Full Press Release Details
Fourth Quarter and Full Year 2016 Financial Results
Doug VanOort - Chairman and CEO
George Cardoza - Senior Vice President and Chief Financial Officer
Steve Jones - Executive Vice President
Bill Bonello - Craig-Hallum
Amanda Murphy - William Blair
Drew Jones - Stephens
Paul Knight - Janney Montgomery Scott
Chris Lewis - ROTH Capital Partners
Raymond Myers - Benchmark
Bryan Brokmeier - Cantor Fitzgerald
Joe Munda - First Analysis
Greetings and welcome to the NeoGenomics' Fourth Quarter and Full Year 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 CEO. Thank you, Mr. VanOort. You may begin.
Doug VanOort - Chairman and CEO
Thank you, Tim. Good morning, everyone. I'd like to welcome everyone to NeoGenomics' fourth quarter and full year 2016 conference call and introduce you first to the NeoGenomics team that's with us here today. Joining me in our Fort Myers headquarters is Steve Jones, our Executive Vice President; George Cardoza, our Senior Vice President and 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 Vice President and Chief Information Officer. Dr. Maher Albitar, our Senior Vice President, Chief Medical Officer and Director of R&D, is joining us from our Aliso Viejo Lab in California.
Before we begin our prepared remarks, Steve Jones will read the standard language about forward-looking statements.
Steve Jones - Executive Vice President
This conference call may contain forward-looking statements which represent our current expectations and beliefs about our operations, performance, financial condition and growth opportunities. Any statements made on this call that are not statements of historical 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.
Doug VanOort - Chairman and CEO
Thank you, Steve. In this morning's call, I will put 2016 into context, comment on fourth quarter performance, update you on the status of the Clarient integration, and conclude with a look forward to growth and value creation opportunities for our company this year and over the next few years.
2016 was clearly a transformational year for NeoGenomics. We more than doubled the size of the company with 2016 revenue of $244 million compared to $99 million in 2015. We significantly deepened our oncology testing menu and capabilities and now have a leading position in many geographic areas and in every key testing discipline for oncology.
We added an exciting new growth business, serving the pharmaceutical industry and are now positioned as an emerging lab services leader for immuno-oncology. And importantly, our adjusted EBITDA more than tripled to almost $35 million from about $10 million in 2015.
In addition, we leveraged our $21 million in cash flow from operations and improved financial position to redeem more than half of the Series A Preferred Stock we issued to GE in connection with the acquisition. We ended the year with a strong new bank syndicate and with borrowing capacity and financial flexibility to pursue our growth strategies.
Now, just 13 months after our acquisition of Clarient, we have successfully migrated all of the approximately 2,500 Clarient clients and today every single one of our clients is using a common service offering, a common laboratory information system, and a common billing system. With this migration effort completed, we can now build on our strengths in a common, efficient, and more effective manner, and unlock meaningful synergies.
Integrating an equally sized laboratory into our operations has been a challenging and complex undertaking that could have stretched into a number of years rather than a number of months. It's noteworthy that our team was able to accomplish this while achieving a 15% full year pro forma volume growth in our core clinical genetic testing business at the same time.
Most importantly, NeoGenomics is now exceptionally well positioned as a leader in our industry with a unique business model, scale and outstanding opportunities to grow and create value for our employees, our clients, and patients and for investors. So, we're very pleased with this transformation and are proud of the results we achieved in 2016.
That context is important as we review our fourth quarter results. Our teams did an excellent job with the very complex work of integration. To successfully migrate Clarient accounts, we focused our full attention on service and client retention during the quarter.
At the same, time, our California labs were transitioning their work to common processes while still operating out of two laboratories. During the same time, our volume of immune-oncology PD-L1 testing grew enormously. All of these dynamics placed a lot of stress on our operations.
To provide a clearer understanding of the fourth quarter, let's review our key business metrics.
Fourth quarter clinical genetic test volume growth was good with volume up 140% in total or 16% on a pro forma basis with Clarient included in both years. Average unit price was down more than expected at 10.5% due to the effect of mix changes. However, cost for test reduction was exceptional with a 10.7% reduction compared with last year, which fully offset the price reductions and allowed us to hold gross margins steady.
Service levels continued to be exceptional, other than in certain California lab departments which experienced large and sudden influxes of volume particularly of PD-L1 testing, which we are diligently working through.
