Clarient, Inc. Q42007 Earnings Call Transcript

Clarient, Inc. (CLRT)

Q4 2007 Earnings Call

March 31, 2008 8:00 am ET

Executives

Matt Clawson - Allen & Caron

Ron Andrews - President and CEO

Jim Agnello – CFO

Analysts

Un Kwon – Pacific Growth Equities

Debjit Chattopadhyay - Boenning & Scattergood

Presentation

Operator

Welcome to the Clarient Fourth Quarter and Year End Conference Call. [Operator Instructions] I would now like to turn the conference over to Matt Clawson of Allen & Caron.

Matt Clawson

Good morning everyone and thank you for joining us for the Clarient 2007 Fourth Quarter and Year End Results Conference Call. You should have all received a copy by e-mail this morning of the release announcing the company’s results for the fourth quarter and year ended December 31, 2007. If any of you did not receive a copy of this release you can call our office after the conference call and we’ll be happy to e-mail you a copy.

I’ve been asked to make the following statement. Statements made on this call and answers to questions as posed will include forward looking statements. Forward looking statements are subject to various known and unknown risks and uncertainties and Clarient cautions you that any forward looking information provided is not a guarantee of future performance. Actual results could differ materially from those anticipated in these forward looking statements due to a number of factors.

Some of which are beyond Clarient’s control and may be discussed in Clarient’s filings with the Securities and Exchange Commission including those on Forms 10-K, 10-Q and other periodic filings. All such forward looking statements are current only as of the date on which those statements were made. Clarient does not undertake any obligation to publicly update any forward looking statement to reflect events or circumstances after the date on which the statements were made or to reflect the occurrence of unanticipated events.

Also a quick reminder, a replay of this conference call will be available on the Clarient website at www.ClarientInc.com. The company’s 2007 fourth quarter year end results can also be found in the company’s annual report on Form 10-K which will be filed today with the Securities and Exchange Commission. With me on the call this morning from Clarient are Ron Andrews, Clarient’s CEO and Jim Agnello, the company’s Chief Financial Officer.

Members of the management team will provide a review of the financial results, discuss operational and financial outlook and will conduct a Q&A session, ending the call with closing remarks. With that said I’d like to now turn the call over to Ron Andrews.

Ron Andrews

Good morning everyone and thank you for joining us. Welcome to Clarient’s Fourth Quarter 2007 Year End Conference Call. I’m Ron Andrews, Clarient’s President and CEO and with me today is our CFO Jim Agnello.

The fourth quarter was another solid growth and operating period at Clarient. It was a period in which we maintained good growth velocity in sales, diversification of our testing menu and good cost control. Before we get to that, however, I’d like to start today’s discussion with an overview of the situation that led to the 8-K filing on March 17^th and the subsequent revenue adjustments. Three years ago we were building a laboratory service strategy we believed it was best to defer the significant expense of an in-house billing group until we had reached a certain critical mass.

At that time we engaged a local billing company with experience in physician office and laboratory billing to act as our billing agent. In February, as we were in the process of finalizing our Q4 2007 audit we identified some information from our outside billing agent that led us to believe that we may have some outstanding credits that had accumulated over the course of our tenure with the billing agency. These credits accumulated as a result of overpayment by insurance company’s and pricing adjustments and until this point had not properly been accounted for by Clarient’s internal processes.

As soon as we identified these potential inconsistencies management determined the best course of action was to perform an analysis of the origin and likely disposition of these credits. Obviously this took some time and pushed back our earnings release and the end result was the identification of numerous refunds and price adjustments dating back several years that had been incorrectly accounted for. As a result of this analysis we determined we needed to adjust revenue by $950,000 over multiple quarters over the past two years.

However, we concluded that the impact of these adjustments was not material for any single quarter over that reporting period. It is very important to note that while this situation does not impact our growth trajectory our revenue for future quarters will take into account proper accounting treatment for these customer credits. Even with these adjustments we still believe we are on track to deliver between 30% and 40% revenue growth in 2008 over fiscal year 2007.

The timing of this issue was certainly inconvenient and highlighted what we consider to be a material weakness in our revenue recognition processes. We are now working to remediate the issue and avoid having another situation like this. In the near term we are implemented additional review procedures with respect to our review of information provided by our third party billing vendor. In addition, as we had mentioned in previous calls and our previous filings management made the decision to bring the third party billing process in-house due to our continued volume growth.

Last summer we made the decision to engage [Zifon] an industry leader in billing software to assist us in transitioning billing away from outsource billing vendor and establish our in-house program. In the fall of 2007 we began the process of hiring our own billing team and installing the [Zifon] software. Our goal is always to execute a transition to our in-house group in the late spring of 2008. We will now incorporate the new information gleaned from our most recent analysis into our new billing process and we believe we are still on track for launching our in-house billing program the second quarter. Eliminating our ongoing dependence on an outside billing vendor for new billings after that date.

The March 17^th 8-K also announced the completion of our negotiations with affiliates of Safeguard Scientifics to renew and restructure our $6 million credit facility. The new facility increases our availability under the facility to $21 million. This new credit facility provides us the flexibility to begin our debt restructuring and allow us to pay off in full our debt facility with GE Capital. While management believes it’s unlikely we would need to access the full amount of the Safeguard facility we believe we now have the working capital to support the continue rapid growth for base business and put the appropriate amount of energy into the launch of our new breast cancer tests.

