Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)

Neogenomics (NASDAQ:NEO)

Q3 2013 Earnings Call

October 23, 2013 11:00 am ET

Executives

Douglas M. VanOort - Executive Chairman and Chief Executive Officer

Steven C. Jones - Chief Compliance Officer, Executive Vice President of Finance, Director of Investor Relations, Director and Chairman of Compliance Committee

Maher Albitar - Chief Medical Officer and Director of Research & Development

Analysts

Matthew Hewitt - Craig-Hallum Capital Group LLC, Research Division

Debjit Chattopadhyay - Emerging Growth Equities, Ltd., Research Division

Grant Zeng - Zacks Investment Research Inc.

Jack Wallace - Sidoti & Company, LLC

Zarak Khurshid - Wedbush Securities Inc., Research Division

Kevin DeGeeter - Ladenburg Thalmann & Co. Inc., Research Division

Operator

Greetings, and welcome to the NeoGenomics Third Quarter 2013 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Doug VanOort, Chairman and CEO. Thank you. Mr. VanOort, please go ahead.

Douglas M. VanOort

Thank you, Brenda, and good morning, everyone. I'd like to welcome everyone to NeoGenomics' Third Quarter 2013 conference call and introduce you to the NeoGenomics team that's here with me today. Joining me this morning are Steve Jones, our Executive Vice President for Finance; George Cardoza, our Chief Financial Officer; Bob Gasparini, our Chief Scientific Officer; Steve Ross, our Chief Information Officer; and Jerry Dvonch, our Director of External Reporting. Dr. Maher Albitar, our Chief Medical Officer, is joining us from our Irvine, California office by phone.

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

Steven C. Jones

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.

Douglas M. VanOort

Well, thank you, Steve.

I'll begin our call today with some remarks about our performance in the third quarter of 2013, discuss some important initiatives and comment briefly on the status of CMS's proposal. I'll then turn the meeting back over to Steve to discuss our financial results in more detail.

NeoGenomics performed well in the third quarter, and we were pleased with the company's overall financial results. Sales volume improved throughout the quarter, and our costs remained in good control. Our teams executed well even in a difficult industry environment.

Revenue grew nearly 19% compared with last year's third quarter. After 4 quarters of tough year-over-year comparisons caused by expiration of the TC Grandfather Clause, our revenue growth was at a similar rate as our test volume growth.

At $16.9 million, revenue was at the top end of our upwardly revised guidance. Revenue growth was driven by a combination of new products and new customers. In fact, revenue from new products launched in the last 18 months resulted in about half of our growth in the quarter. These factors more than offset the reduction in revenue caused by more cautious ordering by hospitals and pathologists.

Our growth rate was strongest in territories in the Western region, as we are capitalizing on our new laboratory facility in Irvine, California. But it was positive in almost every one of our territories across the country.

We were especially pleased that incremental profit was strong. Our gross margins improved to over 48%, and we drove over 85% or $2.3 million of the incremental $2.7 million of revenue on a year-over-year basis to the gross profit line.

We've discussed many of our productivity and process improvement initiatives in the past, and these are clearly helping to improve the company's efficiency.

Operating expenses also remained in good control despite continued investment in information technology and innovation. And adjusted EBITDA grew by 157% to $2.2 million in the quarter. We recorded $900,000 of net income compared with a loss of $975,000 last year.

The balance sheet also improved as our billing team made progress with cash collections. And day sales outstanding fell to 86 days from the 93 days we recorded at June 30. We were especially pleased that performance -- with our performance since the billing team also began implementation of a new billing system at the same time. As a result of their efforts and our improved profitability, the company's cash flow is better than ever. So overall, we were pleased with the company's third quarter performance.

We've explained in previous investor calls many of our 2013 objectives. And I'd like to give you a brief update on the progress we made in quarter 3.

Let's start with our quality and performance-related objectives. We're making very good progress by focusing on disciplined process management using Lean process techniques, deploying best practice teams across the company, leveraging our information technology platforms and using automation to make improvements in our processes. As a result, productivity, as measured by the number of tests processed per full-time equivalent laboratory employee, increased by nearly 10% compared with last year's third quarter. As a result of this and other cost optimization initiatives, we drove average cost per test down to record low levels and 12% lower than quarter 3 last year.

To clarify, we are not cost cutting. Rather, we are managing our processes to eliminate nonvalue-added steps, improve quality, reduce errors, increase speed and increase throughput without significant increases in people. For example, so far this year, we've had 6 Lean Kaizen events. This is a process involving a dozen or so of our people from various disciplines who meet together for 3 straight days working through a particular process in great detail. Their work culminates in a project list of large and small improvements. We combine these projects with the work of 5 best practice teams involving over 40 people from each of our laboratory locations. Some projects are immediately implementable, and some take time as they involve changes in automation, supplies or suppliers and/or programming changes in our information systems. We've already realized savings from these events and will realize more, as additional projects are implemented.