Pharma Services revenue was down slightly on a pro forma basis compared with last year. And in the billing area, days sales outstanding increased by two days from the level reported on December 31, 2015.
There are many underlying dynamics affecting these key business metrics and I want to provide some context and insight in a few important areas.
Let's start with volume. The 16% pro forma growth and clinical genetic testing volume was very strong, especially given the fact that we're in the midst of such a large integration effort. To grow volume at the same time as we're migrating so many clients during the quarter is actually remarkable.
The nature of the growth was somewhat unusual. Nearly all of the volume growth occurred in two different test types, molecular and immunohistochemistry. Molecular volume continued to be strong because of our leading molecular test menu and particularly as an expanded molecular offering for the Clarient client base. Immunohistochemistry volume grew primarily because of the incredible growth in immuno-oncology related therapies.
Specifically the FDA approved companion diagnostic test, PD-L1 grew dramatically for us. NeoGenomics was a leader in performing clinical trials testing for this biomarker and we were capable of performing the test clinically as soon as the Keytruda and Opdivo drugs were approved. This led to sudden and dramatic growth in the quarter. In fact, based on external sources and our own analysis we believe we currently have close to 50% market share for this important and growing test. Both the molecular and PD-L1 volume growth demonstrate the strength of our business model and present exceptional long-term opportunities but they stressed our operations in the short term.
Average unit price for our testing services declined as a direct result of the outsized growth in molecular and IHC testing. In fact, nearly half of the fourth quarter decline in average unit price was due to higher growth in these two testing categories relative to our other tests. In terms of PD-L1, we had priced the service at the same price as our typical IHC service and we gained strong market share. Notably, the cost of the FDA approved PD-L1 supply kit is more than four times higher than a typical IHC test. So, this also affected our profitability in quarter four and we expect this trend to continue in the short term.
Having now achieved a high market share, we are reevaluating our pricing strategy and refocusing on costs. We expect to take action shortly that will improve profitability on this test as the year progresses.
The 10.7% decline in cost per test was exceptional and reflects the beginning of synergy realization from the Clarient acquisition and the benefit of scale. About a third of the cost per test reduction resulted from product mix changes and two-thirds from improved operating efficiencies.
We ended the year with 969 full-time employees which was up 105% from 473 people just prior to the Clarient acquisition at the end of 2015. Employee growth of 105% should be viewed in relation to the 155% clinical genetic testing growth and a pharma business that's nearly 20 times larger. Clearly, productivity has improved in our business with scale and those trends remain healthy.
In terms of synergies from the Clarient acquisition, frankly, we have yet to realize the bulk of them. In fact, I might argue that we had some negative synergies in the fourth quarter as we operated two different LIS systems, two different billing systems, and had significant migration of many clients from one system to another. We continue
to expect the same level of strong cost synergies as we originally planned but now expect that benefit to begin to be more fully realized starting in the second half of 2017.
NeoGenomics prides itself on exceptional and consistent service. And this has been a hallmark of our success. And clients who have experienced our service levels regularly refer us to others. During the last few weeks of 2016, the service levels in our California labs did not meet our internal requirements as the client migration was being completed.
In some cases our clients told us that our service levels had become similar to other lab service levels. This is not the "NeoGenomics way" and, as a result, our people necessarily moved the full focus of their attention to operational matters and to client retention.
As we now speak, most of our service levels have returned or are quickly returning to the exceptional levels for which we are known. We expect that exceptional service levels will become consistently delivered once again as we complete the combination of our Irvine and Aliso Viejo labs at the end of March.
Having managed many large lab integrations in my career, I can say that they haven't gotten any easier. In the case of the Clarient integration, we planned very well and executed many aspects in an outstanding fashion. We prioritized speed of integration, and had a goal of 100% client retention. However, there is no question that as we completed the process of migrating Clarient clients as the year ended, we stressed our operations in a few different areas. Our teams have been working diligently and we are moving well through these growth pains.
Since accountability is one of our core values at NeoGenomics, I want to give you an integration progress report and rate how we've done so far in key areas to provide you with some context for this process.
Our teams did a great job with the hundreds of activities necessary to extract Clarient's operations from GE. We seamlessly took over every back office function that GE previously provided, including payroll and payables and accounting and information systems and human resources. For this activity I believe our team deserves very high marks.