It’s important not to lose sight of the fact that the fourth quarter 2007 was another quarter of solid growth volume for Clarient despite the traditional seasonality due to the holidays. Our number of cases succession grew 52% year over year and 10% sequentially quarter over quarter. We believe these trends are solid indications that our business model and value proposition have sustainable market momentum. Also our gross margins were again at 52% which means we exited 2007 having successfully improved our margins by 900 basis points over the course of 2007 in comparison to our gross margins for 2006.

This improvement in gross margin resulted in gross profit increase of 78% versus Q4 of 2006. This increase is indicative of our continued ability to absorb our strong growth without significant expansion in our current infrastructure and reflects the improvement of our revenue mix toward higher margin leukemia lymphoma testing. In the fourth quarter we completed over 6,400 patient cases resulting in over 17,000 tests in our flagship breast cancer testing program, representing a 6% quarter over quarter growth rate and an 18% year over year growth rate.

Our leukemia lymphoma program also continued to grow rapidly as we performed over 4,000 cases representing an impressive 18% quarter over quarter growth rate and 65% year over year growth. In total we handled over 21,500 patient cases in the quarter which was a 10% increase over Q3 of 2007. In 2007 Clarient touched over 74,000 patient cases versus 48,000 in 2006 a 55% increase. This continued growth velocity of our case and testing volumes is very encouraging. It was catalyzed by the acquisition of 50 new customers in Q4 11 of which came from our ‘A’ target list.

We were also able to retain greater than 95% of our pathology customer base within the quarter. I’m extremely proud of our operations team and while managing our rapid growth and navigating through the holiday’s continued to improve in each of our operating efficiency metric categories versus prior year. These metrics include gross profit per employee and lab tests per full time equivalent per day. Our fourth quarter volume increase represented our 14^th consecutive quarter of sequential growth and have provided us with solid momentum heading into 2008.

We have continued to see this momentum build through the first quarter 2008 and believe we once again deliver quarterly results that will exceed 50% revenue growth over Q1 of ’07. We are rapidly achieving critical mass operationally and the commitment among our employees to take the fight against cancer personally has never been stronger. After Jim reviews the financials I’ll sight an update on our new Insight Dx Breast Cancer Profile and other key highlights since we spoke last.

Jim Agnello

I will provide as much clarity as I can around the numbers and the impact to the $950,000 revenue adjustment and an adjustment that we made to our bad debt expense. During the course of our planning for the billing system conversion and our year end activities we discovered that our outside billing service was behind in processing credits resulting from duplicate and overpayments from insurance companies and price adjustments due to our customers. After a review of the nature of these credits we determined that we had not properly recorded their financial statements impact in previous reporting.

We have determined that the error did not materially affect any single quarter and did not have a material affect on our announced quarter over quarter growth rates. As a result we will be providing adjusted quarterly information for 2006 and 2007 in our 10-K and will compare against these adjusted quarter respectively. The fourth quarter information reported in today’s earnings release reflects the impact of a portion of these adjustments that relate only to this quarter and each year has been adjusted for the impact on that year.

Also, during our year end activities we obtained some additional historical collection information from our billing service from which we determined we needed to refine our previous estimate of the allowance for these accounts. This new information increased our bad debt expense incrementally to $1.8 million for the quarter. Though our bad debts have increased over the course of 2007 we believe after this adjustment we will return to more normalized bad debt rates in the range of 6% of revenue.

Going forward we will be utilizing this additional information in our revenue recognition and bad debt accounting. Adjusted revenue for the quarter ended December 31 was $12.4 million an increase of 53% over adjusted fourth quarter 2006 revenues. Adjusted net loss from continuing operations for the quarter was $3.9 million and over $0.05 a share compared to an adjusted net loss of $3.4 million or $0.05 a share for the fourth quarter 2006.

Adjusted net loss for the fourth quarter includes the $0.9 million adjustment for additional bad debt reserves, this $0.9 million being incremental to the amount that this initially recorded. Our adjusted operating loss was $3.2 million for the quarter compared to an adjusted operating loss of $2.9 million for Q4 2006. Average adjusted net revenue per case in Q4 was $576 compared to $612 in Q3 2007 with the reduction primarily due to lower collection experience in that quarter.

Our adjusted net revenue for average employee for this quarter was approximately $60,000 an improvement of 24% compared to Q4 2006. Gross profit per average employee for the period was approximately $31,000 which was a 44% improvement over the fourth quarter 2006. This improvement from prior year was due to a combination of more profitable test mix increasing lab productivity. Our adjusted gross profit was $6.4 million or 52% in the quarter compared to $3.6 million or 45% in the fourth quarter 2006 an increase of 78%.

The improvement is due to the improved revenue mix containing lab staff growth to less than our volume growth, improvements in lab supply usage and better utilization of lab equipment capacity. Adjusted operating expenses were $9.6 million for the quarter compared to $6.4 million in Q4 2006. The increase was principally due to increases in lab services building costs due to increased collections, increased sales commissions, increased professional fees such as legal and accounting, and as stated earlier we also recorded $1.8 million in bad debt expense in the quarter due to the impact of obtaining better objective collection information during our year end activities.