Many initiatives involve some sort of change in our laboratory information system. We commented previously that we believe we have an advantage, in as much as we have one standard laboratory information system and we own the source code for that LIS, and we have the ability to modify and enhance our systems. In order to take advantage of this opportunity, we've reorganized and built out our IT organization, beefed up our IT project management processes and developed a more comprehensive plan to make significant improvements.

Process management and Lean concepts also apply to sales, marketing and general and administrative functions. Even with a large number of objectives and initiatives underway, total SG&A cost increased less than 7% compared with last year. And much of that increase was in sales and marketing, information technology and billing resources.

After the successful expansion and move of our laboratory facility in Irvine last year, we are now engaged in an expansion of our largest laboratory in Fort Myers, Florida. We are making significant changes in workflow and expanding our capacity at the same time. With this expansion, we now have 75,000 square feet of laboratory and administrative space, which we expect to be fully operational in the first quarter of 2014.

Looking forward, as a result of our quality and process management initiatives, we expect to continue to drive process improvements and reductions in our cost of testing continuously.

Those of you that have followed NeoGenomics for any time know that innovation is very important to our company. And we expect it to be a major driver of future revenue growth and value. We continue to invest and work on developing and introducing a variety of new products during quarter 3, although reported R&D expense actually declined. This reduced level of expense was due to a reduction in stock-based compensation expense associated with our R&D personnel or our full-time contractors rather than employees. However, the underlying rate of R&D spending was largely the same as last quarter. Even with this rate of spending, our R&D group is extremely productive.

So far in 2013, we have introduced over 30 new molecular tests and disease profiles. And since January 2012, we have introduced almost 70 molecular tests and disease profiles, as well as an additional 10 FISH tests. In this revolutionary time of precision medicine, where new molecular biomarkers are being discovered rapidly, NeoGenomics is working hard to quickly assess and develop new assays for the benefit of our client pathologists and clinicians and their patients.

We are excited to be at the leading edge of genetic testing for oncology, and we believe we have the most comprehensive menu of oncology-focused tests available in America. We believe that molecular testing is essential for cancer care, and we intend to continue to invest in this area. We intend to significantly expand our cancer profiling capabilities by introducing over 20 hematologic and solid tumor disease profiles early next year. To be responsive to our health care environment and to make these tests as widely available and cost-effective as possible, our expanded menu will include both concise and comprehensive profiles for each disease using both conventional Sanger sequencing and next-generation sequencing.

Concise profiles will feature a fewer number of key driver genes and will be a cost-effective tool for use by cost-sensitive hospitals and pathologists. The comprehensive profiles will include those key driver genes, as well as other newly discovered biomarkers. We expect that the comprehensive profiles will be used by specialists, academic centers and by pharmaceutical companies in clinical trials of new therapeutics. The goal of this profiling is to allow clinicians to choose therapy that specifically targets the molecular abnormality in the tumor they are treating.

In terms of our technology platforms, we have available some of the most advanced testing methodologies, including next-generation sequencing, SNP standard genetics arrays, bidirectional Sanger sequencing and, of course, FISH and color flow cytometry, digital immunohistochemistry, cytogenetics and other anatomic pathology technologies. We plan to introduce the next-generation sequencing platforms for clinical use in the next few months. And we see multiple applications for this technology that conventional sequencing cannot provide.

Innovation efforts also apply to our testing technology platforms, where we are constantly looking for better approaches. One example of this is the use of proprietary support vector machine, or SVM technology, to automate certain testing processes such as cytogenetics. We have been working on this for about 18 months, and we believe we are now close to having a technology that we can beta test in our own labs in the fourth quarter. If successful, it can have a major impact on our cytogenetic capabilities and provide us with an opportunity to license the technology to others.

The combination of our new tests and comprehensive oncology-focused capabilities gives us an excellent opportunity to diversify our business into clinical trials. Clinical trials testing serves biopharmaceutical clients rather than oncologists and pathologists, and the precision lab biogenetic and molecular testing is critical to many drug development programs. We expect some increased clinical trials projects in this fourth quarter, but more importantly, we are beginning to develop and execute plans to significantly expand our presence in this area. In fact, looking ahead, we see no reason why we can't build a significant clinical trials business within NeoGenomics. And we are beginning to invest more aggressively in commercial resources to support this promising opportunity for growth.

