term have you been speaking about, I guess? Or could you share some color on that?

Yes, we've said for quite some time that we would like to be a consolidator in this industry. We think there are opportunities for acquisition. You've seen how we've behaved on that front. We like to acquire where we have an acquisition opportunity to acquire technology which is more advanced, where markets are growing a little bit faster.

We are very interested in pursuing data management and informatics kinds of initiatives. We've got a lot of experience now with Clarient. And as I said, it's sort of a process now by which we are integrating and migrating customers. So we think that we've got a process under management and we think we can do some more of it.

Thank you. I'll hop back in queue.

Drew Jones, Stephens Inc.

On the Clinical Services side, it seems like we've been talking a little bit more over the past couple of quarters about larger customers. Hoping to quantify that a little bit. Can you talk about how you are getting these guys off the ground? Is it just a matter of getting your foot in the door with one certain test, and then kind of working your way towards one-stop shop?

And then secondly, how much is left in the pipeline? I think, Doug, you said you pulled one over the wall so far. I guess what is stacked behind that?

Yes, Drew. So, our customers are getting bigger. And it's -- this consolidation is occurring not only in the lab business but also with hospitals and (technical difficulty). So this is a trend which is occurring in the marketplace.

We are increasingly penetrating the managed care market, so that offers opportunities, opens up opportunities for us. We are contracting with big hospital systems that, like Premier last year. That opens opportunities for us. And as a result, we are gaining larger clients around the country. So, I think in terms of getting these accounts, it's all the stuff that we talked about.

It's having the managed care plans. It's having the one-stop shop. It's having the comprehensive menu, it's having the service and coverage geographically. All of these things are very important to gaining these accounts. And I would say it's not one thing, but it's the combination of capabilities that's allowing us to gain market share.

Okay. And then on the Pharma Service side, you guys had kind of mentioned last quarter that it is a lumpy business. Is there normal seasonality to expect? And then maybe a little more color on the MultiOmyx platform that you guys have exclusivity with from GE, what kind of opportunities does that present longer-term?

Yes. I don't think there's a lot of seasonality in the business, Drew. This is a long sales cycle business, and the lumpiness has come partly because we haven't had a consistently strong sales team. There's been some change in our sales team. And now we think we've got a very good sales team and a good service.

So hopefully, it will be a little less lumpy going forward. The MultiOmyx technology is very interesting technology that GE invested heavily in and Clarient invested heavily in over the last three years.

You know, rather than me trying to explain the technology, Dr. Albatar, do you want to just give a quick summary of what the technology allows for pharmaceutical clients?

The technology allows multi-balance analyses of one sections of tissue. So you practically you can analyze a pathway, entire pathway ,using one sections of tumors. As you know, tumor material becoming extremely precious, especially in the context of clinical trials. So you can really apply multiple antibodies on the same sections, and see the interaction between these antibodies or these markers on the sections provide a lot of information on the mechanisms of oncogenesis and how drugs can work on these pathways.

I hope I didn't confuse you more.

Yes, that -- I guess it again just kind of hits with a consistent theme of the tissue samples limited. Is that a fair point?

Exactly. Exactly. So that helps in pharmaceutical companies very excited about the concept of using only the limited samples and getting as much information as possible.

Right. There is one other key component of this that's worth mentioning, which is, many people think next-generation sequencing is the be-all and end-all for molecular testing. And the issue with that NGS is you don't get the relationships in terms of where the concentration of markers are in the tumor. And the MultiOmyx platform gives you the spatial relationships to where the markers are appearing.

It's a really cool technology that allows you to do multiple stains on a slice of tumor, and then compare them and subtract one or more, and look in stains four, eight, and 10 together, alone, isolated, and taking out the others and doing all kinds of permutations of that. So it's a very important technology and it's very interesting to a lot of pharma companies.

And nothing to kind of change the view that that Pharma Service revenue longer-term is still going to be the higher-margin revenue stream, is that right?

Well, we think it's both higher growth and potentially higher-margin. But we think that it will be higher-margin as we get to scale through. Right now we are investing heavily in the business and we need to get it at scale. At that level, we think it's going to grow very fast and should be higher-margin than our Clinical Services business.

Great. Appreciate it, guys.

Thanks, Drew.

Chris Lewis, ROTH Capital Partners.

Thanks for taking the questions. I wanted to start just a question on the Neo-based business, growth of 25% in the quarter continues to be strong, perhaps even more impressive given the migration requirements in the quarter. Can you just elaborate on what continues to drive the underlying strong growth there and the continued market share gains?

Sure, Chris. I think it's a lot of things. So, it's having a very robust managed care contract base. It's having consistent service. It's being able to be partners with pathology practices around the country. It's having a one-stop shop menu that is the most comprehensive around.