We restructured the sales team, eliminated duplicative territories, added special teams and installed new compensation and management structures. And a couple of weeks ago, we held our National Sales Meeting and it couldn't have gone better. We have a very experienced, professional and dedicated team of 67 commercial people who are ready to move their focus from integration and get back to growth activities. I believe our team deserves very high marks for the way we've integrated our sales teams.
In billing, our team deserves a solid rating. We restructured the Clarient billing process, eliminated outsourced vendors, hired our team and got the billing process under good management and we now have all clients using the NeoGenomics billing system. We did stress our billing operations in December, though, because of the large influx of claims being billed exclusively through the Neo billing system during the last few months of 2016. DSOs increased to 84 days at the end of 2016, but this is still a major improvement from Clarient's standalone DSO level of 108 before the acquisition.
We had to train the Clarient billing team on the Neo billing system and productivity dipped initially as people managed through all the complexities of the new system. While productivity has increased over time, we do have a backlog currently in getting claims billed to insurance companies. The backlog has not been visible to our clients but has temporarily resulted in delayed cash collections and increased DSOs. Our teams are making considerable progress and we see a clear path to further reductions in DSOs over the next few months.
I believe our team deserves high marks for planning associated with migrating Clarient accounts to the NeoGenomics system in a disciplined manner in eight predetermined waves ending in October.
However, we deserve a much lower mark for execution of the client migration process. I reported to you in October that half our larger clients had been migrated by then and so the other half migrated in November and December.
The first half of client migration was very smooth but the second half was not so much. Migrating a large volume of accounts in November and December caused stress on our operational processes such as logistics, order entry, and billing. Although the quality of our testing processes remained outstanding, the challenges in logistics, for example, caused client dissatisfaction.
Frankly, these operational issues could have and should have been prevented. We recognized the issues and have mobilized ourselves accordingly. There is considerable effort now being made and we expect our operating processes to be that and better balanced by the end of quarter two.
I believe our teams deserve very solid marks for the Aliso Viejo facility renovation, which is moving along well. We knocked down a lot of walls, built a state-of-the-art molecular lab facility with lots of capacity, standardized equipment and moved every department to temporary space as construction was being performed. I reported to you in October that we expected to be done at the end of February, but we are now scheduled to complete this activity by the end of March as a result of construction delays.
In five weeks we are moving the Irvine lab, people, equipment and processes into our completely redesigned Aliso Viejo lab. We have excellent plans in place and are working very hard. We're looking forward to a good move and to all being in one lab facility with all the accompanying benefits that that provides. We're also looking forward to showing it to investors on May 25th at our annual meeting and first ever Analyst Investor Day which we'll hold in the Aliso Viejo lab.
Our rating for client retention frankly is not yet in. So far, one client has told us they're dissatisfied and plan to leave. However, we know we've stretched the patience of several others, not for quality of testing by the way but because of logistics errors or order entry errors. And client retention at this point is actually excellent, but we will need to wait until our next earnings call before we can give you a full accounting on this aspect of the integration.
Finally, I want to comment on our Pharma Services division. After an exceptionally strong first half of 2016, we experienced weaker revenue performance in the second half of the year. In fact, revenue in quarter four was about the same as in quarter three at a little over $5 million. We have expected Pharma Services revenue to bounce back nicely from quarter three levels, but that didn't happen.
We reported in October that we have rebuilt our pharma commercial organization and are also rebuilding the pipeline. We're encouraged by the strength of our commercial team, our strong client relationships and our backlog of projects.
Many clinical research organizations regularly report their backlog of signed contracts as an indicator of future revenue. We've reviewed our backlog over the past several months and have enough confidence now to begin to report it to investors. At the end of 2016, our Pharma Services backlog was $37 million compared with $20 million at the beginning of the year. This 85% growth in backlog is very encouraging for us and supports our belief that Pharma Services will be a strong source of growth for us in the future.
We're also encouraged by the breakthrough that immunotherapies are providing in oncology and by NeoGenomics' position as a market leader in PD-L1 testing. We're leveraging our early leadership in immuno-oncology testing as an area of promising growth for the company, both in clinical trial services, new therapeutics, as well as clinical testing as the new therapies are improved for clinical use.
