UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

For the quarterly period ended September 30, 2017

or

For the transition period from            to                   

Commission File Number: 001-35756

NEOGENOMICS, INC.

(Exact name of registrant as specified in its charter)

 

 

(239) 768-0600

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes  ☑   No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☑   No  ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes  ☐   No  ☑

As of November 7, 2017, the registrant had 80,409,557 shares of Common Stock, par value $0.001 per share outstanding.

 

 

 

 

 

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TABLE OF CONTENTS

 

 

 

 

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FORWARD-LOOKING STATEMENTS

The information in this Quarterly Report on Form 10-Q contains “forward-looking statements” and information within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) relating to NeoGenomics, Inc., a Nevada corporation and its subsidiaries, NeoGenomics Laboratories, Inc., a Florida corporation (“NEO”, “NeoGenomics Laboratories”), NeoGenomics Bioinformatics Inc., a Florida corporation, and Clarient, Inc., a Delaware corporation and its wholly owned subsidiary, Clarient Diagnostic Services, Inc. (together “Clarient”) (collectively referred to as “we”, “us”, “our”, “NeoGenomics”, or the “Company”), which are subject to the “safe harbor” created by those sections.  These forward-looking statements include, but are not limited to, statements concerning our strategy, future operations, future financial position, future revenues, projected costs, prospects and plans and objectives of management. The words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “will,” “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. These forward-looking statements involve known and unknown risks and uncertainties that could cause our actual results, performance or achievements to differ materially from those expressed or implied by the forward-looking statements, including, without limitation, the risks set forth under “Risk Factors” and in Part I, Item 1A, “Risk Factors” contained in our Annual Report on Form 10-K as filed with the SEC on March 14, 2017.  

 

Forward looking statements include, but are not limited to, statements about:

 

Any forward-looking statement speaks only as of the date on which such statement is made, and the Company undertakes no obligation to update any forward-looking statement or statements to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time and it is not possible for management to predict all of such factors, nor can it assess the impact of each such factor on the business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

 

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PART I — FINANCIAL INFORMATION

 

 

ITEM 1. FINANCIAL STATEMENTS

NEOGENOMICS, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)

(unaudited)

 

See notes to unaudited consolidated financial statements

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NEOGENOMICS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

 

 

 

See notes to unaudited consolidated financial statements.

 

 

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NEOGENOMICS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

 

See notes to unaudited consolidated financial statements.

 

 

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NEOGENOMICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Unaudited

 

Note A – Nature of Business and Basis of Presentation

 

NeoGenomics, Inc., a Nevada corporation (the “Parent”), and its subsidiaries, NeoGenomics Laboratories, Inc., a Florida corporation (“NEO” or, “NeoGenomics Laboratories”), NeoGenomics Bioinformatics Inc., a Florida corporation, Path Labs LLC., a Delaware limited liability company (“PathLogic”) and Clarient Inc., a Delaware corporation, and its wholly owned subsidiary Clarient Diagnostic Services, Inc. (together, “Clarient”), (collectively referred to as “we”, “us”, “our”, “NeoGenomics”, or the “Company”), operates as a certified “high complexity” clinical laboratory in accordance with the federal government’s Clinical Laboratory Improvement Act, as amended (“CLIA”), and is dedicated to the delivery of clinical diagnostic services to pathologists, oncologists, urologists, hospitals, and other laboratories throughout the United States and Europe.  

The accompanying interim consolidated financial statements are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. These accompanying interim consolidated financial statements include the accounts of the Parent and its subsidiaries. All intercompany transactions and balances have been eliminated in the accompanying interim consolidated financial statements.

Certain information and footnote disclosures normally included in the Company’s annual audited consolidated financial statements and accompanying notes have been condensed or omitted in these accompanying interim consolidated financial statements. Accordingly, the accompanying interim consolidated financial statements included herein should be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company’s annual report on Form 10-K for the year ended December 31, 2016, filed with the SEC on March 14, 2017.  

The results of operations presented in this quarterly report on Form 10-Q are not necessarily indicative of the results of operations that may be expected for any future periods. In the opinion of management, these unaudited consolidated financial statements include all adjustments and accruals, consisting only of normal recurring adjustments that are necessary for a fair statement of the results of all interim periods reported herein.

 

We have one reportable operating segment that delivers testing services to hospitals, pathologists, oncologists, other clinicians, and researchers, which represents 100% of the Company’s consolidated assets, net revenues and net income (loss) for the three and nine months ended September 30, 2017 and 2016.  We have evaluated our segments based on how the Chief Operating Decision Maker (“CODM”), our Chief Executive Officer, reviews performance and makes decisions in managing the Company.  At September 30, 2017, we provided services within the United States and Europe and had assets located within the United States and Europe.

 

We have two primary types of customers, clinical and pharma.  Our clinical customers include community based pathology practices, oncology groups, hospitals and academic centers.  Our pharma customers include pharmaceutical companies to whom we provide testing and other services to support their studies and clinical trials.  As we grow, we continue to assess the information available to the CODM.  Currently, discrete financial information is not available to the CODM about the separate financial performance of our clinical and our pharma customers.  As we continue to grow and focus separately on the two customer types we will routinely assess the information available and reviewed by the CODM and determine if we meet the criteria for having separate segments.

 

Correction of Immaterial Accounting Error

The Company performed an internal analysis in the third quarter of 2017 which identified an immaterial error in the revenue reported in our Form 10-K for the year ended December 31, 2016, Form 10-Q for the quarter ended March 31, 2017 and Form 10-Q for the three and six months ended June 30, 2017.  We have concluded that the error identified was not material to any prior annual or interim periods.  We assessed the extent of this error and it was corrected in the third quarter of 2017, resulting in a reduction of revenue, and thus a corresponding reduction in accounts receivable of $2.4 million and $0.6 million for the three and nine months ended September 30, 2017, respectively. See Item 4. Controls and Procedures for additional details regarding this error.

 

Note B – Recently Adopted and Issued Accounting Guidance

 

Adopted

 

In January 2017, the FASB issued ASU No. 2017-01, Business Combinations.  This standard clarifies the definition of a business and provides guidance on when transactions should be accounted for as acquisitions of assets and when they should be accounted for as acquisitions of businesses.  The Company early adopted this standard on July 1, 2017 and applied this guidance to the customer list

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NEOGENOMICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Unaudited

 

that was acquired on August 1, 2017.  The customer list acquired was not determined to meet the definition of a business under this standard and was therefore determined to be an asset acquisition.  