Another area of future growth fueled by innovation is in proprietary test development. The most interesting of these development initiatives continues to be our test for prostate cancer, which is performed on blood plasma and urine, rather than on prostate tissue biopsies. As we've described, the 2 goals for this test are to diagnose the presence of cancer in patients with BPH and to distinguish high-grade from low-grade prostate cancer in patients with prostate cancer. We began Phase II of the prostate test validation in the third quarter, and we received approximately 200 additional samples from a source in the U.S. and solidified arrangements to extend the validation by getting samples from outside the U.S. The ultimate goal of this validation is to build solid evidence of clinical significance and clinical utility to satisfy increasingly stringent coverage requirements by Medicare and other insurance carriers. We continue to be excited about the potential for this test and expect to launch the test in the first half of next year.

We believe that our focus on innovation is increasingly building our reputation as a leader in oncology, and we are excited to play a role in bringing the exciting science of genetic and molecular testing into clinical practice in America.

Growth objectives are at top of mind for us. Certainly, revenue for our new products helped us to grow in quarter 3. We were pleased that after a slowing of our test volume growth over the past several quarters, growth in quarter 3 increased to 19.1% compared with last year. Growth occurred, as I said, in all regions across the country and was particularly strong in the western and central regions of our company. We were pleased with that team's performance.

Since the end of the second quarter, we've hired 5 very talented and experienced sales representatives. In addition, we've begun to experiment by hiring a couple of experienced product specialists. Although it takes several months of work for any sales professional to make an impact on the top line, the new people are off to a strong start, and we believe their efforts will begin to yield results in the fourth quarter and beyond. We now have 21 sales representatives, 2 product managers and 3 business development managers. We expect to hire 4 to 6 additional sales professionals and at least 2 clinical trials commercial leaders by the end of 2014. Clearly, our sales and marketing team is the strongest we've ever had, and we intend to build it further.

Before I conclude my comments, I'd like to update you briefly on the status of new proposed rules for calendar year 2014 that the Centers for Medicare and Medicaid, or CMS, issued on July 8. As you know, the proposal seeks to change both the clinical lab fee schedule and the physician fee schedule. The proposal of greatest impact in NeoGenomics is a proposed cap on reimbursement for tests covered by the physician fee schedule at levels that Medicare pays to hospitals under payment structures referred to as the Hospital Outpatient Prospective Payment System, or HOPPS, and the Ambulatory Payment Classification System or APC. The tests targeted for reduction under the physician fee schedule, such as FISH and flow cytometry, are used for the diagnosis and monitoring of critically ill cancer patients. And these tests are absolutely essential to patients receiving proper care. We were very active in opposing CMS's proposal. We were also very pleased with an extremely strong response by the College of American Pathologists, the American Clinical Laboratory Association and a host of patient advocacy groups and medical associations. All in all, CMS received 10,220 public comments on the proposed rule through its website, which we understand is one of the highest number of comments ever received for a proposed rule relating to lab testing. In addition, a letter written by Representatives Gerlach and Pascrell were co-signed by 113 members of Congress, asking CMS to reconsider its proposal. Senators Isakson and Klobuchar, along with 38 other senators, sent a similar letter to CMS last week.

We do not know how CMS will decide this matter, but clearly, there is widespread opposition to their proposal. CMS has indicated before the government shutdown that they intended to make a decision by November 1.

To summarize my comments, I'd like to make just a couple of key points. First, we were pleased with the company's performance in quarter 3. Growth accelerated, cost remained in good control and profitability improved significantly. Secondly, NeoGenomics offers the most advanced and comprehensive oncology-focused product portfolio in America, and we believe that our focus on innovation in this area is unmatched and will continue to yield good growth prospects. And finally, we are very process-focused as a company, and we offer both high-quality and low-cost cancer genetic testing services. And we believe that we can lower our cost continuously for the foreseeable future. Our teams remain excited about the company and its prospects, and we are focused on continuing our growth momentum in the coming quarters.

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

Steven C. Jones

Thanks, Doug.

I'll start by reviewing some of our financial and operating metrics for the third quarter, and then we want to open it up for questions.

Third quarter revenue was $16.9 million, a 19% increase from Q3 last year. Test volume also grew by approximately 19% versus last year. Average revenue per test was $501, just $1 below the level reported in Q3 2012. We are delighted to report that the impact of the TC Grandfather Clause expiration has now been annualized into our results and is no longer affecting the year-over-year comparisons.

Gross profit was $8.2 million in Q3, a 39% increase over last year. As discussed in the press release, we improved our average cost of goods sold per test by 12% by increasing lab productivity and efficiently leveraging our infrastructure. This drove our gross margin up by almost 700 basis points to 48.4% in Q3 from 41.5% in Q3 2012. To put this into context, we were able to drive nearly 85% of each incremental dollar of revenue year-over-year to gross profit in Q3. You don't see that every day.

We believe we can continue to make further improvements in average cost of goods sold per test over the next year as a result of the increasing scale in our business and increasing productivity. Providing there are no material changes in reimbursement, this should translate into further gains in gross margin in 2014.

