Neogenomics' (NEO) CEO Douglas VanOort on Q2 2016 Results - Earnings Call Transcript

| About: NeoGenomics Inc. (NEO)

Neogenomics, Inc. (NASDAQ:NEO)

Q2 2016 Earnings Conference Call

July 26, 2016 09:00 ET

Executives

Douglas VanOort - CEO

Steve Jones - EVP, Finance

Analysts

Bill Bonello - Craig-Hallum

Amanda Murphy - William Blair

Drew Jones - Stephens

Bill Marsh - Janney Montgomery

Raymond Myers - Benchmark

Chris Lewis - ROTH Capital

Scott Billeadeau - Walrus Partners

Operator

Greetings and welcome to the NeoGenomics' Second Quarter 2016 Conference Call. [Operator Instructions]. And I would like to turn the call over to your host, Mr. Douglas VanOort, Chairman and CEO of NeoGenomics', Mr. VanOort you may begin.

Douglas VanOort

Thank you, Tim and good morning. I would like to welcome everyone to NeoGenomics' second quarter 2016 conference call and introduce you to the NeoGenomics team that's here with us today.

Joining me in our Fort Myers headquarters, we have Steve Jones, our Executive Vice President for Finance, George Cardoza, our Chief Financial Officer, Fred Weidig, our Controller and Principal Accounting Officer and Jessica King, our Manager of SEC Reporting, Rob our Chief Growth Officer, Steve Ross, and our Chief Information Officer. We also have Dr. Maher Albitar, our Chief Medical Officer and Director of Research and Development is joining us from our Irvine Lab in California.

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

Steve 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 facts 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 VanOort

Thanks, Steve. And in this mornings conference call I will make some brief comment about our second quarter performance. Update you on status of our integration, and conclude by sharing some of our plans as we look forward to the remainder of this year and into 2017. Neogenomics reported very strong financial results in quarter two. We were particularly pleased with our performance, because we are in the midst of a significant integration initiative. And our people are extremely busy with those activities.

Once again revenue growth continue to be excellent driven by market share gains in our clinical business, and by strong growth in our -- in our Biopharma and research business. Adjusted EBITDA was about three times higher than last year, as a result of revenue growth and strong employee productivity. We're also pleased that our integration activities are moving forward exactly as planned. And we are on track to achieve our key integration milestone. After nearly seven months of Clarient ownership we can still say; so far so good.

And now with greater visibility about the integration and the reimbursement environment for 2017. We're excited about our prospects, as we look ahead to the future. Steve will describe our financial performance in more detail in a few minutes, but I would like to give you a high level review and comment on some trends and dynamics.

Revenue and volume growth dynamics in the second quarter were excellent. Clinical tests volumes in the business excluding Clarient and PathLogic grew by about 32% which exceeded our expectations. The NeoGenomics volume growth was driven mostly by new clients. Clarient tests volumes stabilized and reflect the last year. As you know new products are important for our growth and Clarient volume stabilized partly due to the recently introduced immunotherapy related testing for PD-1 and PDL-1 overseas high cost by many clients across our company.

Overall client retention has continued to be excellent. Although we reported that average reimbursement for test declined by 5% from last year, this was caused by the inclusion of Clarient mix of business. On a pro forma basis, average revenue per test in the clinical business was actually up about 2% from last year. This is the first time in many years that we've had a year-over-year increase in average reimbursement, and even if it's minor the fact that it's up is a welcome relief.

This pro forma increase is primarily related to increase in FISH reimbursement as Medicare made corrections to last year's FISH rates. The reimbursement of stabilization along with the recently released 2017 proposed physician fee schedule by Medicare gives us more confidence that we are now in a period of greater stability and reimbursement. We are very pleased with the bio-pharma revenue in quarter two. Revenue in this business can be a bit bumpy but we had a good comp this quarter. Revenue was up nearly 30% year-over-year on a pro forma basis and nearly 3% to 4% sequentially from quarter one.

Clearly, testing related to development of immunotherapeutic drugs are driving some of the growth in this business. We are beginning to gain momentum in the bio-pharma business as we begun to win new clients and get more repeat business. A broader and more diversified client base, greater number of projects and a broader and deeper offering has made this business less volatile from quarter-to-quarter and that's what we are working to achieve. The combined expertise of Clarient and Neogenomics's strong value proposition to pharmaceutical companies. We are bullish about this business on a long term basis and are investing to make it an even more important part of our company. Our commercial teams throughout the company continue to work on the healthy list of growth opportunities.