 

In March 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-09, Improvements to Employee Share-Based Payment Accounting. The standard update required excess tax benefits and tax deficiencies to be recorded directly through earnings as a component of income tax expense. Under previous GAAP, these differences were generally recorded in additional paid-in capital and thus had no impact on net income. The change impacted the computation of diluted earnings per share, and the cash flows associated with those items are now classified as operating activities on the condensed statements of consolidated cash flows.  Entities were permitted to make an accounting policy election for the impact of forfeitures on the recognition of expense for share-based payment awards. Forfeitures could be estimated, as required under previous GAAP, or recognized when they occur.  

 

The Company adopted this ASU on January 1, 2017 using the transition method prescribed for each applicable provision:

 

Issued

 

In August 2017 the FASB issued ASU 2017-12, Derivatives and Hedging.  This standard refines hedge accounting to better align an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results.   This update is effective for annual periods beginning after December 15, 2018 and interim periods within those annual periods.  Early adoption is permitted.  The Company does not expect the adoption of ASU 2017-12 to have a material effect on its consolidated financial statements.

 

In May 2017, the FASB issued ASU 2017-09, Compensation – Stock Compensation.  This standard provides guidance related to the scope of stock option modification accounting, to reduce diversity in practice and reduce cost and complexity regarding existing guidance. This update is effective for annual periods beginning after December 15, 2017.  Early adoption is permitted. The Company does not expect the adoption of ASU 2017-09 to have a material effect on its consolidated financial statements.

 

In January 2017 the FASB issued ASU No. 2017-04, Intangibles – Goodwill and Other:  Simplifying the Test for Goodwill Impairment.  This standard eliminates Step 2 of the goodwill impairment test. Instead, an entity should perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. This update is effective for annual and interim periods beginning after December 15, 2021.  Early adoption is permitted for interim or annual goodwill impairment tests performed after January 1, 2017.  The Company does not expect the adoption of ASU 2017-04 to have a material effect on its consolidated financial statements.  

In August 2016, the FASB issued “ASU” 2016-15, Statement of Cash Flows – Classification of Certain Cash Receipts and Cash Payments.  This standard clarifies how specific cash receipts and cash payments are classified and presented in the statement of cash flows. This update is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2017.  Early adoption is permitted.  The Company does not expect the adoption of ASU 2016-15 to have a material effect on its consolidated financial statements.  

In February 2016, the FASB issued ASU No. 2016-02, Leases. The update requires organizations to recognize lease assets and lease liabilities on the balance sheet for those leases classified as operating leases under previous GAAP. ASU 2016-02 requires that a

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NEOGENOMICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Unaudited

 

lessee should recognize a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term on the balance sheet. ASU 2016-02 is effective for periods beginning after December 15, 2018 and interim periods within those periods.  The adoption of this ASU will result in an increase on the balance sheet for lease liabilities and right-of-use assets.  The Company is currently evaluating the quantitative impact that adopting ASU 2016-02 will have on its consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, Revenues from Contracts with Customers. This standard update calls for a number of revisions in the revenue recognition rules. In August 2015, the FASB deferred the effective date of this ASU to the first quarter of 2018, with optional early adoption beginning in the first quarter of 2017.  The ASU can be applied using a full retrospective method or a modified retrospective method of adoption.  The Company expects to adopt this ASU in the first quarter of 2018 using a full retrospective method of adoption.  We anticipate the adoption of this standard to impact our Pharma Services revenue, specifically the timing of revenue recognition for our long term research and clinical trials contracts.  Many of these contracts have distinct terms which need to be evaluated separately, therefore, we are still in the process of contract review in order to determine the quantitative impact this standard will have on our Pharma Services revenue.  We also expect this standard to impact our Clinical testing revenue.  Under the new standard, substantially all of our bad debt expense which has historically been presented as part of selling, general and administrative expenses will be considered an implicit price concession and will be reported as a reduction in revenue.  We also anticipate enhanced financial statement disclosures surrounding the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.  The Company continues to assess the full impact the adoption of this standard will have on our financial statements.

 

Note C – Goodwill and Intangible Assets

Goodwill as of September 30, 2017 and December 31, 2016 was $147.0 million.  There were no changes in the carrying amount of goodwill during these periods.

 

Intangible assets as of September 30, 2017 and December 31, 2016 consisted of the following (in thousands):

 

 

 

On August 31, 2017, the Company acquired a customer list from Ascend Genomics in exchange for 450,000 shares of restricted stock, see Note H – Equity.  This customer relationship was recorded at fair value and is being amortized over 15 years.  As part of the transaction, Ascend Genomics signed a non-compete agreement which was also recorded as an intangible asset and is being amortized over 2 years. We recorded approximately $1.7 and $1.8 million in straight-line amortization expense of intangible assets for the three month period ended September 30, 2017 and 2016, respectively.  We recorded approximately $5.2 million and $5.5 million in straight-line amortization expense of intangible assets for the nine month period ended September 30, 2017 and 2016, respectively. The Company recorded amortization expense from customer relationships and trade names as a general and administrative expense.  

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NEOGENOMICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Unaudited

 

The estimated amortization expense related to amortizable intangible assets for each of the five succeeding fiscal years and thereafter as of September 30, 2017 is as follows (in thousands):

 

 

Note D – Debt

 

The following table summarizes the long term debt at September 30, 2017 and December 31, 2016 (in thousands):

 

The carrying value of the Company’s long-term capital lease obligations and term debt approximates its fair value based on the current market conditions for similar instruments. 

 

Term Loan

On December 22, 2016, the Company entered into a Credit Agreement with Regions Bank as administrative agent and collateral agent.  The Credit Agreement provided for a $75.0 million term loan facility (the “Term Loan Facility”).  The Credit Agreement also provides incremental facility capacity of $50 million, subject to certain conditions.  On September 30, 2017 and December 31, 2016, the Company had current outstanding borrowings under the Term Loan of approximately $3.8 million and long-term outstanding borrowings of approximately $67.5 million and $70.1 million, net of unamortized debt issuance costs of $939,000 and $1.1 million, respectively.  The debt issuance costs were recorded as a reduction in the carrying amount of the related liability and are being amortized over the life of the loan.