It is having a sales team that's pretty experienced in the marketplace, that can go in and talk about new tests almost every couple of weeks. It's all those things. It's the total franchise that allows us to capture the imagination of our clients and help to convince them that we can offer them a lot of value. I think unlike other companies in our industry, we are very, very focused on what we do. And I think we do it pretty well.

And on the LIS migration process, I understand it's early, but for those customers that have been successfully migrated, any early commentary you can share in terms of what you're seeing in terms of satisfaction levels, general feedback you've received from them, and potentially any kind of changes or consistency in ordering trends with those customers?

The customers that we have migrated so far, we think are very happy. So, we try to get feedback from them both through surveys and obviously from our own people, from our sales team and from many of us that call on these clients. But they like the Clarient capabilities that we've added to the NeoGenomics test offering, particularly in the area of digital pathology.

We are starting to see the older Clarient, the legacy Clarient clients begin to order molecular testing. And so they like the combination of capabilities, and they like the LIS system that has been reprogrammed to provide the best of the best. So I think there's going to be a lot more growth opportunity as they begin to explore the full capability of our LIS system. Because quite often, they are using the system just for one aspect of our testing menu and not for all aspects, and there's real power there.

And then on the Clarient Clinical Services business, I think you said in your prepared remarks that did return to growth this quarter around [2% to 3%], which is a nice trend to see and rebound from what that business has been doing. What steps and kind of processes have you put in place to return that business to underlying growth? And how should we think about kind of the sustainability of organic growth in that Clarient legacy clinical business going forward? Thanks.

Yes, thanks. So one of the things that we did was got back to basics. So I'll give you an example of that, and that's the billing process. So we heard early on from Clarient clients that they were not happy with the billing process. And so, as you saw from our results, we invested in the Clarient billing process. We've changed the team. We've invested in the system. We've got some terrific people. And we don't hear any complaints any more from Clarient clients.

That was a real value detractor for Clarient clients and that's fixed now. The other thing is that service in this business is very important. And we've been able to maintain our service level, so we really haven't lost anyone. Through the migration process, I think we've lost one pathologist in one pathology practice, and I'm not happy about that. We are going to try to get her back.

So the retention rates have been very, very strong, and that's the first thing that needs to happen in order for you to grow. You've got to retain all your clients. And so with that base now, we've got a very good sales team. And the sales team is starting to make inroads, and I think they are really hungry and can't wait to have this integration process behind them, because they've got a number of clients on the radar screen. And we think that growth in this business is sustainable, and it ought to approach the levels that we've had at Neo in the past.

Okay, thanks guys.

Raymond Myers, Benchmark.

First, Steve, I wanted to clarify your discussion regarding the convertible debt that NeoGenomics is considering retiring. Can you just clarify for us whether the Company is considering any form of equity raise to retire that debt? Or is this all cash and bank debt?

Thanks, Ray. But first, a clarification -- we do not actually have any convertible debt in our [cap] structure. It's a Series A redeemable preferred stock. Although it's accounted for similar to debt, there is no obligation to ever repay if we choose not to.

At this time, we have no plans to issue any equity to redeem the GE preferred. It's far more accretive to our shareholders to redeem these shares with internally-generated funds and incremental bank debt than to raise equity solely for this purpose. One of the things we are considering doing, and in discussions about now, is putting in a large revolving credit facility that can be used this year and perhaps even again next year to do something similar next year.

Of course that will depend on what other strategic opportunities we may pursue. But at this point in time, we don't actually think we're going to need to issue any equity to redeem all of the GE preferred shares over the next year or so.

Very good. I just wanted to clarify that. And also, it sounds like the customer conversion process will be concluding fairly soon. Can you help us understand the cadence of organic growth in the business once that process is concluded?

Sure. So the customer migration process I mentioned is about halfway through. We are now in the final throes of that, and we should wrap that up clearly by the end of the year.

The -- I'd mentioned to you that the list of large opportunities that we have on our radar screen is -- has got us pretty excited. And so we expect that we are going to be able to move pretty quickly to pursue those and to close those.

I would say that, just so people understand, this integration process has been quite a distraction really for our sales reps. Some of our sales reps have spent 50% of their time migrating accounts. Because migrating an account is just not calling them up and saying, hey, you're going to be migrated next week.

It's talking with them, explaining the capabilities of our LIS system. It's talking with them about pricing changes. It's training them on our new systems. It's all of that stuff and it takes a while. So, in areas, geographic areas, where a rep has a lot of clients that are migrating, they're spending a lot of time on this and not spending time hunting. So, beginning of next year, we are back to hunting.