Turning now to SG&A. Total sales and marketing expenses increased by $500,000 or 27% versus quarter 3 last year as a result of increasing personnel costs and incremental commissions on the increases in revenue. As Doug discussed, we have added 5 experienced sales representatives and 2 new product managers to our sales and marketing teams since the end of quarter 2, and we expect to continue to add additional sales reps in coming quarters. Thus, investors should expect our sales and marketing expenses to continue to rise.

General and administrative expenses increased by $405,000 or 10.3% from last year, and R&D expenses decreased by $468,000 or 58% versus Q3 2012. This decrease in R&D spending was primarily the result of a large reduction in noncash stock-based compensation relating to certain warrants awarded to our R&D team. As we have discussed before, we are required to use variable accounting to account for these warrants. And when our stock price rises or falls by a significant amount, it has a disproportionately large impact on stock-based compensation charges on any given quarter.

Total SG&A and R&D expenses were up about $434,000 or 6.6% year-over-year and were just 41.5% of total revenue as compared to 46.3% of total revenue in Q3 2012.

Net income for the quarter was $900,000 or $0.02 per share compared to a net loss of $975,000 or $0.02 per share in quarter 3 of last year. This $1.9 million increase in profitability is due primarily to the excellent cost controls and productivity increases the company has pushed through over the last year.

Unadjusted EBITDA was $2.3 million in the third quarter. And total noncash stock-based compensation charges resulted in a credit of $116,000, which resulted in adjusted EBITDA of $2.2 million, a 157% increase from the $842,000 reported last year.

We finished the third quarter with 308 full-time equivalent employees and contract doctors as compared to 293 at June 30, and 268 at December 30 -- December 31 of last year.

Our accounts receivable balance, net of allowance for doubtful accounts, was $15.7 million at September 30, down approximately $300,000 from the balance at June 30. Our AR balance, expressed in terms of day sales outstanding, was 86 days as of September 30, down 7 days from the level reported at June 30. We are very pleased with this nice decrease in DSO.

In terms of overall liquidity, as of September 30, we had $4.9 million of cash on hand and $7.3 million of availability under our working capital line of credit, which results in $12.2 million of total liquidity as compared to $11.4 million of total liquidity at June 30. Our cash flow from operations in Q3 was $2.2 million as compared to $1.9 million in Q2 and negative $510,000 in quarter 3 2012.

We purchased $1.3 million of property, plant and equipment in the quarter. However, we were able to lease finance approximately 400k of this amount. Thus, the net use of cash from investing activities was $877,000. In addition, we were able to pay down approximately $672,000 of our revolving credit facility balance during the quarter, which leaves the revolver balance at just $2.7 million as of September 30, the lowest it has been in years.

To summarize, we paid cash for $877,000 of CapEx and paid down debt by another $672,000 in the quarter, yet we were still able to increase our cash balance by approximately $300,000 from Q2.

Turning now to the guidance we issued this morning for the fourth quarter of 2013. In quarter 4, we are expecting revenue of $17.6 million to $18.1 million and $0.01 to $0.02 per share of net income. Growing this Q4 guidance into our full year guidance implies that we will finish 2013 with $65.7 million to $66.2 million of revenue, with earnings of $0.03 to $0.04 per share.

At this point in time, I'd like to close down our formal remarks and open it up for questions. [Operator Instructions]

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

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Matt Hewitt with Craig-Hallum Capital Group.

Matthew Hewitt - Craig-Hallum Capital Group LLC, Research Division

First question. Obviously, the new tests are contributing to the growth, and I'm wondering if there's any 1 or 2 or handful of tests that you've launched over the last year or 2 that's leading the way. And what we can expect from those tests over the coming quarters?

Douglas M. VanOort

Well, Matt, we've continued to see strong increases in most of the new tests we've launched. I would highlight our 10-color flow and ALK FISH tests, in particular, were very strong in Q3. Our molecular remains strong on a volume basis, but we had about a 22% decrease in average revenue per test in molecular year-over-year, as a result of the new CMS rules on molecular. So that didn't translate into as much revenue. But we've seen a new molecular fee schedule just in the last 3 weeks. It's effective October 31, which is going to result in about a 10% to 12% increase in our average revenue per molecular test and probably gives us $60,000 to $70,000 a month of revenue just from that alone. So there has been some relief put through on the molecular front.

Matthew Hewitt - Craig-Hallum Capital Group LLC, Research Division

Well, that's great news. And that hits starting -- I'm sorry, November 1, or is that for January 1?

Steven C. Jones

October 1.

Matthew Hewitt - Craig-Hallum Capital Group LLC, Research Division

October 1, okay. Secondly, you had mentioned obviously strength geographically across the board. You particularly called out to the western region and the central region. I'm wondering if there's anything in particular that's helping those 2 areas? Is it the sales people in place? Or is there something about those markets in general that you could replicate across the country?