The Term Loan Facility bears interest at a rate per annum equal to an applicable margin plus, at NeoGenomics Laboratories’ option, either (1) the Adjusted LIBOR rate for the relevant interest period, (2) an alternate base rate determined by reference to the greatest of (a) the prime lending rate of Regions, (b) the federal funds rate for the relevant interest period plus 0.5% per annum and (c) the one month LIBOR rate plus 1% per annum, or (3) a combination of (1) and (2). The applicable margin will range from 2.25% to 3.50% for LIBOR loans and 1.25% to 2.50% for base rate loans, in each case based on NeoGenomics Laboratories’ consolidated leverage ratio (as defined in the Credit Agreement). Interest on borrowings under the Revolving Credit Facility is payable on the last day of each month, in the case of each base rate loan, and on the last day of each interest period (but no less frequently than every three months), in the case of Adjusted LIBOR loans.  The Company entered into an interest rate swap agreement to hedge against changes in the variable rate of a portion of this debt.  See Note E-Derivative Instruments and Hedging Activities for more information on this instrument.

 

The Term Loan Facility and amounts borrowed under the Revolving Credit Facility are secured on a first priority basis by a security interest in substantially all of the tangible and intangible assets of NeoGenomics Laboratories and the Guarantors.  The Term Loan Facility contains various affirmative and negative covenants including ability to incur liens and encumbrances; make certain restricted payments, including paying dividends on its equity securities or payments to redeem, repurchase or retire its equity securities; enter

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NEOGENOMICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Unaudited

 

into certain restrictive agreements; make investments, loans and acquisitions; merge or consolidate with any other person; dispose of assets; enter into sale and leaseback transactions; engage in transactions with its affiliates, and materially alter the business it conducts.  In addition, the Company must meet certain maximum leverage ratios and fixed charge coverage ratios as of the end of each fiscal quarter commencing with the quarter ending March 31, 2017.  The Company was in compliance with all required covenants as of September 30, 2017.

 

The Term Loan Facility has a maturity date of December 21, 2021.  The Credit Agreement requires NeoGenomics Laboratories to mandatorily prepay the Term Loan Facility and amounts borrowed under the Revolving Credit Facility with (i) 100% of net cash proceeds from certain sales and dispositions, subject to certain reinvestment rights, (ii) 100% of net cash proceeds from certain issuances or incurrences of additional debt, (iii) beginning with the fiscal year ending December 31, 2017, 50% of excess cash flow (as defined), subject to a step down to 0% of excess cash flow if NeoGenomics Laboratories’ consolidated leverage ratio is no greater than 2.75:1.0 and (iv) 100% of net cash proceeds from issuances of permitted equity securities by NeoGenomics Laboratories made in order to cure a failure to comply with the financial covenants. NeoGenomics Laboratories is permitted to voluntarily prepay the Term Loan Facility and amounts borrowed under the Revolving Credit Facility at any time without penalty.

Auto Loans

The Company has auto loans with various financial institutions.  The auto loan terms range from 36-60 months and carry interest rates from 0.0% to 5.2%.

Capital Leases

The Company has entered into capital leases to purchase laboratory and office equipment.  These leases expire at various dates through 2020 and the weighted average interest rate under such leases was approximately 4.81% at September 30, 2017. Most of these leases contain bargain purchase options that allow us to purchase the leased property for a minimal amount upon the expiration of the lease term. The remaining leases have purchase options at fair market value.      

 

Property and equipment acquired under capital lease agreements are pledged as collateral to secure the performance of the future minimum lease payments.

 

Revolving Credit Facility

On December 22, 2016, the Company entered into a Credit Agreement with Regions Bank as administrative agent and collateral agent.  The Credit Agreement provided for a $75.0 million revolving credit facility (the “Revolving Facility”).  On September 30, 2017, and December 31, 2016, the Company had outstanding borrowings of approximately $24.5 million and $21.8 million, net of unamortized debt issuance costs of $939,000 and $1.1 million, respectively.

 

The Revolving Credit Facility includes a $10 million swingline sublimit, with swingline loans bearing interest at the alternate base rate plus the applicable margin. Any principal outstanding under the Revolving Credit Facility is due and payable on December 21, 2021 or such earlier date as the obligations under the Credit Agreement become due and payable pursuant to the terms of the Credit Agreement.  The Revolving Facility bears interest at a rate per annum equal to an applicable margin plus, at NeoGenomics Laboratories’ option, either (1) the Adjusted LIBOR rate for the relevant interest period, (2) an alternate base rate determined by reference to the greatest of (a) the prime lending rate of Regions, (b) the federal funds rate for the relevant interest period plus 0.5% per annum and (c) the one month LIBOR rate plus 1% per annum, or (3) a combination of (1) and (2). The applicable margin will range from 2.25% to 3.50% for Adjusted LIBOR loans and 1.25% to 2.50% for base rate loans, in each case based on NeoGenomics Laboratories’ consolidated leverage ratio. Interest on the outstanding principal of the Term Loan Facility will be payable on the last day of each month, in the case of each base rate loan, and on the last day of each interest period (but no less frequently than every three months), in the case of LIBOR loans.

 

The Credit Agreement requires NeoGenomics Laboratories to mandatorily prepay the Term Loan Facility and amounts borrowed under the Revolving Credit Facility with (i) 100% of net cash proceeds from certain sales and dispositions, subject to certain reinvestment rights, (ii) 100% of net cash proceeds from certain issuances or incurrences of additional debt, (iii) beginning with the fiscal year ending December 31, 2017, 50% of excess cash flow (minus certain specified other payments), subject to a step down to 0% of excess cash flow if NeoGenomics Laboratories’ consolidated leverage ratio is no greater than 2.75:1.0 and (iv) 100% of net

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NEOGENOMICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Unaudited

 

cash proceeds from issuances of permitted equity securities by NeoGenomics Laboratories made in order to cure a failure to comply with the financial covenants. NeoGenomics Laboratories is permitted to voluntarily prepay the Term Loan Facility and amounts borrowed under the Revolving Credit Facility at any time without penalty, subject to customary “breakage” costs with respect to prepayments of Adjusted LIBOR rate loans made on a day other than the last day of any applicable interest period.

Maturities of Long-Term Debt

Maturities of long-term debt at September 30, 2017 are summarized as follows (in thousands):

 

Note E – Derivative Instruments and Hedging Activities

Cash Flow Hedges

In December of 2016, the Company entered into an interest rate swap agreement to reduce our exposure to interest rate fluctuations on our variable rate debt obligations.  This derivative financial instrument is accounted for at fair value as a cash flow hedge which effectively modifies our exposure to interest rate risk by converting a portion of our floating rate debt to a fixed rate obligation, thus reducing the impact of interest rate changes on future interest expense.