Despite this adjustment, adjusted operating expenses as a percentage of sales decreased in the quarter as we continued to absorb more growth in our existing infrastructure. We expect this reduction to continue. Adjusted interest expense was higher by $200,000 in Q4 2007 compared to Q4 2006 due to increased borrowings under our asset base and revolving loan agreement. At December 31, 2007 the company’s cash balances were $1.5 million compared to $0.4 million as of December 31, 2006.

The increase in cash was due to proceeds from the sales management business in the first quarter and net borrowings on our revolving lines of credit partially offset by the loss from continuing operations working capital changes, capital expenditures and the repayment of capital leases. Day sales outstanding were 90 days in Q4 2007 compared to 89 days in Q3 2007. Our available cash including cash on hand and the availability from the revolving facility totaled approximately $5.5 million as of December 31, 2007.

On March 14^, 2008 we entered into a $21 million subordinated revolving credit agreement with Safeguard. This facility renews, expands and extends the existing line which had been $6 million to April 2009 by providing $15 million in additional availability. The facility was used to pay off the remaining outstanding balance on our lease and asset based lines with GE Capital Corp and will be used to launch our new breast marker offering as well as provide working capital for the company.

We have concluded that we have material weaknesses in our internal control over financial reporting in particular we determined we need to improve our policies and procedures in revenue and bad debt accounting. In addition, we concluded that we did not design and maintain adequate controls for review and accounting for information provided by our third party billing vendor and to ensure we use historical collection experience in our bad debt and allowance for accounts accounting.

We are taking steps to improve our internal controls in these areas which include enhanced training and oversight of our staff and the billing service, more diligent review of information coming from our outside billing service, better monitoring of the timeliness of their activities and the use of the newly available objective collection information for evaluating our allowance for doubtful accounts. These changes along with the impending implementation of an in-house billing process are included in our plan to remediate these material weaknesses.

Details of these weaknesses will be included in our Form 10-K which will be filed later today. We have been advised by the company’s independent registered public accounting firm that their audit opinion with respect to the company’s consolidated financial statements for the fiscal year ending December 31, 2007, will contain and explanatory paragraph to the effect that substantial doubts exist with respect to the company’s ability to continue is a growing concern.

This opinion is based in part on their analysis of the company’s historical financial performance and history of operating losses, our difficulty in meeting previous debt covenant obligations and their conclusion regarding the uncertainty whether the company will be able to maintain compliance with the tangible net worth covenant contained in the company’s credit facility with Comerica Bank. This covenant was set jointly by the company and Comerica Bank based on the company’s budget in the upcoming year and we believe we will be able to maintain appropriate compliance.

Ron Andrews

During our third quarter call I outlined our path forward and our novel marker capability strategy. I’d like to update you today on our progress and additional color to our approach to better understand the future announcements regarding this exciting program. Clarifying treatment decisions for doctors and their patients is our core mission. In order to hit the commercial sweet spot in that effort we’ve identified five cancers where we believe pharma is currently spending over 50% of the clinical trial dollars for phase two and phase three studies.

These cancers, breast, prostate, colon, lung and leukemia lymphoma are the focal point of our strategy. To stay lean and to balance our risk across multiple cancer types we’ve developed relationships with a number of diagnostic biotech companies that have made discoveries these critical cancers. We in turn are helping these companies to market their tests. Over the past three years we developed a world class commercial approach capable of delivering critical information to community physicians to help them manage cancer from their local practices minimizing the impact on the patient’s quality of life by eliminating unnecessary trips to the distant academic research centers.

Our rapid growth over this period is evidence that this approach is sound and that we have succeeded so far. During this period we also work with partners to develop novel market ideas that could have a profound impact on how certain cancers are managed. In early January we announced our agreement with one of these partners, Prediction Sciences, for an exclusive license on their mathematics that will be used to provide a risk for current score to pathologists and oncologists for patients with estrogen receptor positive breast cancers.

Prediction Sciences did their original work using a retrospective study of 324 stage one to stage three breast cancer patients with estrogen receptor positive cancers. This paper was published in clinical cancer research and is the foundation of our new offering. The Clarient Insight Dx Breast Cancer Profile is the first in our Insight Dx line of novel tests. Today estrogen receptor positive cancers are typically treated with a combination of anti-estrogen therapy and chemo. The majority of the women who are placed on chemotherapy receive no benefit from the treatment yet they suffer horrible side effects from these toxic drugs.

The Clarient Insight Dx Breast Cancer Profile can provide information to pathologists and oncologists to help them better assist their patients in making the right treatment decisions for these types of cancer. Our approach is to use protein and opo gene markers adding to the panel of traditional information such as tumor size, tumor grade and node status which by the way have been used for a number of years to assess risk of recurrence and then apply the new license mathematics provide risk recurrence information to the pathologists or oncologist.

We believe this additional information will ultimately lead to better therapeutic decisions and fewer women getting chemotherapy unnecessarily. Clarient’s Insight Dx Breast Cancer Profile can be used for any operable estrogen receptor cause of breast cancer which represents a much broader group of cancer patients than the competitive offering and will be able to be performed on paraffin embedded tissue the most common sample type available for analysis.

The results for each marker in the profile will be made available to local pathologists and treating physicians in real time via our PATHSiTE suite of virtual services, minimizing the black box approach currently taken by competing tests. We believe this transparency will encourage participation by the local pathologists and oncologists in sharing market acceptance. The US market for this type of test is quite large.