Douglas M. VanOort

Yes, I think, Matt, thanks for the question. The geographic growth has been stronger in the west and also quite strong in the central regions. In the west, part of that is a result of the effort that we put into building our Irvine, California facility and staffing it with some great people. So Dr. Albitar's office is there. We've attracted some very good talent. The facility shows very well, and we've had a lot of clients that visit our facility. And that's been very helpful to our growth out there. We've also been successful in building our sales team more in the central region and the western area, and that's helped as well. We have some market share opportunities in both of those regions and we're trying to capitalize on them.

Matthew Hewitt - Craig-Hallum Capital Group LLC, Research Division

Okay. Maybe one more for me then I'll hop back in the queue. Obviously, a great quarter from a gross margin perspective. You talked about the opportunity to potentially expand those, barring any dramatic changes from CMS here in the next month or so. As you look out over the next couple of years, where do you see that line getting to? I mean, is it a situation where you can get back to a 50% gross margin? Is there an opportunity above that? Just how should we be thinking about gross margin?

Steven C. Jones

So you have to start any analysis of gross margin with an assumption about what average revenue per test will be. Barring any material changes in average revenue per test through regulatory changes or whatnot, I think we feel very comfortable that we can get back to 50% or even into the low 50s on the gross margin front. But as we've all learned over the last year, CMS can and will do whatever it wants to do. And generally speaking, we internally model at least some reduction every year into average revenue per test on our own assumptions because we just think it's the best way to be conservative and to plan for your business. And what we really are focused on is making sure that we always increase productivity and reign in average cost per test further than any potential average revenue per test decreases, so that we are always covered in a situation like that.

Operator

And your next question comes from the line of Debjit Chattopadhyay with Emerging Growth Equities.

Debjit Chattopadhyay - Emerging Growth Equities, Ltd., Research Division

Just a segue into the last question then. You had a very nice uptick in average revenue per -- or your position on average revenue per test, especially in the test side, 30 points above the previous quarter. So what drove that? I mean, was that something that changes incremental or is it a change in mix of the test? How should we look at that compared to -- and what should we expect for the next quarter?

Steven C. Jones

So we actually increased by just about $21 per test from Q2 to Q3. It's really not any one thing. We continue to see strong growth in FISH. We've always seen strong growth in FISH. Those are among the highest of the average revenue per test things. I would say that we've had an uptick in some of our molecular profiles, which usually results in substantially more revenue per test. But it's not any one thing that jumps out. That was offset a little bit by the decrease in molecular revenue per test. Although that wouldn't show up on a sequential basis; it did show up on a year-over-year basis. So I'd just tell you, it's good solid execution. We added new accounts, and we added new products into our mix and that translated through.

Debjit Chattopadhyay - Emerging Growth Equities, Ltd., Research Division

Now in terms of the uncertainties around the CMS, which clearly is the albatross around your neck right now, what are the contingency plans that you have put in place, assuming the worst case scenario?

Douglas M. VanOort

Yes, it is kind of an albatross, I guess. So what -- it's basically kind of hard to plan, to be honest with you, because there's sort of a binary decision point. We have put in place some plans in the event that they enact this proposal. And as you might imagine, they would be significant cost-reduction plans. Other than that, we are doing what we know how to do. Every day, we're trying to apply good process management techniques. We're trying to keep our customers very happy, attract new customers, try to diversify our business. So we're doing all the things in the long term that we believe are required, but, certainly, if the proposal is enacted, we would have to take some much more major cost-reduction actions.

Debjit Chattopadhyay - Emerging Growth Equities, Ltd., Research Division

Just one more question before I hop back in the queue again. More on the next-gen sequencing side of things. You mentioned you're prepping up the next-gen platform more on the -- for the pharma side, and you're looking after -- looking at fewer driver genes. Now what drove the selection of the driver genes, as opposed to, say, foundation medicine and just looking at 236 and looking at a lot more drugs for patients? What -- I mean, how did you select these driver genes? Was it purely a therapeutic decision in terms of what's available in the market and the ongoing clinical trials?

Douglas M. VanOort

Dr. Albitar, would you care to take that?

Maher Albitar

Actually, you are exactly on target. It is mainly therapeutic. So we always review and look at what's on the market or clinical trials pipelines as targeted molecules. And we try to be ahead of the curve and be prepared to analyze and test for the targeted genes. And we have a large profile or large list of the positive genes and would try to focus our testing on these genes.

Operator

Our next question comes from the line of Grant Zeng with Zacks Investment Research.

Grant Zeng - Zacks Investment Research Inc.

