Greetings, and welcome to the NeoGenomics' Third Quarter 2017 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to Doug VanOort, Chairman and CEO. Thank you. Please go ahead.

Thank you, Brenda, good morning. I'd like to welcome everyone to NeoGenomics' third quarter 2017 conference call. Joining me from our Fort Myers headquarters is Steve Jones, our Executive Vice President; George Cardoza, our Senior Vice President and Chief Financial Officer; Bill Bonello, our Treasurer, and Director of Corporate Development; and Jessica King, our Director of External Reporting. I would also like to welcome and introduce Kathryn Mckenzie, our Vice President of Finance and Principal Accounting Officer who is joining us for our the first time on this call. Dr. Maher Albitar, our Senior Vice President, Chief Medical Officer, and Director of R&D, Rob Shovlin, President of our Clinical Services Division and Deena Murphy our Director of Billing are 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.

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

Thank you, Steve. I will begin my comments this morning by providing some context for our quarter three results we pre-announced two weeks ago. I will then comment on our guidance for this quarter four and conclude my remarks by describing our analysis of the current environment in our outlook for the longer term. I won't sugarcoat this, we are disappointed with our third quarter results. We did not deliver what our investors were expecting and we accept full accountability for that that said there are also some very positive trends in the third quarter and we remain very optimistic about our growth prospects. There are four areas in which our results differed from what the investment community expected. I'll give you a short explanation of each of these and of course will answer any questions you may have about any of these during the Q&A period. The first difference between our results and expectations resulted from Hurricane Irma and to a lesser extent Hurricane Harvey. Our Houston and Fort Myers facilities were both directly impacted by these hurricanes, there's not much more we could have done to prepare for these disasters. We executed our business continuity plans and our team did an outstanding job. In fact in my opinion it was an A plus performance. Even though we had lab closures and our people and systems experienced significant disruptions our clients barely felt any impact at all. I'm extremely proud of the manner in which our teams managed through these natural disasters. The second difference has to do with our divestiture of Path Logic, this divesture reduced revenue but had a slightly positive impact on adjusted EBITDA for the quarter. As you know we have been attempting to divest Path Logic for a while because it was no longer…

Thanks, Doug. Before we open it up for questions, I would like to briefly touch on a few financial highlights from the quarter and then describe a new accounting standard that will go into effect next year. Third quarter consolidated revenues were $63.1 million, a 3.8% increase from last year. Clinical genetic testing revenue increased 3.5%, Pharma Services increased 37% and PathLogic revenue increased 78% as a result of its divestiture on August 1. As discussed in the press release, we estimate the 2 hurricanes depressed volumes by approximately 1.5% and revenue by approximately $1 million in the quarter. Average revenue per clinical genetic test was $342, an 11.2% reduction from the prior year. The revenue adjustment related to unbilled tests was responsible for approximately $8 of the revenue per test decline. Consolidated gross margin was 45.7%, a 70 basis point increase from the 45% reported last year. This improvement was driven by the 11% decrease in Cost per Test as well as a 350 basis point increase in our Pharma Services gross margin from last year. The sale of PathLogic also helped to improve gross margin. We estimate that we incurred approximately $300,000 of overtime and other expenses directly related to the hurricanes which depressed the Cost per Test improvement by approximately $2 or 1%. Incremental margins in our Pharma Services business continue to be strong with approximately 2/3 of the incremental Pharma Services revenue from Q2 to Q3 falling to gross margin. Consolidated SG&A expenses increased by 19.9% or $5.2 million from last year's third quarter primarily as a result of increases in bad debt and personnel expenses including stock-based compensation. Bad debt expense increased by $2.3 million and personnel expenses increased by $1.9 million from last year. Doug has already discussed the changing payer dynamics with respect…

[Operator Instructions]. Our first question comes from the line of Amanda Murphy with William Blair.

I'm sorry, I jumped on a bit late and I caught the end of your comments Doug around prior auth and Medicare. I was just curious, did you also talk about those dynamics with commercial payers given some of the changes Anthem has made as well as United kind of upcoming.

Sure, I'll try Amanda. Thank you for the question. We are seeing that more payers are adopting prior authorization procedures. UnitedHealthcare I think begins -- at the beginning of November and we're gearing up for that. There has been a number of payers that have then requiring prior authorization. Frankly, that's one of the reasons that our bad debt expense has crept up this past quarter. I think that we have very good processes in place engaging our sales team and our billing operation. So that would be pretty well prepared particularly for the United prior authorization for molecular testing.