So that's a good explanation. Help us to understand how quickly you go -- a rep will go back from completing the conversion process to actually growing revenue again? Because they can start hunting, but then there is a sales cycle there. So, how fast do you expect revenue growth rates to return to the historic norm?

Well, I would say you are right. There is a sales cycle, but these accounts have been in the pipeline for some time. I mean, it's not like we are walking in fresh and saying, hi, I'm NeoGenomics and they don't know us. So, these things, some of them will take some time, but I think that we have a list of accounts on our radar screen and we think we can get to them pretty quickly.

Excellent, good. And then touching finally on the Pharmaceutical Services business, you expressed a lot of optimism for that growing. Is the $6.8 million in Q2 was a really nice high-watermark in that business. How long do you think it would take before you might achieve that high-watermark account?

Yes. (laughter) We don't want it to be a high-watermark for long. (laughter)

Okay. Well, that sounds very optimistic. Thank you.

(laughter)

Nicholas Jansen, Raymond James.

I just wanted to touch a little bit on the incrementals that you are seeing in the business; clearly continuing to be quite strong. So maybe can you just remind us how you think about the drop-down as the synergies play out in 2017 and 2018, and the continued reduction in cost per test on a standalone basis, how we should be thinking about the margin and effectively the cash flow generation of this business, as we move forward to 2017 and beyond?

A great question. Thanks, Nick. We haven't really given any guidance for 2017 or 2018 yet, except we have said that we expect to be at a 20% to 25% EBITDA margin when we get north of $300 million in revenue, which currently you guys have us achieving that goal in 2018. So if you just took 22.5% of $300 million would imply EBITDA of $67.5 million. If you take the midpoint of our range for this year, $35 million -- $36 million to $38 million -- so we go from $37 million to $67.5 million over the next few years, those are some pretty strong incrementals.

We'd be adding $30 million-plus of EBITDA on something on the order of $53 million of incremental revenue, if you just assume we hit the midpoint of our guidance for this year. So, those are 50-plus-percent incremental EBITDA margins on the incremental revenue, and we have no reason to believe that that won't come true.

I think we have been fairly conservative in our guidance so far on when we're going to realize synergies. We have an opportunity to really accelerate that synergy realization process next year to not only continue hard synergies from combining facilities, and combining people into one system, but also unlocking a lot more productivity and efficiency. So next year is going to be something that we think will continue to be a stellar year for gaining on or improve -- further improving our cost per test metric. I think we're going to leave it at that.

Okay, that's helpful. And then kind of my second question regarding kind of the facility consolidation or the lab consolidation that's expected in the first quarter of 2017, I wasn't sure how much risk there is tied to that from an operational perspective. I understand fully the LIS integration was kind of very handholding all your customers. But are your customers going to notice anything regarding that lab consolidation? Or is that more of an easier thing to kind of consider from a risk perspective?

Well, if you ask our internal people, it's not easy because we're choreographing a lot of movement of people back and forth. But I don't think our customers will know the difference.

You know, we said all along that the facility will be consolidated around year-end. We've had maybe a few-week slippage to that. I think the air conditioning systems that we loaded on the roof were a little too heavy, and so we had to structurally support those. So that delayed us maybe two or three weeks.

But it's being managed very, very well; very disciplined process. We don't think there's really much risk. But there are moving parts. But it's -- we've moved laboratories before and we don't think there is a significant risk there.

You know, there is an important distinction that I think we have a lot more clarity on this quarter. In previous quarters on our calls, we were still in the middle of an integration project and there were unknown risks to what might happen after we'd get into the project.

I would say we feel highly confident that there is really not much in the way of unknown risks that could pop up. And we have processes around everything that we know about. And it's now managing through the process, as Doug mentioned one of our key leaders said, instead of sort of defining and executing on a brand-new project which requires figuring everything out. We've got a pretty good handle on what needs to happen and we are well underway in terms of managing that process.

Okay, that's helpful. And then last one from me in terms of the -- about halfway through the LIS integration thus far. Is there any difference in the customers converting in 4Q relative to 3Q? Or is there any sizable difference? Just trying to get a sense of have you done the easier customers versus the larger or vice versa? Thanks.

We started off -- the Wave 1 was customers that use both NeoGenomics and Clarient. So they were a little bit friendlier. But we are now in Wave 6. So we are moving along very nicely, and we expect this process to wrap up uneventfully in the next six to eight weeks.

Nice job in the quarter, guys. Great progress.

Thank you.

Joe Munda, First Analysis.

A few quick questions here. Doug, I think in your prepared remarks, you talked about the sales force, your rationalizing, keeping the best people of both companies. Can you give us a sense of the numbers, where the rep count is? And then a follow-up to that, you talked about building out possibly a separate sales force pro forma. I mean, could you give us some sense of what that would look like as far as size and timing?