We're also investing in our Pharma business, both in human resources and lab infrastructure. I reported in our last call that in response to requests from several of our global pharma clients, we're finalizing plans to expand internationally. I can now report that we will be opening a lab facility in the Geneva, Switzerland area to support European clinical trials. This move is essential to our strategy of supporting global clinical trials and has been well
received by those clients with whom we have shared our plans. We expect this facility to become operational in the second half of the year.
The bottom line here is that we believe our Pharma Services business has great long-term growth potential and we are investing in it. It also has the added benefit of helping keep NeoGenomics at the forefront of developments in the field of oncology.
In our last call, I discussed ten key growth and profitability drivers that offer individually and collectively enormous value creation opportunities. Although our management operations and sales team are presently short-term focused on completing the final aspects of the Clarient integration process, we remain dedicated to market share driven growth as a result of innovation and great service. Our sales team is extremely motivated to get the integration behind us and return their full efforts to sales. And, we remain committed to being a company known for operating discipline and can translate that revenue growth into earnings and cash flow growth.
With that as a backdrop, here once again are the ten key growth and profitability drivers for NeoGenomics over the next few years that we reviewed on our last call:
In each of these ten areas there are opportunities that we are actively pursuing and we think 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 fourth quarter results in more detail and lead us through a Q&A session.
Steve Jones - Executive Vice President
Thanks, Doug. Before we open it up for questions, I would like to briefly touch on a few financial highlights from the quarter.
We're pleased to report $60.5 million of revenue in quarter four, a 122% increase over the prior year driven primarily by the inclusion of Clarient results. Approximately $53.8 million of this revenue was derived from the core clinical genetic testing business, $1.5 million from Path Logic, and $5.1 million from the Pharma Services division.
Consolidated gross margin was 45.1%, a 30 basis point increase from the 44.8% reported in Q4 2015. This increase in gross margin was driven by the 10.7% year-over-year decrease in average cost of goods sold for clinical genetic tests to $192 per test. 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 expense increased by $12.8 million or 73% from Q4 2015. However, as we discussed in the press release, $1.5 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. And an additional $3.5 million of this
increase was due to a non-cash impairment charge in quarter four to write off the remaining unamortized, intangible values associated with the Path Logic acquisition and a licensing agreement.
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 178% year-over year to $8.1 million and adjusted EBITDA margin grew by 280 basis points to 13.5%.
As we discussed in the press release, we incurred $3.9 million of one-time expenses in connection with refinancing our bank facility of December 22nd; $1.1 million of this amount was due to prepayment penalties and $2.8 million was to write off the remaining unamortized debt issuance costs associated with our original bank facility. Per GAAP regulations, all of this was charged to interest expense in quarter four.
As we discussed in our December 22nd press release, we were able to refinance our existing bank facility, which had an interest rate of LIBOR plus 700, with a new bank facility which is priced at LIBOR plus 300, with further interest rate step downs as we continue to reduce leverage. Thus, although we nearly doubled the amount of bank debt outstanding, we do not expect a meaningful increase in our overall amount of interest expense this year.
This refinancing activity enabled us to redeem 8.067 million shares or 55% of the Series A redeemable Preferred Stock at a redemption price of $6.82 per share, for a total of $55 million. This redemption partially eliminated an increasingly expensive equity instrument and had the effect of reducing our fully diluted "as-converted" shares outstanding by 8.5%.
Fourth quarter GAAP net loss available to common shareholders was negative ($14.2) million and GAAP diluted EPS was negative ($0.18) per share. This compares to GAAP net loss available to shareholders of negative ($1.6) million and diluted EPS of negative ($0.03) per share in Q4 2015.
As disclosed in the press release and in previous earnings calls, we believe that in order to compare the net income related to the true operations of the company on a more consistent basis across periods, it is appropriate to adjust GAAP net loss available to common shareholders to exclude: 1) the non-cash amortization of intangibles; 2) the non-cash stock-based compensation expenses that are partially driven by changes in the company's underlying stock price in any given quarter; 3) the non-cash deemed Preferred Stock dividends required by GAAP accounting; 4) the non-cash amortization of the beneficial conversion feature related to the Preferred Stock which is also required by GAAP accounting; 5) the non-cash impairments of intangible assets; and 6) if applicable in a reporting period, any acquisition-related transaction expenses, debt termination fees and other one-time or nonrecurring income or loss items.