Today over 70% of all breast cancers are applicable for Insight Dx and industry analysts believe the resulting market for this type of risk recurrence monitoring to be in excess of $400 million. Another Clarient advantage is the fact that we have significant market already for such tests thanks to a strong brand in breast cancer. Clarient receives over 130 boxes of breast cancer tissue every day for testing and about 70% of those are good candidates for Insight Dx.

We believe we are well positioned to capture our fair share of this market by providing a one stop shop process for pathologists and oncologists desiring a test that can provide risk recurrence assessment. In order to take advantage of this opportunity we’ll be completing additional comparative trials over the coming months to put stronger clinical legs under our tests and in the meantime we’ll begin the education process for our current customers who are eager to understand how to provide this information to their oncologists.

Currently we believe that we will be in a position for a full market launch of the clarinet Insight Dx Breast Cancer Profile at the College of American Pathology meeting in late third quarter. While 2008 will be a year where we educate the end users on the value of our test information and establish ourselves in the market with more clinician data we do believe we will begin to see market traction for our tests in the second half of the year.

Obviously our initial service offering from our Insight Dx pipeline is very promising and its important to keep in mind the Insight Dx program is geared to deliver incremental revenue opportunities to our rapidly growing foundational business. Also in third quarter 2007 call we spoke of the exclusive license from Health Discovery for four gene for prostate cancer that we believe have a viable opportunity to play a roll in identifying PSA positives, biopsy negative patients that need further assessment.

We completed the characterization and validation of these genes in the fall and have been waiting for internal review boards to be completed by our partner institution so we can receive samples to begin our initial trials. We were recently notified that one of our leading academic partners received clearance to send us our first samples which we now have received and we expect to begin our initial trials on these genes in the next few weeks.

At this time we are not in a position to establish a target launch date for this test but completing our fist round of trials will clearly allow us to better understand the clinical potential for this exciting gene profile. Also, we recently announced our relationship with CombiMatrix to market their HemeScan test for early identification of a type of leukemia call CLL. This is an exciting opportunity for Clarient to further differentiate ourselves and our rapidly growing leukemia and lymphoma program.

At this time we are running validation studies in conjunction with the CombiMatrix laboratory and we’ll speak to our launch plans for this new technology during our first quarter call next months. The HemeScan test should improve the profit margin of our leukemia program and we believe it will provide greater granularity to assist clinicians in diagnosing this horrible disease. Our approach to all of our opportunities is to capitalize on our own the block strategy and drive menu depth for the cancers in which we have significant market presence and reach.

The first three offerings from our Insight DX program provide us with high value offerings in three of the highest volume cancers and our breast profile allows us to capitalize on our current market leading collaboration with community pathologists. Since we are dedicated to cancer and have an extremely talented sales force capable of creating market uptake for such information we believe we have the components necessary for a very successful program.

Clarient’s Insight Dx program fulfills our vision of translating emerging diagnostics discovery into information that will help clarify clinical questions and differential diagnosis, prognosis and theranosis. I look forward to updating you on our progress with our Insight Dx Program in future calls. This concludes our prepared comments I’d now like to open the floor for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Un Kwon with Pacific Growth Equities.

Un Kwon – Pacific Growth Equities

I was wondering, could you talk a little bit about your cash flow break even or profitability goals going into ’08?

Ron Andrews

Sure, as we talked in the past, our goal obviously is to capitalize on the improvement in our gross margins to continue to manage our expenses like we have the variable expenses we have over the previous year and now with the understanding that we have from our billing debacle that we went through in fourth quarter that we now dialed into this years plan. We believe we’ll have significant trajectory towards reaching our goals of cash flow break even and even profitability as we continue to grow the business this year and dial that through this year’s financials.

We have not, as you know, in the past given guidance about when we will be profitable but I think as you see us now take into account the knowledge we have from the learning we gained from fourth quarter and we reevaluate our projections going forward that in future quarters we’ll be addressing the goals of becoming cash flow break even and certainly profitable as our continue growth trajectory goes forward.

Un Kwon – Pacific Growth Equities

Is there something that we should anticipate this year as far as breaking even on the cash flow line?

Jim Agnello

Our challenge is on getting to true cash flow break even is funding working capital in an environment where we are growing as fast as we are. We believe after the experience over the last few months that the transition to a new billing service and new billing capability in-house will give us more control over our own collections but until we get better data on what that implementation of that really provides for us we really are looking at our own current cash flow capability and looking at our growth and obviously in our growth we need equipment, we need agents, we need other items and that working capital in the growing environment increases our requirements.

Although we will be much closer to cash flow break even as the year goes on, as we continue to grow as Ron mentioned earlier getting the full cash flow break even will be a function of how well we implement this new billing capability and how quickly we can moderate things going forward. Obviously, as we mentioned earlier our gross profits continue to grow, our gross margins passed 52% we certainly think we can get those in the mid 50’s in 2008 and so that’s going a long way to get us the cash flow break even.

As long as we keep our operating expenses relatively in line, meaning that we keep bad debt in the range of 6% as I mentioned and keep our other expenses relatively flat on the operating expense area in SG&A there is no reason to think we won’t be very close to those goals some time near the end of 2008.

Ron Andrews

I would say this, before interest and before depreciation we do believe we can make a significant impact this year going forward and you should see some significant improvements in those areas before those two components are added in.