I have 2 questions here about -- the first is about the new projects you launched for this quarter -- or for this year. You mentioned that you have launched about 36 new products for this year, if I remember correct? Noticing that, do you have any specific number for the revenue from the FISH and some of these new projects? Search for a gene is, of course, a clinical project. You mentioned that you are funding the applications into the pharmaceutical industry for the clinical projects and clinical trials. My question is, any specific project done now for this area? And when is the effect for that, as the project comes to fruition in the next few years?

Douglas M. VanOort

Yes. So, Grant, thanks for the question. So the first question, around revenue growth. We were able to generate about half of our growth in quarter 3 versus last year. It was driven by new products that we've introduced really in the last 18 months or so. And we -- Steve mentioned the specific test that we've introduced. I think we're going to get continued revenue growth from new products, particularly in the molecular area, in Barrett's esophagus, in histochemistry, particularly in the digital immunohistochemistry area, and we're looking forward to those. We also mentioned some of these disease profiles that we're planning to introduce early next year, and that should drive some good growth as well. On the clinical trials side, that business is a little different than our core clinical business. And so, for the last several years, we've really focused on our knitting. And now, we believe that we have the capabilities, both in terms of our product menu, as well as our information technology capabilities, as well as the breadth of our management team, to be able to really do a good job for the pharmaceutical companies. And we have decided to invest in this area. We mentioned in our prepared comments that we're going to build out our commercial organization and some of the other specific areas, resources, that we need to do a great job with the pharmaceutical companies. And you'll see, I believe, revenue in 2014 -- increasing revenue gains each quarter as a result of our work. We'll have some clinical trials, or we expect to, in quarter 4 this year and maybe some in quarter 1. But I think quarter 2, 3 and 4, we should ramp up our clinical trials activity revenue.

Grant Zeng - Zacks Investment Research Inc.

That sounds great. One more question about the [indiscernible] you mentioned that you have country-wide test that you have to run now? And how many items [ph] do you hire for 2014?

Steven C. Jones

So we have currently 21 sales reps and regional managers. We have 2 product manager specialists and we have 3 business development managers. All of those are involved in selling in one way, shape or form or another. We expect over the next 12 to 15 months to hire an additional 4 to 6 sales representatives and at least 2 clinical trials commercial leaders who will be engaged in expanding our clinical trials business. So if you add all of that together, 6 to 8 more total selling people over -- by the end of 2014.

Grant Zeng - Zacks Investment Research Inc.

Okay. So you really have the new hires about 4 to 6 -- about 4 to 6 in the next 13 months, right?

Steven C. Jones

Yes. 4 to 6 traditional clinical reps and another 2 clinical trials reps. About 6 to 8 total.

Operator

And our next question comes from the line of Jack Wallace with Sidoti & Company.

Jack Wallace - Sidoti & Company, LLC

Quick question in regards to the oncology, large oncology practice. The trend early in the year was there was some in-sourcing going on. Have you seen some now reversal of that and the outsourcing back into your business for some of those tests?

Douglas M. VanOort

I would tell you it's a very dynamic situation. The larger oncology practices continue to consolidate the smaller oncology practices. And when that happens, we're usually a net beneficiary of that. Most of the firms who were looking at in-sourcing when we were in discussions with to help them, perhaps in-source is one portion of it, stopped all further activity on that, pending the outcome of the CMS proposed rule change. The CMS proposed rule change, if it went in, would dramatically impact both FISH and flow, which would take a lot of the incentive to in-source out of the mix. And so I think that in-sourcing activity has sort of been put on hold collectively by the industry.

Jack Wallace - Sidoti & Company, LLC

That's helpful. And then I just want to talk about the, I guess, a little more detail in some of the cost reduction. Maybe some metric as it pertains to the potential impact of the redesign at the Fort Myers lab. Any thoughts on what that can do to cost per test in '14? And then, additionally, I believe the target was for a 10% reduction of cost per test from last year's Q4 to this year's Q4. Do you still think you're going to be able to hit that 10% target?

Steven C. Jones

So we're at about 7% on a cumulative basis from Q4-to-Q4. We may get there, but you know what, we feel really good about the reductions we've already done. And if we only wind up at 8% or 9% for the year, don't hang us out to dry. It's been since early 2010 that we've seen gross margins at this level and to be just 1 year since the expiration of TC Grandfather and have gross margin levels above where they were before that hit is quite an accomplishment.

Douglas M. VanOort

Yes. I would just add to that, Jack, that the Fort Myers facility changes will allow us to implement a number of both the small and the large process improvement initiatives that we've already identified through these Lean Kaizen events and in our best practice teams. The redesign of the laboratory is actually quite important, knocking walls down, putting people closer together, changing the workflow, adding automation. And so it's hard to answer your question because there are a lot of individual projects that will be implemented as a result of these changes. And with any cost reduction and process improvement, they sort of take a little time. We have a pipeline, good portfolio of them, and we're working through it.