 

We account for derivatives in accordance with FASB ASC Topic 815, see Note B-Summary of Significant Accounting Policies in Annual Report on Form 10-K for more information on our accounting policy related to derivative instruments and hedging activities.  

 

Under this agreement, we receive a variable rate of interest based on LIBOR, and we pay a fixed rate of interest at 1.59%.  The interest rate swap agreement was effective as of December 30, 2016 and a termination date of December 31, 2019. As of September 30, 2017 and December 31, 2016, the total notional amount of the Company’s interest rate swaps were $50 million.

 

The fair value of the interest rate swap will be included in other long term assets or liabilities, when applicable.  As of September 30, 2017 and December 31, 2016, the fair value of the interest rate swap was not considered to be significant due to the change in LIBOR over that time period outstanding, therefore, no amount is included on the balance sheet for this instrument.  As the specific terms and notional amounts of the derivative financial instrument match those of the fixed-rate debt being hedged, the derivative instruments are assumed to be perfectly effective hedges and accordingly, there is no impact to the Company's consolidated statements of operations. Gains and losses on this interest rate swap agreement will be recorded in accumulated other comprehensive income and will be reclassified to interest expense in the period during which the hedged transaction affects earnings.  At September 30, 2017 and December 31, 2016, there was no impact to accumulated other comprehensive income (AOCI) as it was determined that there was not a significant change to record.  The fair value of this instrument will be evaluated on a quarterly basis and adjusted as necessary.    

 

 

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NEOGENOMICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Unaudited

 

Note F – Class A Redeemable Convertible Preferred Stock

 

On December 30, 2015, NeoGenomics issued 14,666,667 shares of its Series A Preferred stock as part of the consideration for the acquisition of Clarient.  The Series A Preferred Stock has a face value of $7.50 per share for a total liquidation value of $110 million.  During the first year, the Series A Preferred Stock had a liquidation value of $100 million if the shares were redeemed prior to December 29, 2016.  On December 22, 2016, the Company redeemed 8,066,667 shares of the Series A Preferred Stock for $55.0 million in cash.  The redemption amount per share equaled $6.8181825 ($7.50 minus the liquidation discount of 9.0909%).  At September 30, 2017, 6,600,000 shares of Series A Preferred Stock were outstanding.  

 

The carrying amount of the Series A Preferred Stock at September 30, 2017 was $30.1 million as compared to the carrying amount at December 31, 2016 of $22.9 million.  The increase in the carrying amount is due to the accrual of deemed dividends of approximately $2.7 million, the accretion of the beneficial conversion feature of approximately $5.1 million during the nine months ending September 30, 2017 and the additional BCF discounts for payment-in-kind shares accrued during the nine months ending September 30, 2017 of $0.6 million.  Both the deemed dividends and the accretion of the beneficial conversion feature are recorded as distributions to the holders of the Series A Preferred Stock on the income statement with the corresponding entry recorded as an increase to the carrying value of the Series A Preferred Stock.

 

Issue Discount

 

The Company recorded the Series A Preferred Stock at a fair value of approximately $73.2 million or $4.99 per share on the date of issuance.  The difference between the fair value of $73.2 million and the liquidation value of $110 million represents a discount of $36.8 million from the initial face value as a result of assessing the impact the rights and features of the instrument and their effect on the value to the Company.  After the partial redemption, the Series A Preferred stock has a fair value of approximately $32.9 million or $4.99 per share.  The difference between the fair value of $32.9 million and the liquidation value of $49.5 million represents a discount of approximately $16.6 million.  

 

 

Beneficial Conversion Features

 

The fair value of the common stock into which the Series A Preferred Stock is convertible exceeded the allocated purchase price fair value of the Series A Preferred Stock at the date of issuance and after redemption by approximately $44.7 and $20.1 million, respectively, resulting in a beneficial conversion feature.  The Company will recognize the beneficial conversion feature as non-cash, deemed dividend to the holder of Series A Preferred Stock over the first three years the Series A Preferred Stock is outstanding, as the date the stock first becomes convertible is three years from the issue date.  The amount recognized for the three and nine months ended September 30, 2017 was approximately $1.7 million and $5.1 million, respectively.  

 

In addition to the beneficial conversion feature (“BCF”) recorded at the original issue date, we recorded additional BCF discounts for payment-in-kind shares accrued for quarters ended March 31, 2017, June 30, 2017 and September 30, 2017, as dividends.  After the early redemption, the face value of the remaining Series A Preferred Stock is $49.5 million.  We will issue 264,000 additional shares ($49.5 million * 4.0%) / $7.50) of Series A Preferred Stock as payment-in-kind dividends for the year ending December 31, 2017, the first year dividends are payable.  The additional 264,000 shares will be discounted and amortized to the income statement over the remaining period up to the earliest conversion date, which is three years from the original issue date.  The additional BCF discount recorded for the three and nine months ended September 30, 2017 was approximately $201,240 and $603,720 respectively.  

 

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NEOGENOMICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Unaudited

 

Automatic Conversion

 

Each share of Series A Preferred Stock issued and outstanding as of the tenth anniversary of the original issue date will automatically convert into fully paid and non-assessable shares of common stock.

 

Classification  

 

The Company classified the Series A Preferred Stock as temporary equity on the consolidated balance sheets due to certain change in control events that are outside the Company’s control, including deemed liquidation events described in the Series A Certificate of Designation.

 

Note G – Revenue Recognition and Contractual Adjustments

The Company recognizes revenues when (a) the price is fixed or determinable, (b) persuasive evidence of an arrangement exists, (c) the service is performed and (d) collectability of the resulting receivable is reasonably assured. The Company’s specialized diagnostic services are performed based on a written test requisition form or electronic equivalent, and revenues are recognized once the diagnostic services have been performed, and the results have been delivered to the ordering physician.  These diagnostic services are billed to various payers, including Medicare, commercial insurance companies, other directly billed healthcare institutions such as hospitals and clinics, and individuals.  The Company reports revenues from contracted payers, including Medicare, certain insurance companies and certain healthcare institutions, based on the contractual rate, or in the case of Medicare, published fee schedules.  The Company reports revenues from non-contracted payers, including certain insurance companies and individuals, based on the amount expected to be collected.  The difference between the amount billed and the amount estimated to be collected from non-contracted payers is recorded as an allowance to arrive at the reported net revenues.  The expected revenues from non-contracted payers are based on the historical collection experience of each payer or payer group, as appropriate.  The Company records revenues from patient pay tests net of a large discount and as a result recognizes minimal revenue on those tests.  The Company regularly reviews its historical collection experience for non-contracted payers and adjusts its expected revenues for current and subsequent periods accordingly.  On January 1, 2017, we had a significant reduction in our patient fee schedule that primarily impacts the amount billed to uninsured patients.