Okay and I guess you gave some quantification, I think that was just Medicare right. So I think people are just trying to figure out what's your exposure, obviously 25% of your business is commercial, the most of it is still hospital-based. How much of a risk is this prior auth component versus the Clarient component, which obviously after a year I think you said you kind of write those off anyway. So that can maybe more temporaneous. So that's kind of what I'm trying to get handle on?

Yes, let's try to put it in some perspective here. The primary issue that we're facing or we have faced for prior authorization and denial -- I'll say denials generally around molecular testing had been for what we call neotypes. These are disease specific multi-gene molecular panels. In total, the amount that we bill to Medicare and managed care for these, even though they've increased a lot is about 2% of revenue.

And the reason, Amanda that percentage is still low is we do have a lot of payers set at 0 for those. So we don't even record revenue. If we see a history of a payer not recording -- not paying for the panels, we will set our expected revenue at 0 for that. With respect to quantification even on the UnitedHealthcare, we know on 11/1 they are putting the pre-authorization in place for all of their molecular tests. Our total sort of the whole population for UnitedHealthcare was about $0.5 million and literally that would assume that we got no pre-authorizations which clearly is not going to happen. So we've been working with our sales team to roll out the communications what clients have to do and again it's a partnership with our sales team to try to go through and basically try to mitigate that risk to the extent possible. I'm not saying it's going to be 0, but I don't think it's going to be anywhere near the full $0.5 million. I think we'll able to get it down substantially and hopefully have this be a relatively small blip.

And Amanda, we've talked about this in the past, but our percentage of revenue from client bill accounts which are mostly hospitals is increasing each year. It's up over 60% so far this year and we think that trend will continue to modestly increase over time. So we have far less exposure to this issue than perhaps some other labs that don't have a client bill component in their revenue mix.

Is Anthem a big payer for you because they obviously have one that's live now, a prior auth program?

Yes, Anthem is a payer and it did go into effect July 1. We have been successful in appealing some of their denies and some we haven't been -- but thus far it's not been a big issue with respect to Anthem per se, but it's something where like every one of these programs that goes into effect, we had to adjust our processes, our people have to adapt to the rules that the payers put in place. In some cases, they use service companies to manage the prior auth period and the service companies don't really have exact add-on, exactly what we have to submit when and so it's a process to figure out how to work with one another and we'll go through a bit of that process with UnitedHealthcare as well as.

Our next question comes from line of Drew Jones with Stephens.

I wanted to dive into the G&A expense a little more, you guys obviously walked through the bad debt expense in detail, you talked a little bit about stock-based comp increasing but if I take 3Q results combine it what you've guided for 4Q, it implies that G&A is still going to be up on an absolute dollar basis, $6 million to $7 million year-over-year versus 2016. Can you give us a feel where that increase is coming from?

We have sort of set out that we expect to continue to have elevated levels of bad debt for quarter four. So a lot of it does come with quarter 4 bad debt. In addition, our stock is, even though it's off 25% in the last 2 weeks, it's still up on a year-to-date basis and what happens when the stock goes up, we have a number of our contract doctors in California that have options and warrants and those get valued each quarter on using variable accounting because that's the GAAP rule and unfortunately in California it's -- they have something called a prohibition against the corporate practice in medicine, so your doctors can't be employed. They form professional service corporations and they have sort of exclusive contracts with us, but since they don't meet the formal definition of an employee, you have to account for the stock-based compensation component on a variable basis and so in quarters like the third quarter where our stock went up quite dramatically, we're going to have higher bad debt expense. In quarters where our stock price goes down, there is actually recoupment of bad debt expense. So it's just -- we're unable to tell what it's going to be. So in our guidance assumptions we've assumed a stable stock price in the fourth quarter.

I guess, even when I back out the impact from the bad debt expense and stock-based comp, we're still seeing a little bit of an increase year-over-year in G&A, I guess if we can just isolate it on the third quarter, I guess, I was under the impression that might not be the case given the lab consolidation that occurred in 2Q. Are we just a little bit or we are still a couple of quarters away from realizing the synergies there?

So let me give you some context, the total SG&A went up by about $5.2 million. We said that the personnel and related portion of that was $1.9 million of the increase and the stock-based compensation component in G&A, stock-based compensation appears in multiple different places in cost of goods sold as well but in the G&A component, it was about a $400,000 increase. The bad debt was the biggest single increase with -- on the order of $2.4 million on a year-over-year basis.

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

Just wanted to go back to the bad debt and the prior authorization that Amanda was talking about. With United kicking in on November 1, I think it's my understanding that [indiscernible] in Florida and Texas aren't affected by that change, is that how you guys are understanding it as well?