Un Kwon – Pacific Growth Equities

With respect to bringing billing in-house, should we be modeling in an increase in one time expenses as you bring that in?

Jim Agnello

The expense side actually goes the other way because we pay a percentage of collection to an outside billing service as we’ve grown that has become an increasing negative component on our operating expenses. It is one of the reasons, not the only reason that we chose to move away from the outside billing service. Beginning when we go live hopefully in the second quarter we will see a reduction in billing costs from about 5% of revenue to something that’s more fixed.

The one time expenses that are involved here have been the fact that we’ve had to hire in-house billing staff in the last quarter and a half just to be ready for this conversion. There is a small incremental expense that’s already baked into our numbers related to training, etcetera that’s been going on with the outside billing service and the conversion costs. You should see a reduction in operating expenses after we go live.

I don’t know how clear it will be in the operating expense line because that will be offset as we launch Insight Dx it might be a little more R&D and little more sales expense that are attached in there. All of that together should keep us relatively flat on operating expenses going forward. There will actually be a positive impact, meaning a negative impact on expense when we go live with this billing service.

Un Kwon – Pacific Growth Equities

Do you have a rough estimate what the fixed cost of the in-house billing service is?

Jim Agnello

Not off the top of my head. I need to work on that a little bit. We have a staff that we will hire effective the time we go live that will be in the range of 18 ftes, we’ve got about 13 of the in-house today and these are not senior level folks so we can do a quick calculation on that and help you to get to what the number should be.

Un Kwon – Pacific Growth Equities

I’m going to transition into the Clarient Insight Dx test. With respect to your revenue guidance of 30% to 40% growth are you including any impact from this test in the later half of this year?

Ron Andrews

We are not including the impact of that test this year on that 30% to 40% so that would be upside for us as soon as we gain significant traction. I think you have chatted about with many people about what we believe the uptake will be. We clearly believe we have a captive audience for this test but a lot of this work is missionary work, it’s a $400 million plus market the largest shareholder in this market still today just reported, I think about $60 million of revenue on their test in ’07 so there is a lot of missionary work to be done to convince physicians that these tests are really important to the process.

We certainly believe with our captive audience of our pathology practices around the United States that we have, again as I said in the prepared remarks we captured over 95% retention of those folks in the fourth quarter. We believe we’ll have a nice chance to do some missionary work through the summer as we validate the new antibody clones and as we begin to bring these markers up in-house which actually we’ve already done for many of these.

We are starting to get orders individually for the individual markers as we start to educate these clinicians. We clearly want to get a couple papers out; we want to get some traction at the College American Pathology Meeting with some announcements there. Going in to the fall we do believe we will have some traction but we chose not to dial that into our forecast for the year because we obviously want to see what the impact is going to be as we roll these papers out.

Un Kwon – Pacific Growth Equities

When should we anticipate these papers coming out?

Ron Andrews

Right now obviously our goal is to have some abstracts at some upcoming meetings through the summer and then hopefully there are a number of journals that we are meeting with and trying to get a seminal paper published in. Today I can’t comment on that because we don’t have any finality to that yet. No one has come back and given us a day to when they might publish the paper. I suspect in our next call, which is only 30 days away that we should be able to give you more granularity by that.

Un Kwon – Pacific Growth Equities

Lastly, with respect to your business mix could you roughly give us what the ASP’s are for the various cases or even the revenue mix overall?

Ron Andrews

That’s a great question; one of the things we committed to, to all the analysts and all the folks that follow us is that as we go to our first quarter call for ’08 we are going to be giving more granular information. We have hired a financial analyst at Clarient recently to come in and begin to do this. I think most of your know that to manage our expenses we have not embarked on a very expensive ERP project so today a lot of the work that we do to get to the details that we need to have for you guys every quarter are really done manually.

We now have someone dedicated to help us get that. We will be giving that information but I can give you high level overview. Today on average as you know initial case work ups are done in the initial phases of differential diagnosis for each of these diseases. The primary work for breast has somewhere in the neighborhood the initial phase is somewhere in the neighborhood, if it’s a tech only case it’s around $140 for the initial set of markers. Obviously if there’s reflex testing it quickly gets to the $600 to $650 range as a total case cost.

Leukemia lymphoma on the other hand starts out with an initial diagnosis process around $650 to $700 and that increases rapidly into the $1,000 to $1,500 as you add following tests. What we hope to do as I said in first quarter is to be more granular as to the number of cases and the revenue per case and the break out of primary versus secondary diagnosis testing and what that might mean in terms of revenue going forward.

Operator

Our next question comes from the line of Debjit Chattopadhyay with Boenning & Scattergood.

Debjit Chattopadhyay - Boenning & Scattergood

My first question was regarding Safeguard and the deal that Safeguard, could you go over that again. I guess you give them 1.6 million shares now, another 1.6 million six months from now. Clearly from [inaudible] perspective this does not really look good for the company in terms of dilution going forward. How long do you think you need to depend on Safeguard before you could be an independent company?

Ron Andrews

Let me hit these things head on. Safeguard has been a great support for the company and continues to be a company that supports Clarient’s vision and goals. One thing I’d like to say is that Safeguard is a publicly traded holding company and because of that they have to look at the current market environment when they invest in companies and this is an opportunity cost for them so clearly why it may look onerous and at times still onerous the reality is Safeguard invests based on the opportunities they have before them and their shareholders deserve venture like returns on any dollar invested.