The table below shows the adjustments made to gross service revenues to arrive at net revenues (in thousands), the amount reported on our statements of operations.

 

Note H – Equity

A summary of the stock option activity under the Company’s plans for the three months ended September 30, 2017 is as follows:

 

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NEOGENOMICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Unaudited

 

Of the 6,492,941 outstanding options at September 30, 2017, 1,240,834 were variable accounted stock options issued to non-employees of the Company of which 445,833 options were vested and 795,001 options were unvested as of September 30, 2017.

The fair value of each stock option award granted during the nine months ended September 30, 2017 was estimated as of the grant date using a trinomial lattice model with the following weighted average assumptions:

 

As of September 30, 2017, there was approximately $6.5 million of unrecognized share based compensation expense related to stock options that will be recognized over a weighted-average period of approximately 1.3 years.  This includes approximately $1.9 million in unrecognized expense related to the 795,001 shares of unvested variable accounted for stock options subject to fair value adjustment at the end of each reporting period based on changes in the Company’s stock price.

Stock based compensation expense recognized for stock options and restricted stock and included in the consolidated statements of operations was allocated as follows (in thousands): 

 

Stock based compensation recorded in research and development relates to unvested options granted to a non-employee.   

 

Common Stock Warrants

A summary of the warrant activity for the six months ended September 30, 2017 is as follows:

 

 

During both the three months ended September 30, 2017 and 2016, we recorded $0 of warrant compensation expense.  During the nine months ended September 30, 2017, we recorded $0 of warrant compensation expense and during the nine months ended September 30, 2016 we recorded a warrant compensation gain of approximately $10,000, respectively.  Warrant expense (gain) for the periods presented is recorded in research and development as the expense is related to unvested performance based warrants that were granted to a non-employee.  As of September 30, 2017, there were no outstanding warrants.  

 

 

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Unaudited

 

Restricted Stock

On August 31, 2017, we issued 450,000 shares of restricted common stock to Ascend Genomics as purchase consideration for the customer list acquired.  The customer list was recorded as an intangible asset, see Note C – Goodwill and Intangible Assets.  As a condition of the purchase, Ascend is prohibited from trading the shares for a period of six months from the closing date.  

Employee Stock Purchase Plan

We offer an employee stock purchase plan (“ESPP”) through which eligible employees may purchase shares of our common stock at a discount.  On May 25, 2017, the Company amended the ESPP, increasing the discount from 5% to 15% of the fair market value of the Company’s common stock.  As a result of this change, we have recorded stock based compensation expense related to the ESPP for the quarter ended September 30, 2017.  

 

During the three months ended September 30, 2017 and 2016, employees purchased 23,664 and 26,092 shares, respectively under the ESPP.  The expense recorded for these periods was $41,907 and $0, respectively.  During the nine months ended September 30, 2017 and 2016, employees purchased 74,756 and 75,623 shares, respectively under the ESPP.  The expense recorded for these periods was $41,907 and $0.

 

Note I – Commitments

During the three and nine months ended September 30, 2017, the Company entered into leases of approximately $683,000 and $3.2 million in laboratory and computer equipment, respectively. These leases have 36 month terms, a $1.00 buyout option at the end of the terms and interest rates ranging from 0.0% to 19.5%.  The Company accounted for these lease agreements as capital leases.

During the nine months ended September 30, 2017, the Company entered into a construction contract for the expansion of our laboratory in Houston, Texas.  The contract is for approximately $5.0 million, which the Company intends to finance through a capital lease with a 36 month term and a $1.00 buyout option.  The interest rate under this lease will vary based on the timing of the construction payments.  We anticipate this project to be complete in the first quarter of 2018.  

 

Note J – Other Related Party Transaction

 

During each of the three and nine month periods ended September 30, 2017 and 2016, Steven C. Jones was an officer, director and shareholder of the Company.  In connection with his duties as Executive Vice President, Mr. Jones earned approximately $46,000 and $66,000 for the three months ended September 30, 2017 and 2016, respectively.  In addition, as compensation for his services on the Board, Mr. Jones earned approximately $13,000 and $0 for the three months ended September 30, 2017 and 2016, respectively.  During the nine months ended September 30, 2017 and 2016, Mr. Jones earned approximately $164,000 and $197,000, respectively in connection with his duties as Executive Vice President.  Mr. Jones also received approximately $85,000 and $79,000 during the nine months ended September 30, 2017 and 2016, respectively, as payment of his annual bonus compensation for the previous fiscal years.  In addition, as compensation for his services on the Board, Mr. Jones earned $25,500 and $0 for the nine months ended September 30, 2017 and 2016, respectively.

During each of the three and nine month periods ending September 30, 2017 and 2016, Kevin Johnson was a director and shareholder of the Company.  In May of 2017, the Company engaged Mr. Johnson to provide services as a consultant.  This engagement ended in June of 2017.  In connection with his role as a consultant, Mr. Johnson earned approximately $0 and $0 for the three months ended September 30, 2017 and 2016, respectively.  In addition, as compensation for his services on the Board, Mr. Johnson earned approximately $14,000 and $15,000, for the three months ended September 30, 2017 and 2016, respectively and approximately $44,000 and $45,000 for the nine months ended September 30, 2017 and 2016, respectively.

On May 25, 2017, the Company granted stock options and restricted stock to each of its board members as part of its annual board compensation process.  Mr. Jones and Mr. Johnson were each granted 10,000 stock options and 8,667 shares of restricted stock for their Board services.  The options were granted at a price of $7.27 per share and had a weighted average fair market value of $2.38 per option.  The options vest ratably over the next three years.  The restricted stock has a weighted average fair value of $7.27 per share and vests ratably on the last day of each calendar quarter up to March 31, 2018.

 

END OF FINANCIAL STATEMENTS

 

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NEOGENOMICS, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

NeoGenomics, Inc., a Nevada corporation (referred to collectively with its subsidiaries as “NeoGenomics”, “we”, “us”, “our” or the “Company” in this Form 10-K) is the registrant for SEC reporting purposes. Our common stock is listed on the NASDAQ Capital Market under the symbol “NEO”.