Yes, that is correct. Florida already had a program from Beacon Laboratory Benefit Solutions, BeaconLBS, but the model in Florida is fairly different than the model in the other 49 states. I don't believe they rolled this out into Texas yet, but Florida was sort of the combination of really a narrow network with the pre-authorization model. The other 49 states is really BeaconLBS are really acting as just a pre-authorization company, similar to what Evercore or some of these other companies do. So basically it's not excluding providers, any provider can participate, you would just need to register and get your approvals through them. So Florida was a little bit different, but again, as we said earlier our total, if you look at the whole population of UnitedHealthcare molecular would be about $0.5 million and again that would assume that we actually didn't get one pre-authorization and we think we're going to have a fairly high success rate given our sales teams engaged, our managed care teams engaged and we have a lot of communications with clients as to what the requirements are and even on the backend if clients aren't cooperating, we are going to have hard conversations to do there potentially although perhaps having the client bill them or certainly making hard decisions along those lines, but clearly I think our risk is moderate and then certainly we're going to do a lot of things over the coming weeks if this rolls out to mitigate that.

Sure and then, how long do you think it will take before your bad debt normalizes and I guess when I say normalized, what sort of levels do you think it will actually get back down to?

Well, on January 1, we may not have bad debt anymore. I guess that would be part of it, but certainly, we're at 6.8% year-to-date. I think clearly the Clarient integration was a factor in that as Doug said, our billing team had some performance issues earlier this year as they struggled with the integration. So we think there is some room for improvement. I wouldn't go crazy certainly, but obviously for next year we're hoping to bring that 6.8% down some.

Great and then one quick question for you Doug, in your prepared remarks you talked about preferred provider relationships with some national healthcare systems, just wondering if you can give any more color as to which systems, how big we're talking and then also on the oncology side, what type of groups you're targeting because I think U.S. Oncology already has a relationship with Quest?

Yes, Kevin, thank you. We were engaged with a lot of the large hospital organizations. I think you know that we have agreement that we've announced with Premier. There are a lot of other large groups that we have been engaged with. We love to be able to tell you the name of the organization that we just contracted with, but we don't have their permission to do that, but these are large organizations and we are meeting with a lot of success in contracting with these GPOs. Relative to the oncology groups, we've had a lot of recent success talking with, meeting with a number of oncology groups and these range in size from a dozen oncologists to 100 oncologists or more and we think that we have a unique business model and solution that might help them as they engage in the new value-based payment model systems and try to do engage even further in this environment of precision medicine and so we've had a lot of success meeting with them and we've actually closed a few and we think that our pipeline is pretty robust and we're looking forward to closing a number of others over the next several months.

Next is Paul Knight with Janney Montgomery Scott.

Doug, can you talk to the pricing down 11% in the quarter. How much is related to PDL1 and the lower price of that particular test?

We think about 2/3 is caused by the huge growth in PDL1 testing on a year-to-date basis.

And molecular testing?

And some molecular testing, yes. Now, I would just add Paul that the big growth in PDL1 testing for us occurred in the fourth quarter of last year and accelerated quite a bit in November and December. So we believe that the impact of that on price will begin to modulate as we go forward here.

Paul, in addition 2% of the 11% reduction is a result of this one-time revenue adjustment. In order to look at it, you probably ought to normalize that impact on entire year-to-date basis. So our actual revenue per test on a year-to-date basis would run closer to $350.

Okay, in your opinion in a still a price per test decline world of low single digits or where are we do you think?

Paul, I don't know if this is helpful for people, but I did a little history, looked at history the other day and when I started 34 quarters ago, our price per test was $660. So now it's about $350 and even though that's occurred every quarter and every year, we've been able to manage through it pretty successfully. I think at this point, we expect less reduction on an annualized basis going forward in our particular business and we've said that we could suggest that we model maybe 3% kind of declines, absent the impact of mix. And if you think about next year, for example, we've got PAMA which is impacting the lab industry in general. For us, even though we think that whole approach by CMS is flawed, the impact to NeoGenomics in 2018 will be less than a $1 million from PAMA. We have some residual impact from reductions in flow cytometry, but the combination of those would be well within the guidance that we've provided for reductions in revenue per test.

Our next question come from the line of Nick Jansen with Raymond James.

My first is on volume growth. You've had very impressive volume growth this year partly due to some of this explosion that you've talked about in PDL1, but how confident you are as that moderates beginning in the month of November that this kind of mid-teens range is the right range because I would assume that right now you are not growing mid-teens in the other categories given some of the integration related noise with Clarient. So just wanted to kind of get your thoughts on maybe growth recently ex-PDL1 as we kind of frame our expectations for '18 revenue growth.