In the clinical business, our sales team has been building and/or rebuilding their pipeline and forecasts for new business is solid. In particular the opportunities for growth with large oncology groups and larger hospitals and academic centers is picking up good momentum. The clinical sales team continues to work hard on growth despite spending a significant amount of time devoted to integration related activities. In fact we have expected a slowdown in volume growth as our sales team is spending a lot of time training existing clients for changes in products and service offerings. But that wasn't the case in this past quarter.

We also made changes and added to the bio-pharma sales team over the past several months. We are pleased with the quality and experience level of our new bio-pharma commercial team. Pipelines are now beginning to grow as we have now executed a significantly more contracts and statements of work in the last three months than in the first three months of year. There is some lag time in between signing these arrangements and generating revenue but this activity suggests good growth in the future. As with our commercial teams, the company's operations teams were full with activity during the quarter, they maintained good levels of service as we continued to grow testing volumes and also manage the complexity of merging different practices and prophecies as we integrated the Clarient and Neogenomics' operations.

Cost per test in our core clinical genetic testing business was down about 4% from last year. We had strong performance in labor productivity but it was offset by some inefficiencies in supply usage for test validations and other matters mostly related to integration work. These temporary inefficiencies will soon be behind us as we fully implement our combined best practices and merge operations. We ended the quarter with about 945 employees, that's up about 3% from the year-end level while volume is up over 10% from the year-end level. Clearly our people are more productive, even though we just started the integration process and haven't yet combined our laboratory testing facilities or other operations. Adjusted EBITDA increased 281% over last year's second quarter as a result of the solid operational efforts. In fact, adjusted EBITDA as a percentage of sales was 14.5% which is a record high for our company.

Cash flow from operations was also strong at $5 million for the second quarter and $12 million for the first half of the year. Looking ahead now to the rest of 2016, we believe the key for Neogenomics success is focus and execution. We have exactly what we need to do and we are focused on the things that matter most. Creating a one company high performance culture, providing great quality and service for our clients and integrating Clarient extremely well. Culturally, we are making progress to bring everyone together as one high performance team, though we have a lot of work to do. We have some of the very best people in our industry and it's our job to positively manage cultural change to keep everyone engaged and to keep our teams focused on our clients and their patients.

We have a number of tools and processes in place to help us manage and monitor the pace of change and we are feeling good about the combined company's culture. As you know quality and service is the bed-rock of our company. We are laser focused on the needs of our client's, our payers and most of all the patients we serve.

With a company more than twice the size it was eight months ago, we are investing in more systems and resources to continually raise the bar on quality and service, not only for ourselves but for our editors. We know that our success for the rest of 2016 and in the future generally depends on how well we execute the integration of Clarient and Neogenomics. Great execution requires great team work and there's a lot of great teamwork happening throughout our company. Those teams involve sales, medical, lab operations, IT, finance & billing and others and they are doing an excellent job executing our integration plans. So far, I couldn't be more pleased with our progress. We have now updated and revised many of our laboratory and customer IT systems to incorporate best practices of each company. We have made many changes in systems, processes and organizations and in roles and responsibilities and those activities have been well planned and well executed.

Now, we are in the early stages of migrating the Clarient's clients to the Neogenomics Laboratory Information and Billing Systems and that is also going well. That client migration will continue over the next few months and we are rigorously implementing and manning this activity. Our goal is to have all of our clients' using a single laboratory information systems, a single billing systems, a single uniform service offering and a single test menu in the fourth quarter. We expect, especially during this client migration phase, our sales, operations, marketing, medical and other teams to be predominantly focused on a well-executed integration.

Other objectives such as reducing cost for test and attracting new clients are secondary to our primary objective of achieving outstanding client retention during these few months. We will return to those traditionally strong operational activities after this integration is complete. Our objective is to retain a 100% of our clients through both of these prophecies, even though none of us know about lab integration on a scale that is ever composed to a 100% client retention, we believe we have a good shot at it. Even as we are migrating clients we are also making changes to our 78,000 square foot Aliso Viejo facility in order to fully combine our Irvine operations into it around the end of the year.

We are investing over $3 million in our Aliso Viejo facility to make it truly a state of the art laboratory. As we look a little further ahead, I must say that we are very excited about 2017 and beyond. We must keep in mind that Neogenomics is still a young company and while we reported a good quarter, we know that it is important to stay focused on our vision and future strategic opportunities.

