Greetings, and welcome to NeoGenomics Second Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It's now my pleasure to turn the conference over to your host, Doug Van Wert, Chairman and CEO.
Please go ahead, Mr. Van Wert.
Thank you, Rob, and good morning. I'd like to welcome everyone to NeoGenomics' Q2 2018 conference call. Joining me from our Fort Myers headquarters is Sharon Virig, our Chief Financial Officer Rob Shovlin, President of our Clinical Services Division George Cardoza, President of our Pharma Services Division and Bill Bonello, Vice President of Strategy, Corporate Development and Investor Relations. Before we begin our prepared remarks, Bill Bonello will read the standard language about forward looking statements.
This conference call may contain forward looking statements, which represent our current expectations and beliefs about our operations, performance, financial condition and growth opportunities. Any statements made on this call that are not statements of historical fact are forward looking statements. These statements, by their nature, involve substantial risks and uncertainties, certain of which are beyond our control. Should one or more of these risks or uncertainties materialize or should the underlying assumptions prove incorrect, actual outcomes and results could differ materially from those indicated in the forward looking statements. Any forward looking statement speaks only as of today, and we undertake no obligation to update any such statements to reflect events or circumstances after today.
Before turning it back to Doug, I want to let everyone know that we will be making a copy of our transcript for this morning's call available on the Investor Relations section of our website shortly after the call is completed. We also want to let everyone know that we are going to limit the number of questions to 2 per person in order to give more people a chance to ask questions within the 1 hour that has been allotted for this call.
Thank you, Bill. For today's call, I will briefly review some quarter 2 highlights and then turn the call over to Sharon for a more detailed review of the financial results. After that financial review, I will provide some additional commentary on our 2018 growth initiatives and some of the investments that we're making to drive both near term and long term growth. Let's begin with the quarter 2 highlights. We're pleased with the quarter 2 results.
Our fundamentals are strong and our growth prospects are very encouraging. In the Clinical Services division, our volume growth rate was once again in the mid teens with solid growth across all test types. Revenue per test stabilized and was consistent with quarter 1. We continue to gain market share and expand our managed care coverage and our sales pipeline is strong. Our Pharma Services division revenues grew over 20% compared with last year, and we signed a record $27,000,000 worth of new contracts for future work.
At the end of our quarter 2, our Pharma Services division backlog was up 95% year over year and currently stands at more than $90,000,000 Profitability also improved as we gained leverage with gross margin up 120 basis points versus last year. We continued to drive cost per test lower compared with last year and productivity increased again to record high levels of performance. Importantly, service levels continued to be outstanding and we achieved record high levels of customer satisfaction. Adjusted EBITDA was in line with our expectations for the quarter. During quarter 2, we invested more in our sales and marketing programs and continued to pursue FDA approval for our large multi gene next generation sequencing panel.
We remain confident in our full year guidance for adjusted EBITDA. Cash collections also remained strong during the quarter. For the first half of the year, cash provided by operating activities was 4 times higher than last year and our accounts receivable balance improved once again with days sales outstanding dropping 10% from the level reported at the end of quarter 2 last year. We had a number of other important developments during the quarter. In early June, we announced a global strategic partnership with PPD.
NeoGenomics will be the preferred by moving into a much larger new state of the art laboratory facility in Houston, Texas. We also expect this new facility will help accelerate our clinical division growth in the state of Texas. On June 25, we announced that we had redeemed all remaining 6,900,000 shares of Series A redeemable preferred stock from General Electric for approximately $50,100,000 In less than 30 months since completing the Clariant acquisition, we have redeemed 100 percent of the $110,000,000 preferred stock issued in conjunction with the deal at a total redemption cost of just $105,000,000 using our borrowing capacity and internally generated cash flow. Finally, we are pleased to announce that we have entered into a national agreement with Cigna Corporation to become a participating in network provider for all Cigna Health Insurance products effective August 1 this year. At this point, I would like to turn the call over to our Chief Financial Officer, Sharon Garrig, for a more detailed review of 2nd quarter financial results.
Thanks, Ted. Before I begin, I'd like to remind everyone that we adopted ASC 606 effective January 1, 2018. As part of that adoption, we have restated 2017 results and the year over year comparisons that we discussed will include the adoption of ASC 606 for both periods. Our 2nd quarter revenues were $67,700,000 a 9% increase from last year. After adjusting for the sale of PathLogic, total revenue grew by nearly 12% year over year.
Clinical genetic testing revenue increased 10% to $59,500,000 and pharma services revenue increased 22% to $8,200,000 Clinical genetic testing volume increased 14% year over year. Importantly, this growth was balanced across modalities with double digit growth in flow cytometry, FISH and IHC and more than 20% growth in molecular testing. Excluding high levels of PD L1 test volume, which has now flattened out, test volume growth rates accelerated in quarter 2. Average revenue per clinical genetic test was 3.18, a 3.6% reduction from the prior year, but stable with the Q1 of this year. The year over year decline resulted primarily from changes to Medicare reimbursement and regulation.