In fairness to what they put before us in the tightening credit markets and as we look at the uncertainty of those markets and clearly as we looked at the GE debt covenants and the onerous terms that we were under, under those debt covenants working with Safeguard to get rid of that GE debt was the first step in a restructuring plan that management had going through 2008. The next step for us to now go forward and identify, which we’ve already done, and begin to work with a company that would allow us a new accounts receivable line with greater latitude in terms of the dollars we could borrow against our accounts receivable as well as better interest rates than we have in the current Safeguard line.

That work will be the next step in our debt restructuring process as well as we also got rid of the GE lease line which had some fairly onerous collateral terms and now we will be working with some more favorable lenders in the area of leasing so that we can not use our own cash going forward to buy new equipment as the company grows rapidly but that we can actually have some flexibility on a lease line with some favorable leasing terms and rates that would allow us to manage those expenses as capital expenses versus draw down on our cash.

Given all of that as we go forward obviously the Safeguard program incents us to find these other alternatives and to not have to utilize the Safeguard credit facility going forward. Certainly management is committed to that and this is really the way I look at it is this is a great opportunity to use the very strong support of Safeguard to bridge us through difficult credit environment and continue to position the company to manage its growth, its good working capital and to allow us the flexibility in timing to go out and restructure some of this debt to improve the company’s financial footing going forward.

The question is when we will be on our own footing. Obviously you’ve heard me say this over and over again we have been building this company to get to that point and we certainly believe that opportunity is in the future and its not the distant future its something that we believe obviously once we get through the debt restructuring, continue to grow the business like it has been growing if we can continue the current velocity we can continue the ongoing management of our expenses that we’ve been holding very tight to for the last three or four quarters that all that combined with the gross margin improvement we should be able to get to that stand alone point in the near future.

Debjit Chattopadhyay - Boenning & Scattergood

You guys are stating a 10% increase sequentially in revenue, how much was the revenue for the third quarter taken down. The originally recorded $12.05 million.

Ron Andrews

That 10% number was 10% in test volume. Due to the adjustments and we went back and what we found in the fourth quarter we chose to talk about testing volumes because we felt it was a better indicator of quarter over quarter growth given the fact that we were making adjustments within the year to each quarter.

Debjit Chattopadhyay - Boenning & Scattergood

In terms of the granularity for the first three quarters of the past year would you know how much you had to take down off the $950,000 that was impaired?

Jim Agnello

It will be very clear when we release the 10-K later today. There’s a table in the 10-K that has the individual quarters listed. Rather than provide them on this call, it gives the full context of the whole adjustment I’d prefer if you take a look at that and if you have any questions obviously we can handle them at that point. It’s not a significant number in any quarter. It goes back two years and the biggest single quarter is the second quarter 2007 which is the quarter that we had primarily temporary financial staff in place. That particular adjustment is a little over $400,000. The other quarters are $100,000 here $150,000 there. All that detail will be in the 10-K that will come out later today.

Debjit Chattopadhyay - Boenning & Scattergood

Moving on to the Insight Dx, Oncotype Dx, in 2007 they analyzed about 24,000 cases and they are guiding to about 34,000 to 37,000 cases for 2008. It’s taken a pretty long time for them to actually get any traction in this. Could you go over the Insight Dx in terms of advantages over the Oncotype Dx, in other words node negative, node positive of the four stages of breast cancer or not?

Ron Andrews

I do want to say one thing before I do that. I do believe it is important for everyone to note that I don’t want to speak negatively to Genomic Health I think they are a company that has really blazed a trail for many of us in this area because they have reestablished the value of these advanced diagnostic tests in the market. The fact that they are receiving $3,500 per procedure for their tests I think is really indicative of the appetite out there today for these types of tests. That appetite is growing. Obviously we want to encourage, they have very deep pockets and they continue to spend a lot on sells and marketing to establish the value of these tests.

Let’s speak to what we believe our advantage is to be. First, the Insight Dx test as we know it today with the original data set and additional data that we’ve looked at since, we believe we will be introducing a test that has the ability to identify stage one through stage three operable ER positive breast cancers. Any operable cancer we believe we will be able to go after. The second differentiator for us is that we are using very well characterized protein markers in combination with a well characterized and well published oncogene in combination with the tumor grade, tumor size, and node status all of which have been used traditionally to assess risk recurrence and that these well characterized markers really differ from the black box approach that run today not just by Genomic Health but other competitors.

Today if you understand how they operate, they take a sample and that sample it could be from the actual tumor cavity itself, which means they don’t always know they have cancer cells. They crush those cells up, they extract the DNA, the run three different tests on that same DNA, they throw out the most apparent result and they average two together to come up with their score. Obviously we will be using quantitative immunohistic chemistry results using patented immunohistic chemistry imaging technology with FDA cleared applications where they are available to actually score these results.

We are very confident in the reproducibility of our tests. We don’t need to run it three times, throw out the worst result and add two together. It will be very specific to the immunohistic chemistry connotation that we are able to do. To oncogene will be done in a fish format Florescent In-Situ Hybridization which we believe we can also quantify using advanced mathematical instrumentation that we have. That combined with these other components will go into what believe are a very robust risk assessment.