Much as the work we are doing now and in the remainder of this year is to position the company for very strong performance in 2017. With all of our clients and operations utilizing common systems and platforms and with our facilities having been consolidated, we will be positioned to make sizable improvements throughout the company. We believe that cost and revenue synergy civilization should be well within the range we originally estimated with the potential for approximately $20 million to $30 million synergies to be achieved by 2018.

Perhaps just as importantly, we have emerging clarity for strategies to allow Neogenomics to be the leading cancer testing and information company in the world. We aim to separate Neogenomics from the rest of the industry when it comes to quality and service. We are to invest and grow our bio-pharma business, develop and grow multiple new revenue streams in Big Data and informatics and continue to be a leader in new test development. As I end my remarks, I want to share a comment made by one of our key people a couple of days ago. This person came into my office and said, "Even though we've grown incredibly these past eight years, I'm more excited than I've ever been about our future." And personally, I couldn't agree more. Now we're going to turn the floor over to Steve Jones, our Executive Vice-President for Finance to review our second quarter results in more detail and lead us through a Q&A Session.

Steve Jones

Thanks, Doug. Before we open up for questions, I want to briefly touch on a few financial highlights. We're pleased to report $63.1 million of revenue, a 159% increase over the prior year and this was driven primarily by the inclusion of Clarient end results but also by strong growth in the quarter of base NeoGenomics clinical business. Approximately $54.2 million of this revenue was derived from clinical genetic testing, $2.1 million from pathologic and $6.8 million from biopharma and research. Incidentally, this will be the last quarter that we're able to breakout the base NeoGenomics growth rate separately because we are now actively migrating the clearing clients and joint accounts onto the NeoGenomics LIS System.

Consolidated gross margin was 45.3%, a 90 basis point increase from the 44.4% recorded in Q2 last year. This increase in gross margin was driven by the 4.4% decrease in average cost per clinical genetic test as well as strong margin growth in the biopharma business.

Consolidated SG&A cost increased by $15.6 million or 145% from quarter two last year. However as we discuss in the press release, $2.5 million of this increase was due to non-cash stock based compensation and non-cash amortization of intangibles directly related to the Clarient acquisition. Importantly, SG&A the percentage of total revenue fell to 41.8% from 44.3% in quarter two 2015. Given the reductions in cost per test in the economy for the scale we achieved on the cash portion of our SG&A expenses, consolidated adjusted EBITDA increased by 281% to a record $9.2 million. Importantly, adjusted EBITDA margin grew by 460 basis points year-over-year from 9.9% in quarter two last year to a record 14.5% this year. This levels also $1 million higher than the $8.2 million of adjusted EBITDA we recorded from Q1.

Second quarter GAAP net loss available to common shareholders was negative $5.2 million and GAAP diluted EPS was negative $0.07 per share. This compares to GAAP net loss available to common shareholders of 176,000 and diluted EPS of zero cents per share in last year's second quarter. However, as we discussed 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 income or loss available to common shareholders to exclude the non-cash amortization of intangibles such as the customer list acquired with the pathologic and Clarient acquisitions.

Two, the non-cash stock based compensations that are partially driven by changes in the company's underlying stock pricing in the given quarter. Three, the deemed preferred stock dividends required by GAAP accounting which are a non-cash charge. Four, the amortization of the beneficial conversion feature related to the preferred stock that is also required by GAAP accounting and is also a non-cash charge. And five, other one-time or non-recurring income or loss items of which there were none in quarter two. We've referred to this measure as adjusted net income and on a per share bust basis adjusted diluted earnings per share, and we had included a table with how this is calculated in our earnings release. In the second quarter, adjusted net income was $3.7 million, a 577% increase over the 540,000 for last year's second quarter, and adjusted diluted EPS was $0.04 per share compared to $0.01 per share in quarter two, 2015.

Before opening it up for questions, I would like to comment briefly on the 2017 draft wool for the physician fee schedule that was released by CMS on July 7. Overall we were very pleased with the implied reimbursement rates in this preliminary rule. If the rule holds up through the final rule making process in November and we have no reason to believe that it won't, then that result will be in line with our previous expectations and should result in approximately 1% reduction in average revenue per test in 2017. Considering that we have reduced average cost per test by approximately 5% to 7% per year over the last five years, we believe we will be able to absorb these reductions in 2017.