Jack Wallace - Sidoti & Company, LLC

Okay. And then lastly, do you have any, I guess, thoughts or any insights on any potential delay in when CMS is likely to come ahead and give their announcement, given the recent government shutdown, as well as the massive pushback that many of the industry players have had for the [indiscernible].

Douglas M. VanOort

Yes, we really don't have any visibility as to when they might decide. They haven't changed or issued anything that has changed the date that they've already indicated that they would decide by. I can tell you that I think the lobbying groups, the American Clinical Laboratory Association and others, are quite pleased with the response rate from within the industry and clients and advocacy groups. And I think we've all done as good a job as we can trying to give evidence why this would be disastrous for patient care. There have been good legal arguments made by the College of American Pathologists. And I think CMS has got a lot to think about.

Steven C. Jones

I will say, they put off releasing the unemployment number until yesterday. And so that was about an 18-day delay. And CMS, we've heard at least, has reserved the right to use a day-for-day slip on any statutory deadline as a result of the shutdown. That doesn't mean that they will, but it wouldn't surprise us if they didn't come out by November 1. It's possible they will, but we just don't know.

Operator

Your next question comes from the line of Zarak Khurshid with Wedbush.

Zarak Khurshid - Wedbush Securities Inc., Research Division

Just one question really regarding the launch of your NGS-based product in the next few months. Can you talk about just the target customer there and the selling process and how that might differ or not from your -- kind of your current business model? And essentially, does that plug right into your tech-only pathologist customer base?

Douglas M. VanOort

Yes, they -- initially, well, we have 2 -- really, 2 or 3 target customers with the next-gen sequencing. I mean, one early customer would be in an area of clinical trials, more comprehensive profiles. Academic centers would also fall into this category. But what we want to do is to apply this for clinical use. And we've -- and maybe Dr. Albitar will comment on some of the work that we're doing to make next-gen patient sequencing an adjunct test to some of the work that we're currently doing with some disease states and profiles. So our intention is to be able to use the platform both for clinical use, as well as -- to our current customers, as well as in the area of clinical trials. Dr. Albitar, do you want to comment further?

Maher Albitar

Yes. So it's very important to explain that next-gen sequencing is a technology, has numerous applications that we are investigating, and investing very heavily in exploring how to maximize the benefit of next-generation sequencing. So it generally comes into a test that we cannot perform by convention. For example, if you have a lung biopsy test, it's a very small material -- are very small. Next-gen can be an excellent way of looking at multiple genes because of what you need, very minimal amount of DNA. We are exploring, utilizing this in day to day, well, especially, as our volume increase. And we are at the point we definitely believe that next-gen is cost-effective to be utilized as routinely -- as routine technology. But there are also, in addition to that, some proprietary things we are working on. In addition to that, it is potential in our profiling cancers and making it more cost-effective to come up with answers to guide our physicians in how to target specific molecules and with specific drug that target these molecules. And especially, this is for a patient who fell at the first line of therapy or second line of therapies and clinician run out of options, and they are trying to look for some other means to treat these patients. So these are most of our ways we are investing and looking to utilize next-generation sequencing here.

Zarak Khurshid - Wedbush Securities Inc., Research Division

Understood. Just as a quick follow-up. Are the kind of the large hospital, academic hospital labs and community-based oncologists sort of potential targets as well? Or are you just going to be more of -- it will be more of a targeted kind of a rollout?

Maher Albitar

If I may answer this, I really believe that it is quite possible that when [indiscernible], we can use it not only for community-based practice oncologists, but also for academic centers because it is -- you can only bring the cost of running the next-generation sequencing significantly lower by the volume. So it does make things -- that using academic center to send samples to centralize, whether it is commercial laboratories or otherwise, to perform the testing. So it is on our plans to offer next-generation sequencing as a technical-only test, indeed, but to all levels of servers.

Operator

Our next question comes from the line of Kevin DeGeeter with Ladenburg.

Kevin DeGeeter - Ladenburg Thalmann & Co. Inc., Research Division

Can you talk a little bit about the reimbursement model on the special profiles you are looking to roll up next year? Perhaps talk a little bit more about some of the specific critical areas and indications for some of those profiles? And do you expect to run additional clinical trials to validate a specific profile? Or do you expect to be able to seek reimbursement under an existing core structure?

Steven C. Jones

So let me start with the reimbursement end of that, and then we can flip that back to Doug and back to Albitar. From a reimbursement end of it, CMS has not said anything about whether they will or will not cover reimbursement. There is some debate about whether or not you can at least seek reimbursement for those genes they already cover under the new Mol DX codes. Our expectation is that many of the early clinical tests we offer will be patient-paid tests. And so until you have enough data to go into the payers and show the efficacy and whatnot, it is something that we expect will be really driven by people who want to pay extra for it. I think we actually think that, at least in the nearer term, clinical trials will be the primary consumer of this. But we do expect there to be some clinical uptake. Now over time, what happens is that we have all these molecular profile panels and we can add next-gen sequencing and/or augment those panels with that. And so we have a built-in platform to begin to funnel this into our clinical practice. With regard to the other questions, I'll turn that over to Dr. Albitar.