Today if you look at the negative predicted value of these tests I think that’s a very fair way to begin to assess the competitive nature of this market place. Today if you look at the published data that’s out there for the competing tests, between the two tests that are on the market today the negative predicted value is somewhere between 20% and 30% which means 70% to 80% of all women that received these tests are going to get chemotherapy regardless of what the results are because these tests are only specific in about 20% to 30% of the time.

In other words they can only predict 20% to 30% of the time they can tell women that they do not need to go onto chemotherapy. We believe that due to the nature and the robust approach we are taking that our negative predictive value will be greater than 70% so that means the women that would be exposed to chemotherapy that don’t really need it based on our test that population will be significantly less. We certainly believe that we have some significant competitive advantages in the market place.

One other one for us, not certainly over the Genomic Health test but over the [Igindia] Test is that we will be using paraffin embedded tissue. We do have patents filed for some unique extraction ability to extract DNA out of this paraffin embedded tissue that will allow us to get to very minute samples and not have to have large tissue samples in order to complete all the work. If you look at the combination of these things and the fact that we have a captive pathology audience today that’s sending us the primary breast work up today where we get about 130 boxes of tissue today asking us to do the primary work the initial progestin receptor and HER-2 status that none of those primary work ups are going to any of our competitors in this phase.

We would get all those blocks, we have the block here so clearly for a pathologist or an oncologist to say after they see the S receptor status to say, “Yes” I want to go ahead and reflex to a risk recurrence test that by just touching a button on the internet and requesting that information they’ll be able to get that done and clearing it without the logistical nightmare of having to ship the box back to the pathologist or the oncologist and out to Genomic Health. We certainly believe there are some clear advantages that Clarient has.

However, our initial marketing approach will be to our captive audience of these pathologists and oncologists that are current customers and that will be how we minimize our need to spend the comparative dollars that the other companies are currently spending on marketing itself.

Debjit Chattopadhyay - Boenning & Scattergood

Do you think you need some kind of outcome data before you ask the insurance companies to give a nod for this?

Ron Andrews

That is exactly why we are continuing to do clinical work; we do believe it will be in our best interest to have comparative data as we go in to meet with the managed care organization to show them the value of our tests. At $3,000 for the Clarient Insight Dx test versus the price the other two companies are offering their tests for we believe that our negative predictive value when compared will show that the Clarient test is a significant value as well as a more robust test giving a much broader coverage of patients because its stage one through three.

Debjit Chattopadhyay - Boenning & Scattergood

In terms of long term outcomes, do you need to follow the patients for three to five years to get survival data, to show a benefit?

Ron Andrews

All the studies today, everyone else’s studies have all been retrospective including the Prediction Sciences data on the 324 patients out of France. Clearly the work that has been accepted in the market today is retrospective. Do we want to participate in some ongoing studies, absolutely? Are we working on that, absolutely? That is in everyone’s best interest if we continue to look at the value of these test prospectively especially in light of their ability to identify the potential therapeutics that might be best suitable for specific types of cancer. That’s a much bigger trial and takes much longer time and is certainly not necessary we don’t believe to establish this test as a major player in terms of the value of the information brings to the market place.

Debjit Chattopadhyay - Boenning & Scattergood

During the third quarter I think you mentioned for the long chance of biomarket test you had recognized about $200,000, do you have any clarity as to the fourth quarter, is there an uptake there?

Ron Andrews

With all that’s going on, I have to be honest I did not pull that data but I can get that data for you. I suspect it did grow but I don’t know how much so I will find out for you.

Operator

There are no further audio question at this time I would now like to turn the conference back over to Matt Clawson for any e-mail questions.

Matt Clawson

Just a few questions came in from investors through e-mail and I can quickly read through those. The first one the question is: When was the billing issue first discovered and how did that happen, was it in-house resources or by your auditor?

Ron Andrews

That’s a good question, I think worthy of a transparent response. It was very late February when we really first realized that there was some billing data that we had been getting for a while actually, since the first time we’d seen it was the fall. Because we get numerous reports with numerous different data sets on it this report had not been one we had used in the past to account for revenue recognition. We do have a new controller, as Jim mentioned that the biggest quarter that we will see the adjustment for will be for second quarter of ’07.

That happened to be the quarter when Jim was out with his medical leave and we had an interim controller. Our new controller is now on board and has a quarter under his belt and obviously did a good job, we believe, of identifying an issue that we had not previously seen. That happened in very late February and obviously immediately we began to dive into it and we believe we did the right thing by putting a full court press in doing a very thorough audit as best we could in the time we had of the billing process and of the billing agency.

It was definitely discovered in-house, identified in-house and we believe management did the responsible thing by accepting this fact that we needed to go back and do a full deep dive on this and the results from that deep dive are now public and hopefully we will now use that learning going forward to improve our projection ability and our ability to forecast our future revenues going forward.

Matt Clawson

The second question is, I recognize that the impact per quarter was not material as you stated but in looking forward will it be an impact on you view revenue going forward through the coming quarters based on this adjustment?

Ron Andrews

Let me address it this way, I think I’ve been very consistent about saying how Clarient has been very conservative over the previous quarters at least since I’ve been with the company and we changed the business model in terms of how we recognize revenue. However, obviously this situation has heightened our awareness about how we actually project our revenues and record revenues going forward. Certainly we believe the growth trajectory will not change, we certainly, as Jim said in his prepared comments believe that the quarter over quarter growth rates are not materially impacted by these adjustments.