Introduction

The following discussion and analysis should be read in conjunction with the unaudited consolidated financial statements, and the notes thereto included herein. The information contained below includes statements of the Company’s or management’s beliefs, expectations, hopes, goals and plans that, if not historical, are forward-looking statements subject to certain risks and uncertainties that could cause actual results to differ materially from those anticipated in the forward-looking statements. For a discussion on forward-looking statements, see the information set forth in the introductory note to this quarterly report on Form 10-Q under the caption “Forward-Looking Statements”, which information is incorporated herein by reference.

Overview

We operate a network of cancer-focused genetic testing laboratories in the United States.  Our mission is to improve patient care through exceptional genetic and molecular testing services. Our vision is to become the World’s leading cancer testing and information company by delivering uncompromising quality, exceptional service and innovative solutions.

As of September 30, 2017, the Company had laboratory locations in Aliso Viejo and Fresno, CA; Tampa and Fort Myers, FL; Houston, TX and Nashville, TN.  The Company currently offers the following types of genetic and molecular testing services:

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Clinical Cancer Testing Services

The cancer testing services we offer to community-based pathologists are designed to be a natural extension of, and complementary to, the services that they perform within their own practices. We believe our relationship as a non-competitive partner to community-based pathology practices, hospital pathology labs and academic centers empowers them to expand their breadth of testing and provide a menu of services that matches or exceeds the level of service found in any center of excellence around the world.

Pharma Services and Clinical Trials

Our Pharma Services division supports pharmaceutical firms in their drug development programs by supporting various clinical trials.  This portion of our business often involves working with the pharmaceutical firms (sponsors) on study design as well as performing the required testing.  Our medical team often advises the sponsor and works closely with them as specimens are received from the enrolled sites.  We also work on developing tests that will be used as part of a companion diagnostic to determine patients’ response to a particular drug.  As studies unfold, our clinical trials team reports the data and often provide key analysis and insights back to the sponsors.

Our Pharma Services and Clinical Trials group provides comprehensive testing services in support of our pharmaceutical clients’ oncology programs from discovery to commercialization.  In biomarker discovery, our aim is to help our customers discover the right content.  We help our customers develop a biomarker hypothesis by recommending an optimal platform for molecular screening and backing our discovery tools with the informatics to capture meaningful data.  In other pre and non-clinical work, we can use our platforms to characterize markers of interest.   Moving from discovery to development, we help our customers refine their biomarker strategy and, if applicable, develop a companion diagnostic pathway using the optimal technology for large-scale clinical trial testing.

Whether serving as the single contract research organization or partnering with one, our Pharma Services and Clinical Trials team provides significant technical expertise working closely with our customers to support each stage of clinical trial development.  Each trial we support comes with rapid turnaround time, dedicated project management and quality assurance oversight. We have experience in supporting submissions to the Federal Drug Administration for companion diagnostics.  Our Pharma Services strategy is focused on helping bring more effective oncology treatments to market through providing world class laboratory services in oncology to key pharmaceutical companies in the industry.

2017 Focus Areas: Develop High Performance Culture, Inspire & “Own” Quality, Accelerate Growth and Advance Our Strategy

Over the past several years, NeoGenomics has experienced rapid growth including organic growth from offering new tests to existing customers, growth from gaining market share from our competitors, and growth from acquisitions.  We expect to continue to grow our business in 2017 and are focused on several initiatives to continue to build our Company to be the World’s leading cancer testing and information company.

Develop our High Performance Culture  

We are building our high performance culture by empowering our employees and investing in their growth.  We are providing skill based training, education, and mentoring our supervisors and managers to allow them to grow within the Company.  We communicated career opportunities and performance objectives and hold each employee accountable for their own development.  Teamwork is highly encouraged through the use of team performance incentive plans as well as other meaningful recognition and rewards.  To cultivate teamwork we are committed to improving communication by providing better tools for today’s connected society.  Our organization uses weekly employee surveys and takes actions based on the feedback from those surveys.  We believe that a culture of engaged employees provides superior service to our clients and their patients battling cancer.  We have employee retention targets that are set each year, and we believe our employee retention rate is above average for the laboratory industry.  Recruiting and retaining talented employees is critical in the fast moving field of cancer diagnostics.  

Inspire and “Own” Quality

Since the acquisition of Clarient, Inc. and its wholly owned subsidiary Clarient Diagnostic Services, Inc. (together “Clarient”) we’ve focused on combining the very best of both NeoGenomics and Clarient testing menus and services.  We’ve had functional teams work through every part of the business to ensure that we were able to maintain our high level of quality and create best practices

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throughout our organization.  Maintaining quality laboratory operations and service is enabling us to retain existing clients while adding new ones.  

We have a variety of initiatives designed to further enhance our company-wide quality program, provide training on the importance of quality, reinforce our quality principals, and recognize individuals and teams for providing quality service.  By promoting and reinforcing quality principles, we believe we can strengthen our core processes.  Our focus on continuous improvement, first time quality and the work of our best-practice teams will enable us to continue reducing our cost per test as we have steadily over the past several years.

In 2016, we began work on our next generation Laboratory Information System (“LIS”) and our information technology team is working to complete the LIS for certain key areas of our Pharma Services division in 2017.  We believe the new LIS will help to drive improvements in several laboratory areas and will allow for further automation and operational efficiencies.  The new LIS will also meet the stringent requirements of our Pharma Services clients and will enable these clients the ability to track each step through the laboratory process.  On June 30, 2017, we began using this new system in certain areas of our Pharma Services business and we will continue to roll it out.  Once all of the Pharma Services testing is on the new LIS, we intend to begin using it in our Clinical Testing division.

 

We have renovated our Aliso Viejo, CA laboratory and are currently working on the expansion of our Houston, TX facility which we expect to complete by the end of the first quarter of 2018.  We completed the consolidation of our Irvine Lab facility into the Aliso Viejo Lab facility, and we fully vacated the Irvine facility on April 30, 2017.  We have also completed the sale of PathLogic on August 1, 2017 and therefore no longer have a laboratory in West Sacramento, CA.  We expect these changes in our business to result in additional capacity, economies of scale and operating efficiencies.