Gross profit increased by $3,200,000 to $30,500,000 up 12% from the prior year. This increase represents a 58% contribution on the $5,500,000 of revenue growth. Gross margin improved by 120 basis points year over year to 45.1%. This improvement was driven by the divestiture of Pathologic and a 4.5% decrease in clinical cost per test as a result of increased automation and the benefit of increased economies of scale. Gross margin was reduced by the significant additions to pharma lab capacity in Europe and in Houston.
G and A expenses increased by 2,500,000 or 16% year over year to $21,000,000 Approximately $1,800,000 of this increase is related to one time non recurring costs associated with the relocation of our Houston facility. These moving expenses are counted as non GAAP adjustments in our calculation of adjusted net income, adjusted EBITDA and adjusted EPS. Sales and marketing costs increased by $1,500,000 to $7,700,000 due to the expansion of our sales force and additional marketing initiatives. 2nd quarter GAAP net income attributable to common shareholders was $5,900,000 compared to a net loss of $2,200,000 the Q2 of 2017 and diluted income per share was $0.07 versus a loss of $0.03 in the prior year. The year over year increase is primarily attributable to a one time gain on the redemption of the preferred stock, partially offset by Houston Moving expenses.
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's appropriate to adjust GAAP net income or loss available to common shareholders to exclude certain non cash items and if applicable one time costs. We refer to this measure as adjusted net income and on a per share basis, adjusted diluted earnings per share, And we have included a table with how these are calculated in our earnings release. Adjusted EBITDA was $10,100,000 an increase of 4% year over year. As Doug mentioned, EBITDA growth was consistent with our internal forecast, but substantially lower than we would expect to see in a more typical quarter. The lower growth is attributable to the timing of growth investments as well as slightly lower than normal growth in our pharma services revenue caused by a temporary short term disruption in project revenues as the Houston lab was offline during part of the quarter.
In the second quarter, adjusted net income was $4,500,000 compared to $3,500,000 in the prior year. Adjusted diluted EPS was 0 point $0.04 per share in quarter 2 2017. As Doug mentioned, cash collections were quite strong in the quarter. DSO decreased 9 days year over year and one day sequentially to 82 days. We ended the quarter with $9,400,000 of cash and $138,500,000 of total debt, including our capital leases.
During the quarter, we completed a $30,000,000 expansion of our senior credit facility and drew $10,000,000 on our revolver. At the end of June, we redeemed 6,864,000 shares of Series A redeemable preferred stock from General Electric for approximately $50,100,000 This redemption allowed us to take advantage of a prepayment discount, avoid future diluted paid in capital dividends and significantly simplify our accounting. It also had the effect of reducing our adjusted diluted shares outstanding by approximately 8%. We have now redeemed 100% of the preferred shares. The redemption was funded by the $30,000,000 increase in our term debt and approximately $20,000,000 of cash on hand and borrowings from our revolver.
We finished the 2nd quarter with 10.63 full time equivalent employees, contract doctors and temps versus 1023 as of March 31, 2018, and 982 as of June 30, 2017. We are maintaining our full year guidance for revenue and adjusted EBITDA. We continue to expect revenue to be in the range of $260,000,000 to $272,000,000 We continue to expect adjusted EBITDA to be in the range of $39,000,000 to 43,000,000 dollars As detailed in our press release, we are adjusting our guidance for GAAP and adjusted net income and EPS to reflect the redemption of the preferred shares and interest expense arising from our debt refinancing. Our press release this morning includes a more comprehensive summary of our 2018 guidance, including EPS and adjusted EPS ranges and a reconciliation of non GAAP measures to GAAP. I'll now turn the call back over to Doug to provide some additional commentary on our 2018 growth initiatives.
Thank you, Sharon. Before we begin the question and answer segment of the call, I would like to highlight 5 important drivers for near term and long term growth and profitability. 1st, our strong pharma services backlog is an important driver of revenue growth. We have more than $90,000,000 of signed contracts in our backlog and we expect about 70% of this backlog to convert to revenue over the next 3 years, including about 50% over the next 18 months. Our Pharma Services sales team is performing at a very high level, and we are just beginning to add to our sales capabilities outside the U.
S. 2nd, we expect that our new partnership with PPD will help drive growth, and we are extremely pleased to have established this global strategic alliance. PPD is one of the largest contract research organizations in the world with a significant expertise in oncology trials and an outstanding reputation. Our shared objective is to provide a seamless and fully integrated global pathology and molecular testing solution to PPD's Pharmaceutical and Biotech clients. As part of the agreement, we will be opening NeoGenomics Laboratories in both Singapore and Shanghai.