However, we do believe that going forward we will maintain an even more conservative approach to our revenue recognition to ensure that not only through better processes and remediation of the current issues will we be able to ensure that we never have an issue like this again. Also, we believe that will take a fairly conservative approach to revenue recognition and therefore we do believe there will be some adjustment downward going forward of our revenue recognition process going forward.

Jim Agnello

The impact over the course of two years was about 1% of revenue, that’s what the impact comes out to just a little over 1% of revenue. On a quarterly basis that really is going to be in the range of $120,000 to $150,000 a quarter. It really comes down to how we adjust for the credits themselves. We now have a report and challenge we had before is we had a report, we talked about transparency, and it wasn’t very transparent report.

Now we have clarity around what that report really means, it’s a fairly easy number to pick up every quarter now so the difference between one quarter and the next will be picked up as a reduction in revenue if that’s appropriate we will have them provide refunds going forward so that will offset it. I don’t see it being much more than $100,000 a quarter in the next few quarters and as we grow maybe it’s a little bit higher. It’s not a major change but it is a small change.

Ron Andrews

This has heightened our awareness that we had always projected our revenues at Medicare rates and not taken any upside that might be available for the actual revenue that we were seating for managed care which at some point was 1.3, 1.5 Medicare. We’ve always just recognized revenues at Medicare. Now, based on the insurance adjustments and the credits that we’ve seen its probable that we will be forecasting going forward something slightly less than Medicare to be conservative in this area.

Matt Clawson

That’s the last e-mail question, if the operator could take any follow up questions that are out there, that would be great.

Operator

We do have a follow up question from Debjit Chattopadhyay from Boenning & Scattergood.

Debjit Chattopadhyay - Boenning & Scattergood

The 130 sample you get every day should we model it as five times per week or seven times per week and any clarity as to our reception of the Insight Dx test from your current customers, the pathologists?

Ron Andrews

We have six lab days a week, however, our breast cancer work, if you are modeling I would model it at five days, 130 samples for five days I think to be safe. Also in terms of the early uptake, the new markers that we’ve brought online that are part of the panel we are going to be ultimately offering with the mathematics that we have seen a very interesting uptake in a couple of key markers. There are a couple, p27, p53 and as you know ERPR and HER-2 have always been used.

We’ve seen some very interesting utility this. We have some folks now using CMIT which is the oncogene. There seems to be tremendous interest. Every time we speak to this at a VIP or any meeting we go overwhelming response in the pathology world. Primarily because they are happy to see a company that’s coming forward with one of these molecular profile tests that’s being very transparent about what’s in the test and how to actually identify and to score the markers in the test.

I think that’s going to be very important for anatomic pathology going forward. Remember these molecular tests are only as good as the cells collected on which you run the test. If you do not know what cells you are collecting you could be doing all the DNA amplification you want you may be amplifying cells that come from the tumor cavity wall and those cells have a totally different PCR characteristic and DNA characteristic than the actual tumor cells.

There is no way to know that in every other test because you do not see the cells you collect versus the Clarient test which obviously we can see the cells we are using because we are using immunohistic techniques and quantifying those using digital image analysis. We do believe it’s a very powerful competitive advantage.

Debjit Chattopadhyay - Boenning & Scattergood

How many cases have you analyzed so far with the Insight Dx test?

Ron Andrews

Today we have not formally launched the test in the commercial market. We are in the middle of a soft launch and validation of the new clones for the new antibodies for some of these markers. Obviously having the most appropriate clone since we are going to score these and it’s going to be very important as we go through the regulatory process that we understand the best and most appropriate clones. We do expect that we will be launching this test for the market as a soft launch in the summer time with a full market launch at the College American Pathology Meeting in September.

If there are no further questions why don’t I close the call. First, let me say thanks to everyone that’s been patient with us over the course of the last 30 days. I know that the delay in earnings was difficult for many folks. I want you to know that management felt that frustration. However, I want you to know that it was very important to us to be able to get on this call today and be open and honest and transparent with as much knowledge as we could in light of what we announced today.

I do believe as I close the call today that I’d like to give you some thoughts on our 2008 performance and how I key milestones for Q1. As I said earlier we believe we are very well positioned to continue our growth trajectory. I project we will grow our revenues between 30% and 40% in 2008 in comparison to our 2007 fiscal year. We also believe that we will be able to significantly reduce our operating losses as we capitalize on the momentum we created in revenue growth, our gross margin improvement, expense management and the learning’s from our billing processes.

If we keep a high [inaudible] in Q1 we believe we will continue to achieve some new customer targets this year we are going to continue to focus on 25 new customer acquisitions per quarter with a greater than 90% retention rate of current customers. We will continue to expand our same store sales and again we will try our best to get better granularity into that same stores sales process as we go into our first quarter ’08 call. We are initiating the comparative studies for the Clarient Insight Dx Breast test as well as we are beginning the initial prostate clinical validation with the new patient samples received from an academic partner.

Though progress continues to be encouraging we are confident we built a very balance platform for continued growth. I think our employees; we have the most incredible group of employees who go consistently every day the extra mile to take cancer personally. We also appreciate the support of our shareholders as we continue to execute the plan and we are confident that your patience will be rewarded. I look forward to updating you on our performance on our key milestones for Q1 in about 30 days. Thanks everyone.

Operator

This does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.

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