Accelerate Profitable Growth

Our plans for 2017 include many initiatives to continue our strong organic growth by gaining market share, introducing new tests, and expanding our Pharma business.  Through the acquisition of Clarient we have significantly expanded our Pharma Services business, and plan to develop it further by creating an international presence and incorporating new technologies.  Also, as a result of the Clarient acquisition, we have expanded our sales team and now offer our services in geographic areas where we did not previously have sales representation.  We believe our highly trained sales team has been successful in competing against other laboratories because of our exceptional service levels, and because we have one of the broadest and most comprehensive test menus in our industry. Our broad menu of molecular and immunohistochemistry testing has helped make us a “one stop shop” for many clients who like the fact that all of their testing can be sent to one laboratory.

We currently perform comprehensive analyses for hematopoietic cancers such as leukemia and lymphoma (blood and lymphoid tumors) as well as solid tumors such as breast, lung, colon, and bladder cancers.  Our sales team is experienced with the scientific complexity and medical necessity of our testing services, and understands the needs of our client pathologists and oncologists. We will continue to pursue market share gains by providing high complexity, cancer-related laboratory testing services to hospitals, community-based pathology practices, academic centers, and clinicians throughout the United States.  

Our growth has also been aided by strong client retention.  We believe our client retention success is due to our strong service levels, our tech-only service offerings, and a culture of customer focus in which our engaged employees seek to deliver highest customer satisfaction possible.   Our strong service levels are reinforced by a disciplined management process with a system of detailed measures and metrics to ensure committed turnaround times and customer service.  Our broad menu of molecular and immunohistochemistry testing has helped make us a “one stop shop” for many clients who like the fact that all of their testing can be sent to one laboratory.

In early 2017, we re-branded and created a new logo.  We intend to implement strategic marketing plans to further develop our brand and build brand awareness.  We have re-designed our trade show booth incorporating our new logo and plan to improve new test launches by using social media to improve brand awareness.   We believe by executing and developing our brand we will achieve growth in new and existing markets.

We also look for opportunities to grow our business through mergers and/or acquisitions.  We are focused on strategic opportunities that would be complementary to our menu of services and would increase our earnings and cash flow in the short to medium timeframe.  In late 2015 we acquired Clarient which specialized in advanced oncology diagnostic services, this acquisition has enabled NeoGenomics to

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broaden its offering of innovative cancer diagnostic tests to hospitals and physicians across the country, and to accelerate its growth in the fast-growing worldwide market for pharmaceutical clinical trials and research.  Complementary product offerings and expanded geographical reach of the combined Company will provide customers with substantial benefits and create a significantly larger and more diversified provider of precision oncology diagnostics.  The Clarient transaction is a good example of the type of acquisition opportunity we will consider in the future.

Advance Our Strategy

We are committed to being an innovative leader and believe this has been and will be a key factor in our growth.  We plan to accomplish this goal through strategic actions designed to: 1) advance the technology we use in our laboratories, 2) evaluate, develop and deploy new products and services, and 3) evaluate and experiment with value-based payment models in collaboration with oncology groups and other health care providers.

Our broad and innovative testing menu allows us to serve community-based pathologists and clinicians as well as pharmaceutical customers and nationally recognized academic centers.  Over the past year, we have developed approximately 50 new molecular oncology tests and disease-specific panels, and we believe we have one of the most comprehensive oncology test menus of any laboratory in the world.  By launching new medically significant and necessary tests at a steady rate, we are able to provide cutting-edge developments in molecular genetics with clients and their patients and are developing our reputation as a leader in the field of molecular oncology.  In many cases, customers who begin using us because of our new innovative test offerings also begin to refer portions of their other testing.  

Our comprehensive test offering allows us to be a one-stop shop for all of the oncology testing needs of our clients.  Pharmaceutical firms are also attracted to our laboratory based on extensive test menu, and based on our knowledgeable research and development team as well as our ability to offer tests at the forefront of medical developments. 

We continue to pursue opportunities to offer “liquid biopsy” testing, particularly for hematological diseases.  We have launched twelve NEOLAB^TM liquid biopsy tests for hematological disease using next generation sequencing and other advanced molecular technologies.  Liquid Biopsy testing uses cell-free circulating DNA and RNA found in blood plasma to identify molecular abnormalities in the bone marrow without the need for a bone marrow biopsy. The technology is based on the concept that hematologic cells release their DNA, RNA, and protein into circulation as the cells are immersed in blood.  The cell-free circulating DNA, RNA and protein are referred to as exosomes, microvesicles, apoptotic bodies or simply DNA- or RNA-protein complexes.  Our new tests use proprietary methods to extract these circulating nucleic acids and analyze them using next generation sequencing and advanced methods in order to evaluate molecular abnormalities present in hematological cancers.  

We also continue to develop new testing approaches by combining the capabilities of a variety of testing technologies.   Our NeoTYPE^TM multimodality testing is somewhat unique in the industry and combines immunohistochemistry testing, molecular testing, and FISH testing into disease-specific panels that are very effective and efficient for improving patient care.  We introduced a number of NeoTYPE^TM molecular panels that combine multiple molecular tests into multi-gene panels targeting specific types of cancer to help pathologists and oncologists determine cancer subtypes on difficult cases.  Managed care payers have expressed interest in the more targeted panels as a more cost effective alternative to ordering large whole genome panels that include genes that have never been tied to a particular type of cancer.

Our NeoLAB (Liquid Biopsy) Prostate cancer test which is performed on blood plasma and urine rather than on prostate tissue biopsies is currently available as a Laboratory Developed Test and we have received clinical orders for it.  There are two goals for this test: 1) to diagnose the presence of cancer in patients and 2) to distinguish high-grade from low-grade cancer in patients with prostate cancer.  We are working to gain reimbursement for this test which we believe could significantly increase the acceptance and the number of test orders we receive for this important test.

Competitive Strengths

Turnaround Times

We strive to provide industry leading turnaround times for test results to our clients nationwide.  By providing information to our clients in a rapid manner, physicians can begin treating their patients as soon as possible.  We believe our average 4-5 day turnaround

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time for our cytogenetics testing services, our average 3-4 day turnaround time for FISH testing services, our 5-7 day turnaround time for molecular testing and our average 1 day turnaround time for flow cytometry and pathology testing services are industry-leading benchmarks for national laboratories.  Our consistent timeliness of results is a competitive strength and a driver of additional testing requests by our referring physicians.  Rapid turnaround times allow for the performance of other adjunctive tests within an acceptable diagnosis window in order to augment or confirm results and more fully inform treatment options.  We believe that our fast turnaround times are a key differentiator versus other national laboratories, and our clients often cite them as a key factor in their relationship with us.