Keep in mind also that Medicare is now only 16% of our overall paramex [ph]. Among other highlights, we're pleased that were no significant reductions in the technical component of FISH or IHC testing. Each of which had significant increases in 2016. Thus CMS appears to have upheld the 2016 rate increases. We will -- however, we're receiving 19.3% decrease in the technical component of flow cytometry from Medicare test, but this was expected. To those investors who would like more detail in the implied rates for 2017, please refer to the appendix of the Company overview presentation that is posted on the IR section of our website.

At this point I would like to close down our formal remarks and open it up for questions. Incidentally, if you are listening to this conference call via webcast only and would like to submit a question, feel free to e-mail us at sjones@neogenomics.com in 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 the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Bill Bonello of Craig-Hallum. Please proceed with your question.

Bill Bonello

Good morning guys. Just a couple of quick questions. You covered most everything in the quarter. Just wondering any color on cross-selling activities that you can give in particular. Are you having any success yet capturing IHC revenue from Legacy Neo customers?

Douglas VanOort

Good morning, Bill. Thanks for the question. We have not begun in earnest selling and cross-selling the Clarient book of business to NeoGenomics customers or vice versa except that we are getting some traction in the molecular space and in the IHC area for things like PD-L1 and PD-1. So Clarient has a very strong reputation and product offering in IHC. We're starting to take advantage of that but we've got a lot of room to grow with digital pathology products and other IHC related products with the Neo clients, and we have started selling to Clarient clients the molecular menu of NeoGenomics. I think we've got a long way to go there to grow our volume in both areas.

Bill Bonello

Perfect. And then any chance you would give us a sense of how much of the $20 million to $30 million of synergies are yet to be realized versus what's already reflected in the results?

Douglas VanOort

Well we've said that we expect $68 million of synergies this year and we've also said that we expect sort of 80% of the total synergies will be cost related and another 20% or so will be revenue synergy. It's really hard to isolate what a pure synergy versus what's increase in productivity that resulted in deductions in cost per test. But I think just knowing an entry point I think probably fair to say we're approaching half of what we said we'd do for this year through the first half of this year.

Bill Bonello

Sorry, I cut you off.

Douglas VanOort

Well obviously the bulk of the $20 million to $30 million is ahead of us.

Bill Bonello

Excellent, that's all we have. Thank you.

Douglas VanOort

Thanks, Bill.

Operator

Our next question comes from the line of Amanda Murphy of William Blair. Please proceed with your question.

Amanda Murphy

Hi, good morning. I just had a question on the comments you made about kind of where the source of the growth was for the Legacy business. I guess can you step back for a second if you think about that only as a market. How penetrated are you in that phase and can you also talk a bit about kind of underlying same store sales growth that you're seeing as well.

Douglas VanOort

Sure Amanda, thanks for the question. So the growth in the base neo-business was quite wide-ranging. So it occurred in most of our geographies, it occurred in most of our product line; it was not just tech only, it was really almost every product -- the economy grew very well, molecular continue to grow very well, and I think that in terms of penetration of our tech-only products we have a long ways to go. I mean, I think we've got a good market share but this is a big, big market; as you now it is a $5.5 million market and we think that between our flow cytometry immunohistochemistry and FISH tech-only programs, we've got a very good product line and we're trying to make it better all the time and we think we can continue to penetrate accounts. Not only with that but with our comprehensive menu.

Amanda Murphy

Got it, okay. Is there -- when you think about geographical sense or penetration is there particular area that you feel is underpenetrated that may see a near-term opportunity for you?

Douglas VanOort

Well, I think that our opportunities are continued to be a community based, Healthcare systems but increasingly as a result of larger GEO kinds of arrangements, we're being able to penetrate these larger hospital systems are part of buying group, we're also beginning to penetrate academic centers portfolio. This is not really a geographic focus, but it's rather a type of client. So if you step back and think about the evolution of our company, we were in the past more focused on smaller community based pathology practices of hospitals, well we continue to have that as a focus, we are moving upstream and because of that graph of our menu, we're able to add value to even some very sophisticated academic centers and -- and that's you know that's where we're growing as well.

Amanda Murphy

Got it. And then just a couple more, one on the I think you implied that you have not yet last declined, is that fair [ph] I decline I understood the commentary?

Douglas VanOort

Our client retention is very, very strong. I don't know really of a client that we've lost as a result of integration activities. You know there are always one of cases where there have been through the last years were in the -- you lose one client for reason that they're acquires something that I don't know one client that we've lost as a result of the integration.

Amanda Murphy

And so is it fair to say than -- I guess maybe reverting it, are you still maintaining -- I think you said originally $6 million in terms of a synergy? Are you still maintaining that or do you think that might still conservative?