We refer to this measure as adjusted net income and on a per-share basis adjusted diluted earnings per share, and we have included a table with how this is calculated in our earnings release.
In the fourth quarter adjusted net income was $4.4 million, a 52% increase over the $2.9 million in last year's fourth quarter, and adjusted diluted EPS was $0.05 per share compared to $0.05 per share in Q4 2015.
We finished the quarter with 969 full-time equivalent employees, contract doctors and temps versus 947 as of September 30th and 885 FTEs as of December 31, 2015. Of the 84 people we added to our payroll since year-end 2015, at least 20 were related to internalization of the previously outsourced GE functions. Adjusting for this we added just 64 people or 7% to our workforce, which is less than half of our pro forma clinical genetic test volume growth rate for all of 2015.
Before opening up it for questions I would like to comment briefly on the 2017 guidance we issued this morning. Given the temporary integration challenges we experienced in Q4 which we expect will continue to ripple through Q1 and into Q2, we believe it is prudent to lower growth expectations in the first half of 2017 and push out the realizations of some of the expected EBITDA synergies until later in 2017 and 2018. As a result, we are recommending that analysts reset their 2017 revenue estimates to $260 - $275 million and their adjusted EBITDA
estimates to $42 - $50 million. We also recommend that full year 2017 revenue and adjusted EBITDA growth be more heavily biased towards the second half of the year.
Embedded in these projections is an assumption that our average revenue per test in our core clinical genetic testing business will decrease by another 5 - 7% for the full year 2017 across all payers, to approximately $355 - $360 on average for the full year. This estimate of AUP decreases factors in the approximately 19% reduction to Medicare flow cytometry reimbursement that went into effect in 2017, as well as continued evolution in our test mix towards lower priced molecular and IHC tests, which we expect to drive most of the decreases in AUP in 2017.
As discussed in the press release, we are currently projecting adjusted net income to increase from $14.4 million in 2016 to approximately $15 - $19 million in 2017. And adjusted diluted EPS to increase from $0.15 per share in 2017 to $0.17 - $0.22 per share in 2017.
For context here, a good analogy would be that we ate a big meal in the fourth quarter and we're going to need a quarter or two to digest things. As a result, we think it is prudent to push out some of the growth and synergy realization activities that we were expecting this year by a quarter or two. We still fully expect to realize all of the $24 - 30 million in synergies that we previously forecast, however it is now likely that we will only realize $7 - 8 million in synergies this year, instead of the $10 - 12 million we had been expecting.
I would also like to draw everyone's attention to our announcement this morning that we are planning on having our 2017 annual meeting with shareholders at 8 a.m. on May 25, 2017 at the Renaissance Club Sport Hotel in Aliso Viejo, California. This hotel is just a mile from our Aliso Viejo laboratory facility. Following the annual meeting, the company will hold a series of presentations for analysts and investors to highlight recent developments of interest. In addition, guided tours of the company's newly remodeled Aliso Viejo lab facility will be available. If you believe you will attend, please let us know by contacting Ms. Sherry Terzian, at sherry.terzian@neogenomics.com, so that we can get an accurate count for the hotel.
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 call via webcast only and would like to submit a question, please feel free to e-mail 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.
Thank you. At this time we will be conducting a question-and-session. [Operator instructions]. One moment please while we pose for questions.
Our first question comes from the line of Bill Bonello of Craig-Hallum. Please proceed with your question.
Q: Good morning, guys, a couple follow-ups here. So, the move in price, or in ASP, is that 100% related to mix or are you seeing any kind of price pressure either from payers or large client bill customers?
Steve Jones - Executive Vice President
It's mostly mix related. It's the continued evolution of lower priced molecular and IHC testing, which are growing much faster than the rest of the business and it's creating pressure on our overall average unit price. In terms of reimbursement, we always get a little bit of pressure from clients as time goes on, but it doesn't really wind up being very meaningful on a sequential basis.
Q: Okay. And then there's customers and their customers. Can you give us any greater sense of the client that said they were dissatisfied and planning on going somewhere else? I think you originally gave client attrition estimate of $6 million or something. Are you still within that range or how big a deal is this particular client?