These labs will be located in PPD facilities, but independently operated and managed by NeoGenomics. We are delighted to partner with PPD and expect this important strategic alliance to accelerate already strong growth prospects in our Pharma Services business. We're hoping to generate run rate revenue of at least $10,000,000 from this alliance by the end of 2019 and believe that the longer term potential is greater than that. 3rd, we are excited about our newly signed contract to be a national participating in network provider with Cigna. Up until now, we have not been included in the Cigna network.
This out of network status has negatively impacted volume, growth and revenue per test. This new contract will allow us to better serve existing customers, add additional customers, reduce billing complexity and improve our revenue per test relative to what we are paid today as we expect more of our testing to be covered and actually reimbursed. An important 4th area of growth relates to our FDA initiative. As we have discussed on previous calls, we are in the process of seeking FDA approval for a large multi gene next generation sequencing panel. Earlier this year, we filed our pre submission documents and we have a pre submission meeting with the agency in August.
Seeking FDA approval for a laboratory test is new for us and we're working hard to understand and meet the requirements of the FDA. We believe that an FDA approved next generation sequencing test offering will benefit both our pharma services and clinical testing divisions by further differentiating us from other oncology labs, driving improved reimbursement for our multi panel test and increasing our attractiveness to pharma companies for clinical trials involving companion diagnostics. A 5th area of revenue growth is our initiative to bend the curve for reimbursement by taking proactive measures to address revenue per test. We are now of a size and sophistication where we have the tools to better analyze our reimbursement experience, identify areas where we are being significantly underpaid and implement a plan for improvement. These activities may include securing coverage for non covered tests, improving our billing process to avoid denials and working denials more effectively when they do occur.
We are also evaluating our fee schedules to identify tests that are not appropriately priced. We also believe that the headwinds of the past 7 years are softening somewhat. Structurally, Medicare represents only about 15% of our payer mix today compared with nearly 45% 7 years ago. And we believe many of CMS' most significant physician fee reimbursement reductions are behind us. As an example, we were pleased that the draft 2019 physician fee schedule recently released by CMS is, for the first time in a long while, not expected to result in an overall level of reduced reimbursement for NeoGenomics in 2019.
In summary, we're excited about the near term and long term growth opportunities available to us. As demographics are changing and the incidence rates of cancer continue to increase, cancer testing and treatment is advancing at a rapid rate and is increasingly saving the lives of patients. We're pleased to play an important role in this vital segment of our healthcare system and believe that our services are creating value for patients, employees, customers and for our investors. I'll now hand the call over to Bill Bonello to lead us through a Q and A. Bill?
At this point, we'd like to open it up for questions. Incidentally, if you are listening to this conference call via webcast only and would like to submit a question, please feel free to email us at bill. Bonelloneogenomics.com during the Q and 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. As mentioned at the beginning of this call, we would like to ask each person to limit their questions to 2, so that we may hear from everyone and still keep within the hour allotted for this call. Operator, you may now open the call for questions.
Thank
Thank you. The first question today comes from the line of Amanda Murphy with William Blair. Please proceed with your question.
Hi, thanks and good morning. Doug, I
just had a quick couple
of follow ups on some of the last points you made in terms of the growth initiatives. I suppose first, in terms of the reimbursement per test initiative, I know it's maybe hard, but I was wondering if you could maybe put some context around what that might mean for you in terms of improvements from a quantitative perspective. And then I was also curious in terms of the physician fee schedule commentary. It looks like IHC actually saw some pretty meaningful increases, and I think that's how PD L1 is billed. So curious if you could even potentially see as benefit, I hate even to say that word, from Medicare, but is it possible that over the next several years you might see a positive impact from the physician schedule?
Well, thanks, Amanda. Yes, we were pleased with the physician fee schedule that was just announced. I think for us, we are seeing today a much more stable reimbursement environment than we've seen in the past. Now some of that is what's happening outside. Some of it is what we're doing internally.
I would say that our understanding of our own pricing dynamics has improved a lot. We're all on one system now. We have better data analytics, and we're a fairly price disciplined player. So we do make trade offs in terms of price versus volume, and we think those are smart trade offs to make. They're smart also because, as you know, we're a low cost provider, we believe.
So we're maintaining our price discipline. I think that for us, a benefit is no reduction in price per test. We don't really think of increases in price per test today, but you've seen that in some of the other companies that we compete with and certainly that would be our goal going forward. In terms of the physician fee schedule changes, we expect that that's going to be a slight positive for us in 2019.