Douglas VanOort

Well, that's a sort of vague into our revenue guidance for the year overall, and clearly our sales team is distracted, I mean they've been distracted in the first quarter early, then distracted the second quarter distracted now because what we're doing is we're changing our LIS Systems and products and so you're seeing the distraction in our numbers right now. So I guess you could say that we would have had even better growth you know, had our team not been distressed. I think it's important for us to understand that we're migrating all of the Clarient clients and the joint client to use both our systems, from having to use the Clarient LIS system at all, on to a new NeoGenomics system which have been fairly significantly improved to incorporate the best functionality of Clarient had to offer. But when you're teaching clients the new system, there is a period where the sales reps needs to go talk to the pathologist and the accounts and get some problem with it and answer the questions and those are some time intensive activities that we think will be a distraction for the balance of this year, and we hope to complete this activity later in the fall maybe in November timeframe, but this is what we're entering a period where the most customer facing activities are going to occur in the less important piece of this. So what we're very bullish about the growth prospects we also need to be very focused as Doug mentioned as retaining clients first and foremost.

Amanda Murphy

Yes. Okay, thanks very much.

Douglas VanOort

Okay, thank you Amanda.

Operator

Our next question is from the line of Drew Jones of Stephens Inc. Please proceed with your question.

Drew Jones

Thanks, good morning guys. A little bit more into see our growth strength in the quarter, with that legacy you know when you say pro forma growth and -- and I guess were we thinking new customers is it more FISH based, is it more like -- in flow like what you've seen with Clarient, and then could you just remind us that we have talked about it a while a little bit, what is the pricing and margin structure look like for these relationships relative to the rest of the business?

Douglas VanOort

Okay, thanks for the question Drew. So I would step back for a minute and say we'd really like to buy a Pharma business. And we started to invest in NeoGenomics' a couple years ago and we believe that it's a good diversification and we are investing in it as we speak. We find the of the current business was a -- was a much more sizeable business that we have in NeoGenomics'. And we like it because it keeps us at the leading edge of innovation. We did have to refill the sales team that came with the business at the beginning of the year from Clarient and we've -- we've done that now. As you know salespeople take a little while to generate a good pipelines and forecasts, but activities going on right now. So in quarter two we did have some business that's we're able to execute, from a wide range of product lines, now that the biggest I would say was some contracts relative to immunotherapeutics, this is the PDR-1, PD-1 which is a really growing area for us in the biopharma area as it is in the clinical business. But we also had product lines like multiomics which is something I mean we've talked about in the past, which we've had some good projects and revenue activity with. But the key thing I want everyone to understand about the biopharma businesses this is a terrific business we love it, but it is a little bumpy, and I said in the comments that we had a good bump in quarter two. And we hope we have a lot of good bumps, but it is now about 10% revenue until we have more critical mass, it may be a good bump in the future as well.

Drew Jones

So taking what you said about 2Q, you talked a little bit about distractions from the integration. Is there any reason to think that the second half of the year we would see that normal seasonal strength where that's -- that's meaningfully larger than the second -- first half of the year of the revenue.

Douglas VanOort

No we don't see anything in our business that causes and -- causes us any pause. Now you know from covering us for a while that quarter three is usually a lot like quarter two, there seasonal patterns in the business, and we don't expect that those would be any different this year, but the business is strong we don't see anything that – that causes us pause. We had the benefit of having two great quarters of exceeding guidance, and you know we like to exceed guidance.

Drew Jones

Okay. And the last question from me, I believe as far the guidance is concerned you got to say it was about 50% of your commercial payers would -- would eventually follow-up and the FISH remarked increase this year, where do we stand on that front?

Steve Jones

We said that that was a long term exercise, I mean commercial payers do not move very quickly when it's upto their disfavorite you would. So initially many of our contracts, particularly, the Medicare advantage plan, and there is directly tied to the Medicare rates, those we said immediately but some of the others particularly perhaps in the BlueCross world were actually having to talk to one of the time. I think right now it is happening a lot as we expected, but it still take time.

Drew Jones

Thank you.

Operator

Our next question comes from the line of Bill Marsh of Janney Montgomery. Please proceed with your question.

Bill Marsh

Hi, congratulations on the quarter. Where you think the CMS is on their view of codes, usually have a pretty good run away for the next 12 months that -- Is this I think you mentioned 2% kind of normalized growth. Something that's visible beyond this year?