Yes, thanks for the question. First point I would make is that our growth has been accelerating. That's important to know because I think we said early on in the year that our sales team was not spending a lot of time closing new accounts. That's changed and so now they are back to hunting and so our growth in our clinical business is clearly accelerating. As the PDL1 volume normalizes as we get into the last part of the fourth quarter and into 2018, we expect that our guidance to you, our long-term guidance of volume growth in the clinical business in the mid-teens is pretty good.

Okay, that's good and as we think about kind of just building the bridge from kind of your 4Q EBITDA guidance range of $9 million to $10 million to something in 2018, what are the key puts and takes that we should be thinking about. The way I look at it is, you kind of annualize the 4Q number, you have 25% to 30% incrementals on, let's say, plus or minus 10% revenue growth, is that the right way to think about it or is there something another big headwind to consider for '18 or a potential good guy as we frame up kind of intermediate term EBITDA expectations for the organization?

Yes, I think that you're right. So what we would do is -- first of all it's all about growth for us. So our quarter 4 guidance is somewhat depressed because of the bad debt challenges that we've described. We would hope that that would get better, but in addition to that, we're estimating that we're going to have some very strong growth in both the clinical division and the Pharma division we would expect as we've described, 25% to 35% of that would fall to the adjusted EBITDA line. Obviously, we try to do better than that, but we think that's a reasonable expectation for a reasonably well-managed company.

One thing I'd add, we won't give 2018 guidance till February and we've been saying now for a couple of years that we expect 25% to 35% incremental EBITDA on each incremental dollar of revenue. So I'd encourage the analysts to sort of play within those parameters in their expectations for next year. We'll obviously give you more refined guidance in February.

Our next question comes from line of Raymond Myers with The Benchmark Company.

I don't believe we've talked much about Pharma service on this call yet. Can you describe what your outlook is for the growth of that business after a couple of very strong quarters and also how the Geneva facility affects capabilities and cost structure in Pharma Services?

Thanks, Ray for the question. We're excited about Pharma Services. We explained I think over the last several quarters that we rebuilt our sales and business development teams in Pharma Services. We've invested in the business, we've invested in systems and processes and we're starting to see that in the backlog and in the revenue growth. I think our revenue growth in Pharma Services has been somewhat buoyed by MultiOmyx. So we have a proprietary testing technology, which focuses predominantly in immuno-oncology and it's a very unique testing capability. We've got a lot of interest from pharma companies in this. We also have done a lot of PDL1 and related immuno-oncology sort of testing for the pharma industry and I think our leadership there generally has been good for us. So the growth prospects are very strong, you can tell in the backlog that increase of 70% plus in the end of quarter three compared to last year. So we would expect that our revenue growth is going to continue pretty strong in Pharma Services. Certainly, Geneva will help. It helps being a worldwide provider to this industry. We have incurred some cost to set Geneva up. It's ready to go, we're going to have a grand opening on November 8 and we're essentially ready now to accept our first patient samples. So we're excited about that and we think we'll begin to realize some revenue from Geneva in fact in quarter four.

Geneva won't be a really material item. Literally, we're talking about 6 employees at this point. I mean it's a small operation, it's not that large right now. We did spend about $0.5 million though in terms of all-in in terms of set up costs, but that's obviously behind us now and then now, hopefully we'll actually start to generate some revenue. We've already got one contract in house and we're very bullish on having the capabilities to do European trials.

Good, that sounds great. And is that cost in cost of goods or in R&D?

At this point actually it's all in G&A. All of the set up costs because there was no revenue associated with it to date are flowing through our G&A line. It has elevated a bit from prior year. Once it effectively opens and starts to process samples, then really the vast majority of those costs will go up in the cost of goods.

Okay, sounds good. Second question is around the Clarient integration. Describe again when you felt the Clarient facilities were integrated with NeoGenomics and are there still synergies remaining to be captured from that integration the combination of the businesses in 2018?

Yes, sure Ray. The Irvine lab and the Aliso Viejo lab were combined completely at the end of March of 2017. As some of our people just reminded me, in Aliso Viejo, it takes a month or 2 to know what the processes are that have come into the lab and to revise current processes and I think some of that work continues. So yes, there are synergies that remain to be realized. We think that the integration is going very, very well. I mean we've explained in the past that even though, putting two labs together is never easy. We really had no appreciable loss of any client or revenue as a result. It delayed some of our growth expectations, but on the synergy side, I think overall we said that we estimate $20 million to $30 million of synergy to be realized over the course of 3 years from the Clarient acquisition and we continue to believe that's a good estimate. As you know, I think in the 22 months since the acquisition, I think our Cost per Test is down about 20% and you'd certainly have to attribute some of that reduction to synergies and we're starting to realize some synergies also on the volume growth side as we cross-sell.