Sure, Joe. So, right now we have about 33 representatives plus six sales managers on our Clinical sales team, plus we have three or four people in the managed care side who really are working very hard to gain us access to these big contracts, plus we have a couple of specialty representatives.

So that's the clinical team. On the biopharma team, we've added, I think, four people recently, and I think we are up to about six now. And these are very experienced people, by the way.

Okay. Okay. In regards to Pharma, I mean, are they selling specifically the MultiOmyx platform or the entire suite of NeoGenomics testing? And the question is, is MultiOmyx the centerpiece of biopharma? How should we, I guess, look at it? Is it a component or is it the actual centerpiece of that segment?

Yes, these sales representatives in the biopharma area are selling our whole product portfolio. And MultiOmyx is a very interesting technology, but it's one of a variety of technologies. As you know, we offer -- and we haven't really sold a heck of a lot of flow cytometry to the pharma industry, but we have flow cytometry; some very interesting aspects of that as well.

Molecular and our next-generation sequencing capabilities. We have FISH testing, we have MultiOmyx, we have a huge and probably one of the broadest immunohistochemistry menus around in digital pathology. So they are selling the whole offering.

Okay, okay. And then I guess on the acquisition front, would it be -- what would interest you more? A platform like -- similar to MultiOmyx or an established business generating revenue that you could bolt on? Or does there need to be technology involved, let's say, if you were going to do an acquisition on the Pharma side?

There does not need to be technology involved. So, in terms of acquisitions, we are quite interested in acquisitions where we have synergy. And we said that all along, where there's revenue and cost synergy, we'd be quite interested. But as our strategy is evolving, we are also quite interested in providing capabilities to our clients that's going to allow them -- allow us to add value.

We're going into an era of sort of value-based reimbursement and informatics and data, and powerful analytics and algorithms are very important to that. So we would be quite interested in leveraging the data that we have in oncology with clinical data, and using tools, applying tools, to allow for us to improve the lives of patients who are suffering from cancer.

And not only drive better outcomes, but at a lower cost. And so we would be very interested in data type products and informatics type products. So -- and I think those things would be high on our list.

And it would probably still be in cancer, correct? Or would you be willing --?

Yes.

Right. Okay.

Carolina Ibanez-Ventoso, Janney Montgomery Scott.

On for full night. You've covered a lot of ground already. So just one question from me. On your prostate cancer test that you announced last month, the formation of a special committee, the development committee with your partner, the Health Discovery Corporation, could you provide some commentary on the involvement -- on their involvement in the development of the test? Thank you.

So, we are aware that Health Discovery issued a press release in late September. We are in discussions with Health Discovery to clarify certain aspects of our relationship, but it's important to note that our prostate cancer test does not use the support vector machine technology. It's something that we have used a different approach for.

And so we expect to conclude -- we have very excellent relationship with Health Discovery Corporation. We expect to conclude clarifications on our agreement here in the next few months.

Okay, thank you.

We have a couple of questions that have come in via email that have not actually come up yet. Why the big bad debt reserve? I like 74 days. George, do you want to comment on that? I don't think it's too different from where it used to be, but.

Yes. No, I mean our DSOs are -- I think actually we calculated 76 days based on our analysis, but that was actually down slightly from the start of the year. But Clarient did come in with higher bad debt historically, so you will see a little bit more bad debt this year than in prior years with just NeoGenomics. But we do expect over time that bad debt rate will come down as they migrate more to Neo's billing processes and systems.

Great. And here is one on the delta and other current assets -- and this one is actually fairly easy. We reversed out $16 million of deferred tax assets in the earlier part of this year. And as a result, it was reversed out against deferred tax liabilities. And so, you'll see our deferred tax asset -- or our other current assets are down considerably from year-end.

Let me see -- we got one more on, what sort of interest rate do you think you'll be able to achieve on the bank debt? We are currently in conversations with a range of players. That will depend on whether we use a traditional money center bank or more of an alternative financing source.

We currently pay, after you work out all the different fees and amortization of costs on it, somewhere north of 8%. But we believe there's an opportunity to cut that approximately in half, if we can get the right kind of money center bank involved in our relationship. And so we are optimistic that we can make substantial reductions in the interest rate.

I think we have no further comments via email. So, Doug, if you could wrap us up?

Okay, good. Thanks, Steve. So, as we end the call, we want to recognize the approximately 947 NeoGenomics team members around the country for their dedication and commitment to building a world-class cancer genetics testing program. And on behalf of our NeoGenomics team. I want to thank you for your time joining us this morning for our third-quarter 2016 conference call, and let you know that our fourth-quarter 2016 earnings call will be on or around February 22 of 2017.

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

This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time.