Steve Jones

Yes. so we actually think that everybody should just assume modest price decreases every year, even though we think we're entering into a period of relative price stability, the 2% increase on a pro forma basis with average revenue per test this year is being driven by the pretty pronounced increase in FISH testing that they put through in 2016 and they increase the technical component of FISH, 87% this year to fix an error that they made in 2015. And so I don't think you are going to see many 87% increases moving forward basis. We are expecting a 19.3% cut in the technical component of flow next year and we are actually expecting another 19.3% cut in flow cytometry and 2018 as well.

But when you look at our reimbursement levels for flow cytometry, the commercial players and even the hospitals are well below the CMS levels and one can argue that Medicare probably should reduce the flow cytometry reimbursement if they want to be consistent with where the commercial players which is where Medicare wants to go. We would never like to see that of course, but we are prepared to deal with it as it comes and given that Medicare is only 16% of our overall paramex, it doesn't have anywhere near the impact on us that it used to have when Medicare was 57% of our paramex 6 or 7 years ago.

Bill Marsh

And then you have mentioned LIMS in the California lab build out of past initiatives of building margin visibility of next year, what are the other pieces of low hanging fruit that you see safe?

Douglas VanOort

Yes, this is Doug, let me try that, address that so, we made a lot of changes to our LIS system and I must say our team did a great job. I think we have a very good IT system now which we are migrating clients to and just having all of our clients on one single LIS system and one single billing system and one single offering is going to allow us to be a lot more efficient. Now, in addition when we put the LIS together, there was going to be a lot of efficiencies, and even though we are growing we think we can manage the change to our employment base through attrition and good growth, I think we need a lot of cost reductions. But in addition to those things, there's areas like supplies, savings so having a much bigger critical mass allows us to work with suppliers who try to get the best prices and the best processes for procurement systems.

I think that is a huge opportunity but when we are able to have everything under one roof and a couple of big labs we are going to be able to leverage the best practices and the cost for test reductions that Steve mentioned that we have been enjoying and trying to generate for years, we are going to have that ability when we are all together to start doing that same thing again. But it's going to take a while. We are going to have the labs integrated and everything in the same systems and that will happen this year.

Bill Marsh

Thank you, Doug.

Douglas VanOort

Thank you, Bill.

Operator

Our next question comes from the line of Raymond Myers of Benchmark. Please proceed with your question.

Raymond Myers

Thank you, my first question is for Doug. Doug you talked about the reduction in costs for tests despite an increase in temporary inefficiencies for the validation work involved in integration process, can you give us some sense of modifying how much of these inefficiencies were felt in Q2 and give us some sense of when you feel that those costs would be complete?

Douglas VanOort

Yes, thanks Ray, it's a good question. So let me first explain what we are doing with this activity so for supplies usage what we are doing is find ahead certain prophecies and certain supplies and cash and Neogenomics has certain prophecies and cash and now we are creating one centralized way to do this and so when we move to one single way to process these tests, we get to revalidate as a part of our quality process all of these new tests using new supplies and we are just burning reagents and burning time and we are generally inefficient local supplies usage and people productivity during the timeframe.

Now, I am not sure I should quantify this for you but this activity should be carrying of August by the timeframe and we should be pretty much fully done with this activity in the third quarter so I think we should start to see some benefits of that reduction in excess validation and integration related inefficiencies starting here in the third quarter.

Raymond Myers

Okay, thanks that helps. And one thing as you go through your remarks is that results were very good can you discuss how business was able to grow despite all this integration work?

Douglas VanOort

Well, yes thanks for that Ray but we have a really good team. I think our sales team is terrific. Our medical team is terrific. Everyone in our company is focused on growth and doing the right thing for clients. And unfortunately I think quality and service do matter in our business and I think we have good quality and service and there is a lot of word to mouth that goes on in our business and we are certainly getting the benefits of that in terms of market share gains and we are trying to keep our heads down and do the right thing for patients and clients.

Raymond Myers

And, is this something that you think can continue that wasn't just a one quarter thing, this trend of organic growth that continued even through this LIS integration you would anticipate over the next several months?

Douglas VanOort

Well, Ray what we said was that we expected a distraction because lot of the things we have talked about here. Now we have been fortunate that in quarter one and quarter two the distraction maybe wasn't as significant as we expected but we were cautious. We wanted to make sure people know that we are integrating but we think that same kind of dynamic that has occurred over the past has allowed us to gain market share, will continue.

Raymond Myers

Okay, well that's great and then let me connect with this question. It's the one I get the most from investors, either in the story or new to the story when they ask about the risks of the LIS integration that's probably the factor that concerns them the most. What can you say to alleviate concerns that when you convert to the new information systems, you are not going to uncover or encounter issues and problems?