Just to clarify, Ray, we have always talked about synergies from the acquisition as including the benefits of scale that come from the acquisition, lot of our Cost per Test reductions are hard costs but a lot of the other ones are because of the increased scale.

Next question comes from the line of Joe Munda with First Analysis.

Real quick, one housekeeping item here, on the cash flow statement, it says fair value of restricted stock issued to fund purchase of customer list, roughly $4.5 million. Can you give us some sense of what that actually is?

Yes, a very, very small customer list acquisition. We mentioned in the script that a number of our smaller competitors are finding it increasingly difficult to navigate the industry and we are working hard to try to find small deals that we can do that might be additive/accretive to our business and we think that the revenue that we -- or estimates of revenue from this acquisition are in the $3 million to $4 million range and where we can do other acquisitions of this nature, we will.

Okay. And then as far, you talked about the tissue samples, a new process as well as for QNS, I'm just wondering how much of this new tissue sample process, if you could give us some details around it is factoring into your volume growth expectations as well as the ability to win new business and keep going after accounts because on our end, we get a lot of questions on how do they continue to maintain this mid-teens growth, I know other people have asked that question on the call. How do they keep this mid-teens growth going? Is it more market growth, how much of its market growth, how much of it versus volume growth or taking share if you will and then you factor in this new tissue sample process and I'm just wondering where that all comes into play here? Thanks.

Thanks, Joe. I would characterize the new tissue sample process that we described as in the category of a number of innovations that we regularly make in our business and this one I think is going to be important for patient care, but we're innovating, introducing new tests changing our processes all the time as we try to improve constantly quality and introduce new medically important tests. So I would put the tissue sample initiative in that category. In terms of our growth, the growth is really in two areas, one as you said is the markets grown. We're in this era as we all know of precision medicine. There are new therapies coming out all the time require our precise testing and this is an area we think in which the U.S. market is probably growing at a 8% level, maybe even a little bit faster. In addition to that we've fueled the growth by our ability to take market share and there's no -- I think that one really depends on good old fashion service, quality, focus and having a very comprehensive test menu and we as you know, because we're focused just in oncology, we think we do a pretty good job here and its enabled us to gain share.

Okay, can we just go back to the -- I appreciate the answer, can we just go back to the that small acquisition? Can you give us some sense of what it was as far as area of testing, molecular, as well as can you give us some sense of why the decision to use restricted stock rather than cash?

That was just -- first of all, it was a very small acquisition. I'll say that. Second is the product mix was in our wheel house. FISH, some flow cytometry, some molecular testing. Third thing is that we used restricted stock because that seemed to be what the seller was more interested in and the deal was accretive and had a good return profile for us.

And it was not completed until September. So there was not appreciable impact yet in the quarter because it was just one month of the quarter.

And there won't be because it was quite small.

Yes.

Okay, thank you, we've reached the end of our question-and-answer session. I'd like to turn the floor back over to management for closing comments.

We do have one email question that needs to get addressed here. It says that bad debt is running around 6.8% in 2017 and this will be treated as an offset to revs in 2018. How should we think about revenue and revenue per test growth next year? When we begin to report the quarterly numbers next year, we're going to restate the 2017 financials to show what that would be on apples-to-apples basis, so you can get growth rates, but it does bring up an interesting point about those analysts that are going to model ASC 606 in before we give our guidance for next year. I need to highlight that and to make their assumptions very clear to people because otherwise the consensus is going to be all over the map on this. We again want to reiterate that this will have no impact on adjusted EBITDA or net income, but it will have an impact on revenue and we would actually prefer that people don't model it in yet next year, so we can have everybody reset all at once so we don't have this trickle out over time, but everybody has got to do what they think is best. If you are going to model it make an assumption on what percentage of revenue decline is from ASC 606 so it's clear to everybody.

Okay, good. Thank you, Steve. Thank you, operator. As we end the call, I'd like to recognize the approximately 975 NeoGenomics team members around the country for their dedication and commitment to building a world-class cancer genetics testing program and on behalf of all of our NeoGenomics team, I want to thank you for your time joining us this morning and let you know that our fourth quarter 2017 earnings call will be on or around February 21 of 2018. For those of you listening that are investors or are considering an investment in our company, we thank you for your interest. Goodbye.

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