Maher Albitar

In terms of reimbursing, again, you're thinking of next-generation sequencing as a technology. For example, we can really run EGFR mutation testing on next-gen sequencing by combining 15 or 40 different patients, and we are trying to educate payers to the fact that this is a technology that can reduce cost if it is used properly, and it is not necessarily only a technology for running numerous genes at the same time. So in my opinion, it is educational things to the payers to get them to understand the concept of the utilization of the next-gen. But at the same time, going back into the profiles, by doing -- by profiling the patients, you are managing the patient better. You are predicting prognosis, you are dealing with the patient based on knowledge. In my opinion, that will reduce the cost and eliminate many struggles that clinicians they have to do and they will deal with their patients -- sometimes they are avoiding or was thinking a lot of money and cost on treating with therapy that is not going to work. So it's going to reduce cost by paying for these profiles on the long run, in the bigger picture, in my opinion. And we need to convince the various payers, the various agencies, that this is really a fact. So we are planning some clinical trial or some collaboration with some academic centers to work along these lines and demonstrate these facts for clinical utilization as well as for various insurance campaigns.

Kevin DeGeeter - Ladenburg Thalmann & Co. Inc., Research Division

Second follow-up on that. Do you anticipate being able to reliably and robustly work with both FFT block and fresh frozen samples? Or do you think, initially, this is going to be largely fresh samples as being appropriate?

Maher Albitar

We are doing a lot of work on validating this. I think we have a very reliable -- we feel comfortable that our FFPE or paraffin blocks are adequate and can be used for next-gen sequencing. Also, there are some technical things we have to be very careful. Quality controls are extremely important, and we have a mechanism to check on the quality control of the DNA used for DNA analysis, although we feel comfortable with the broader quality controls that FFPE is good sample to be used for next-gen sequencing. So there would be some incidences where we have to reject a few samples if they are -- if the quality control is not there. But overall, it is adequate and it is good. We feel comfortable with that.

Operator

And the next question comes from the line of Matt Hewitt with Craig-Hallum Capital Group.

Matthew Hewitt - Craig-Hallum Capital Group LLC, Research Division

First, and this is an easy one, were there any clinical trial revenues here in Q3? And what should we anticipate, broadly speaking, for Q4?

Douglas M. VanOort

Yes. We had very insignificant clinical trial revenue in quarter 3, and we would expect that to increase in quarter 4.

Matthew Hewitt - Craig-Hallum Capital Group LLC, Research Division

Okay. And secondly, you mentioned a couple times the new account additions here in the third quarter. Could you put a little bit color on the types of accounts that you're opening up? Are these still larger oncology practices? Or have you tapped into maybe some new market segments?

Douglas M. VanOort

Here, Matt, they are everything. We have opened up new hospital accounts, new pathology accounts. We have actually opened up some clinician accounts as well. In fact, it may be even a broader mix or a higher mix of oncology practices compared to what we're used to. So I think it's a pretty broad spectrum of accounts and it's broad both in the client type, as well as in the geographic presence.

Matthew Hewitt - Craig-Hallum Capital Group LLC, Research Division

Okay, great. And then lastly, M&A. Has -- where do you guys sit on that front? Are you still kind of kicking the tires, looking? Or has it cooled off, given what's transpired with CMS and people are waiting to see what's going to happen before they get maybe a little bit more aggressive? And how do you play into that mix?

Douglas M. VanOort

I think we're at a point of hesitation here in the market, given the CMS uncertainty. There is a great appetite on the part of NeoGenomics to engage in some M&A activity. We are ready. We think it would be good. We continue to talk with people and look. We hope we have an opportunity to execute some really value-added M&A as soon as CMS decides. And then I think people will have a better sense for valuations and what they want to do. But we're ready.

Operator

It seems that we have no further questions at this time. I'd like to turn the call back over for any closing comments.

Douglas M. VanOort

Okay. Thank you very much, Brenda. So as we end the call, I would like to recognize all 308 now NeoGenomics team members around the United States for their dedication and commitment to building a world-class cancer genetics testing program. On behalf of the team here, I want to thank all of you for your time joining us this morning for our quarter 3 2013 earnings call and let you know that our quarter 4 2013 earnings call will be held around February 20 of next year. And for those of you listening that are investors or thinking about investing in NeoGenomics, we want to thank you for your interest in our company.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Neogenomics Management Discusses Q3 2013 Results - Earnings Call Transcript
This Transcript
All Transcripts