Douglas VanOort

Well, I could say this that we have already made the changes. Most of the changes in our LIS systems, we have already migrated the first wave of clients and so far so good.

Steve Jones

Yes, I would also add that Clarient uses a very similar LIS system in fact, the original kernel of the Clarient system was the same original kernel from Neogenomics and we diverged from the vendor that we were using four or five years ago. They diverged two to three years ago. The look and feel of the system was very similar between the two and so, the amount of client re-education work is sort of more of intuitive camp, it's not something that they are going to have to call customer service and say how do I do this? It's something they should be able to figure out pretty readily.

Raymond Myers

Okay, great thank you very much.

Douglas VanOort

Okay, thank you.

Operator

[Operator Instructions] Our next question comes from the line of Chris Lewis of ROTH Capital. Please proceed with your question.

Chris Lewis

Hey guys, thanks for taking the questions. I wanted to follow up on some of the LIS migration. Just a couple of things. When id the migration began and I know it's early but do you have any early feel from the clients who have been converted over in terms of the reception, thus far and when do you expect that to be completed?

Douglas VanOort

Okay, Chris one thing I want to make sure everyone understands is we are not moving to a brand new system that's untested. We are moving to a system that we have been using at Neogenomics for a long time. I mean the system has been revised but it's fundamentally the same system. So the risk is not by moving everything to a brand new system, that's not been time-tested. That's the first thing. Funny thing is the bulk of the changes to allow for the wave of migration has been completed about six weeks ago and so now we are going to migrate the company's Clarients clients in waves, we have a series of those and we have about completed the first wave which we spent a little bit more time on to allow for us to make sure that we are doing the right thing and getting the clients feedback which we are serving clients as well as getting real-time feedback. So far it has gone very well. Robert Shovlin is here who is our Chief Growth Officer, so I will ask Rob if he wants to make any comment. But overall the migration has gone, it is going well and we've got six or seven waves ahead of us to migrate over the next couple of months. Rob, do you have any?

Steve Jones

Yes, I would add that it's a very deliberate process. We did a lot of planning and testing, preparing for wave one and we did a lot of communicating. So as we rolled out wave one with changes that had been implemented as I've said weeks before, it's been a very deliberate measured process, so we've gotten some client feedback and then most of it is just some things are slightly different so you have to answer questions for changes. But it's not something that's drastically new as Doug and Steve pointed out. So the process is going very smoothly and we've learned some things in wave one that we'll apply to future waves and we should be complete over the next few months.

Chris Lewis

Great, I appreciate the color, and then switching over to the lab consolidation. I guess can you just elaborate on how that process is going? What are the key milestones that we should look for over the remainder of this year? And I believe you kind of targeted end of year for that consolidation to be completed, are you still on track for that? Thanks.

Douglas VanOort

Yes, Chris, thanks for the question. Yes, we are on track. Right now what we're doing is we are renovating the Aliso Viejo laboratory. We're making a lot changes to it. During this process it's a bit of a choreography because we're moving some departments to Irvine, we're consolidating some testing in Irvine in anticipation to moving it back to Aliso Viejo. So there are a lot of moving parts on this one but it's really just construction. We're fortunate that the Irvine and Aliso Viejo labs are eight miles apart. So we're bringing up the road moving specimens back and forth a bit and will so for the next few months. But the construction is going just as planned. We are going to have one heck of nice looking lab in Aliso Viejo once we're done and that ought to be around the end of the year.

Chris Lewis

Great, and then can you quantify just the amount of cost savings you expect from the impact of that consolidation in 2017?

Douglas VanOort

Well, the total cost savings, we said, I guess I'm going to our script here on this one. So we've got $20 million to $30 million of general synergies, the bulk of which are cost savings. The bulk of those will happen in 2017.

Chris Lewis

Understood.

Douglas VanOort

The facilities opportunity is not anywhere near in sight as the reduction in cost per test opportunity comes just more scaling, having people operate on the same platform.

Chris Lewis

Great, okay, thanks for the time.

Douglas VanOort

Okay, thanks, Chris.

Operator

Our next question comes from the line of Scott Billeadeau of Walrus Partners. Scott. Please proceed with your question.

Scott Billeadeau

Thanks for taking mine, most of mine have been answered. I guess just one question, anything new with your partner GE and what their status is?