Okay, fair enough. And then just on the FDA, I'm not sure you even have an answer for this yet, but have you had any interaction with them? I'm just trying to get a sense of if there's any more clarity around what they're looking for. Obviously, there was the clearance, the nebulous clearance process that doesn't seem to exist yet. And kind of thinking about labeling and maybe it's a bit early to ask the question, but do you think you might be able to secure a similar label to your in terms of broad cancer coverage?
Well, we that would certainly be our goal to some extent. Extent. I mean, our assay is going to be a little bit different than foundations. We have engaged in some correspondence with the FDA. We have a meeting coming up with them, face to face meeting in August and we'll gain more intelligence as our interactions with the FDA increases.
But we're pretty hopeful about this process. It is new to us and it's requiring us to do a lot of work, frankly, but we think it's worth it and we're looking forward to going through this approval process over the next 12 months or so.
Okay. Thanks very much.
The next question comes from the line of Drew Jones with Stephens.
Sharon, you walked through some of the volume growth for IHC, FLOW FISH and Molecular. Can you and then you called out PD L1. Is that still growing? Is it receding in terms of volumes? How should we think about that in terms of its impact on overall volume growth right now?
Yes, it's really flattened out. And so we're pretty excited to see growth still accelerating even with PD L1 flattening out. You want to add anything, Ram?
Yes. We've seen each of our testing methodologies grow basically in double digit numbers. So we're excited to see the testing across all methodologies today.
Perfect. And then Doug,
can you maybe walk through the process that got Cigna over the finish line here?
Yes. Well, I would say Drew that first of all, we have a terrific managed care organization. And I think you've known us for a long time, you know that we've pursued broad coverage with the national managed care players for many years, and we're really happy about Cigna. We've been talking with Cigna for a number of years. I think what was attractive to Cigna about NeoGenomics was
our broad comprehensive menu,
including a lot of about here is that we would probably have more tests that haven't been covered in the past that we think will be covered. And going back to Amanda's question, the Cigna coverage will, we think help to aid reimbursement overall in terms of revenue per test. So we're excited about it.
Thanks, guys.
Thank you. Our next question comes from the line of Kevin Ellich with Craig Hallum. Please proceed with your questions.
Good morning and thanks for taking the questions and nice quarter Doug and team. I guess could you give us a little bit more color on the strategic partnership with PPD? Appreciate the color you gave us already on your expected run rate. But when we think long term, where do you think this could go? And what's the timing on when you expect to see any contribution maybe later this year?
Let's turn it over to George for a little commentary on that.
Yes. Obviously, we announced this alliance on June 1. So we're still in the fairly early stages. Obviously, there was quite a bit of work ahead of the announcement, but we're really now in the execution phase. We have made joint sales calls.
We've made joint proposals already. Now realize the sales cycle in pharma services is a lot longer than 7 weeks. So those results aren't showing up yet, but we're very optimistic about it. We had stated before that NeoGenomics had planned to open an Asia Pac laboratory. So this sort of came along at a very opportune time for us to actually be able to sort of co locate in their Singapore facility and have sort of their assistance as we try to open the operation.
So it's still very early in the process, so it's hard to put an exact number on it. So but obviously we're very optimistic about this over the next several years. We think this can grow. We think this gives us the opportunity to win bids that we probably would not be able to win alone. And the same time with PPD.
Our oncology and pathology expertise gives them the ability to participate in bids that they probably would not have won on their own as well. So we think it's a fantastic alliance and we're very optimistic about it.
Appreciate the color, George. And then, I guess, more question for Sharon and the finance team. I guess, what's your now that you've gotten the redemption of the convertible preferred out of the way, I guess, what's your comfort with the financial leverage and where you want to operate the company? And what's your appetite for M and A?
Thanks for the question. I think we are very excited to have to close out the redemption of the preferred share. We've gotten that behind us. It did take our leverage a little bit high and we're looking to bring that down as quickly as we can. So we're up at about 3.9x adjusted EBITDA and we're looking to bring that down by the end of the year to a more sustainable level.
But I don't think that we view it as blocking us from being able to consider M and A and we continue to look at things and continue to think about growing the company.
Great. Thanks guys.
Thank you, Kevin.
Thank you. At this time, gentlemen, we have no additional phone questions. Were there any electronic questions?
There are none.
Thank you. I turn the floor back to you for closing comments.
Okay. Rob, thank you very much. Before we end the call, I'd like to recognize the approximately 1,000 NeoGenomics team members around the U. S. For their dedication and commitment to building a world class cancer testing company.
And on behalf of our NeoGenomics team, I want to thank you for your time joining us this morning. For those of you listening that are investors or considering an investment in NeoGenomics, we thank you for your interest in our company.
Goodbye. Thank
you. This will conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.