Douglas VanOort

I can tell that we have a representative from GE Healthcare Life Sciences serving on our board is terrific. We have had great cooperation and support and encouragement from the people at GE. We are moving off of we call it the transition services agreement, TSAs, so we're moving off of the support for IT systems and other things that GE provided us during this transition period, and by the way we're going to save some money as we complete the transition away from this TSA agreements. But that has been terrific. GE has been really really supportive of us. They've helped us and are helping us to open doors and in the healthcare community, and we're really appreciative of their ownership.

Scott Billeadeau

Great, and then most of my questions were asked were already answered. Good quarter, guys. Thanks so much.

Douglas VanOort

Okay, thanks, Scott.

Operator

We have one follow up question from the line of Raymond Myers. Please proceed with your question.

Raymond Myers

Yes, thanks for taking the follow up. I just wanted to touch on the tax rate. Can you give us a sense of what the normalized tax rate is likely to be over the next several quarters or years as you become hopefully increasingly profitable?

Douglas VanOort

Keep in mind our book tax rate will be between 45% to 50%. However right now we are not a cash taxpayer except for various state. We still have an NOL and we're not a cash taxpayer at the federal level yet. However for book tax you will continue to see about 45% to 50%, majority of which will affect [ph] our different tax balance.

Raymond Myers

And would that stay at that rate as you become more profitable in the years to come or is that fixed to some other factor?

Douglas VanOort

No it will stay on that range. We expect 45% to 50% to be a range moving forward.

Steve Jones

Unless the administration lowers business tax which is a lot to talk about.

Douglas VanOort

Assuming it all stays the same in Washington which is a good wild card, and that's a combined state, local, federal tax.

Steve Jones

Okay, we have one question that came in over at e-mail related to the comments about with having a vision to be the leading cancer testing and information company in the world, and asking if we had any plans to grow internationally. The answer is yes, we do. And what we will do is try to grow internationally first in our biopharma and research area. We think that our pharmaceutical clients would enjoy very much having us have a worldwide capability to perform clinical trials not just in the U.S. but outside the U.S. as well. Many of them have asked us to do that, and we will likely grow our footprint outside the U.S. first in that area.

Douglas VanOort

We have one other question here to address the preferred stock and what our plans to take that out. Under the terms of our agreement with General Electric Corporation, we can review the preferred stock at any time over its tenure like we've been given ample incentives to do that sooner rather than later. As we've discussed before, the peak interest rate is 0% this year and then it goes up to 4% in years three to four, and then it increases 1% a year [00:52:41.14]. And in addition to that they gave us a $10 million discount if we take it out this year which reduces to $7.5 million next year and then $2.5 million the year after. The way we think about our opportunity with the preferred stock is that we definitely think that it is in the interest of our shareholders to take that out at an appropriate point in time. Factors that we'll consider when doing that is how much bank debt should we use to take it out versus how much of an equity instrument. Keep in mind the Company is actually generating quite a bit of quarterly cash flow from operations and so our debt capacity is going up. Other things to keep in mind are what's going on with the overall market. The markets have been extremely volatile in recent history. In fact the discount rates that follow on offerings are being priced materially higher this year than they were last year. And so we look at all these things and there's a lot that goes into a decision like this. But I think from our perspective we don't really feel like we have to take out the preferred stock and in great hurry. We view that just a 3% difference in discount rate would more than offset the incremental discount that we get from GE this year. And so from our perspective we want to time it so when we can maximize bank debt and maximize the market receptivity of the offering. And I expect we'll do something in the next three years but we don't have any definitive plans at this point in time. And keep in mind when we do do this we're likely going to remove 14.7 million shares of preferred stock with something significantly less. So we think we have the opportunity on a per share basis to have whatever take on would be actually acuitive, if we took this out with seven, eight, nine million shares of common stock and some bank debt, that would be a very good thing for all the per share metrics moving forward.

Steve Jones

Okay, we don't have any further questions that haven't already been addressed. So Doug, I'll turn it over to you to wrap this up.

Douglas VanOort

Okay, thanks, Steve. So as we end the call I want to take time to recognize the approximately 925 NeoGenomics team members around the country for their dedication and commitment to building a world-class cancer genetics assessing program, and on behalf of our NeoGenomics Team, I want to thank you all for your time in joining us this morning for our second quarter, 2016 conference call. We want to let you know that our third quarter, 2016 earnings call will be held on or around October 25, 2016. And for those who are listening that are investors or are considering an investment in NeoGenomics, we thank you very much for your interest in our company. Goodbye.

Operator

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

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