World-class Medical and Scientific Team

Our team of medical professionals and Ph.Ds. are specialists in the field of genetics, oncology and pathology.  As of September 30, 2017, we employed, or are contracted with, approximately 28 full-time M.D.s and Ph.Ds.  The addition of Clarient’s pathology team has added increased depth to our medical team, and has enhanced our ability to service a wider range of specialties.  

Extensive Tech-Only Service Offerings

We currently have the most extensive menu of tech-only FISH services in the country as well as extensive and advanced tech-only flow cytometry and IHC testing services.  These types of testing services allow the professional interpretation component of a test to be performed and billed separately by our physician clients.  Our FISH, flow cytometry and other tech-only service offerings allow properly trained and credentialed community-based pathologists to extend their own practices by performing professional interpretations services, which allows them to better service the needs of their local clientele without the need to invest in the lab equipment and personnel required to perform the technical component of genetic and molecular testing.

Our tech-only services are designed to give pathologists the option to choose, on a case by case basis, whether they want to order just the technical information and images relating to a specific test so they can perform the professional interpretation, or order “global” services and receive a comprehensive test report which includes a NeoGenomics Pathologist’s interpretation of the test results.  Our clients appreciate the flexibility to access NeoGenomics’ medical staff for difficult or complex cases or when they are otherwise unavailable to perform professional interpretations.  We believe this innovative approach to serving the needs of pathology clients’ results in longer term, more committed client relationships that are, in effect, strategic partnerships. Our extensive tech-only service offerings have differentiated us and allowed us to compete more effectively against larger, more entrenched competitors in our niche of the industry.

Global Service Offerings

We offer a comprehensive suite of technical and interpretation services, to meet the needs of those clients who are not credentialed and trained in interpreting genetic tests and who require pathology specialists to interpret the testing results for them. In our global service offerings, our lab performs the technical component of the tests and our M.D.s and Ph.Ds. provide the service of interpreting the results of those tests. Our professional staff is also available for post-test consultative services. Clients using our global service offering rely on the expertise of our medical team to give them the answers they need in a timely manner to help inform their diagnoses and treatment decisions. Many of our tech-only clients also rely on our medical team for difficult or challenging cases by ordering our global testing services on a case-by-case basis or our medical team can serve as a backup to support our clients who need help to satisfy the continued and demanding requirements of their practice. Our reporting capabilities allow for all relevant case data from our global services to be captured in one summary report. When providing global services, NeoGenomics bills for both the technical and professional component of the test, which results in a higher reimbursement level.

Client Education Programs

We believe we have one of the most extensive client education programs in the genetic and molecular testing industry. We train pathologists how to use and interpret genetic testing services so that they can better interpret technical data and render their diagnosis.

Our educational programs include an extensive library of on-demand training modules, online courses, webinars and custom tailored on-site training programs that are designed to prepare clients to utilize our tech-only services. We offer training and information on new cancer tests and the latest developments in the field of molecular genetic testing. Each year, we also regularly sponsor seminars and webinars on emerging topics of interest in our field. Our medical staff is involved in many aspects of our training programs.

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Superior Testing Technologies and Instrumentation

We use some of the most advanced testing technologies and instrumentation in the laboratory industry. The use of next generation sequencing in our molecular testing allows us to detect multiple mutations and our proprietary techniques allow us to achieve high sensitivity in our next generation sequencing testing.  In addition, we use high sensitivity Sanger sequencing, RNA and DNA quantification, SNP/Cytogenetic arrays, Fragment Length analysis, and other molecular testing technologies.  Our automated FISH and Cytogenetics tools allow us to deliver the highest quality testing to our clients and our flow cytometry laboratory uses 10-color flow cytometry analysis technology on a technical-only basis.  NeoGenomics is continually testing new laboratory equipment in order to remain at the forefront of new developments in the testing field.

Laboratory Information System

We believe we have a state-of-the-art LIS that interconnects our locations and provides flexible reporting solutions to clients.  This system allows us to standardize testing and deliver uniform test results and images throughout our network, regardless of the location that any specific portion of a test is performed within our network.  This allows us to move specimens and image analysis work between locations to better balance our workload.  Our LIS also allows us to offer highly specialized and customizable reporting solutions to our tech-only clients.  For instance, our tech-only FISH and flow cytometry applications allow our community-based pathologist clients to tailor individual reports to their specifications and incorporate only the images they select and then issue and sign-out such reports using our system.  Our customized reporting solution also allows our clients to incorporate test results performed on ancillary tests not performed at NeoGenomics into summary report templates.  This FlexREPORT feature has been well-received by clients.

National Direct Sales Force

Our direct sales force has been trained extensively in cancer genetic testing and consultative selling skills to service the needs of clients.  Our sales team for the clinical cancer testing services is organized into five regions (Northeast, Southeast, North Central, South Central and West), and we have a separate sales team for our Pharma Services division.  These sales representatives utilize our custom Customer Relationship Management System (“CRM”) to manage their territories, and we have integrated all of the important customer care functionality within our LIS into the CRM so that our sales representatives can stay informed of emerging issues and opportunities within their regions.  Our in-house customer care team is aligned with our field sales team to serve the needs of our clients by utilizing the same LIS and CRM.  Our field teams can see in real-time when a client calls the laboratory, the reason for the call, the resolution, and if face-to-face interaction is needed for follow-up.

Geographic Locations

Many high complexity laboratories within the cancer testing niche have frequently operated a core facility on either the West Coast or the East Coast of the United States to service the needs of their customers around the country. We believe our clients and prospects desire to do business with a laboratory with national breadth and a local presence. We have six facilities including three large laboratory locations in Fort Myers, Florida, Aliso Viejo, California and Houston Texas.  We also have three smaller laboratory locations in Fresno, California, Nashville, Tennessee and Tampa, Florida. Our objective is to “operate one lab with multiple locations” in order to deliver standardized, high quality, test results. We have completed renovations in our Aliso Viejo facility and have successfully transitioned all Irvine employees and tests into the much larger Aliso Viejo laboratory during late March 2017.  We are also working to expand our Houston, Texas facility in order to increase capacity and plan to complete this expansion by the end of the first quarter of 2018.  In addition, our new lab in Geneva, Switzerland is fully operational with a grand opening planned for early November of 2017.  We intend to continue to develop and open new laboratories and/or expand our current facilities as market situations dictate and business opportunities arise.

Scientific Pipeline

In the past few years our field has experienced a rapid increase in tests that are tied to specific genomic pathways. These predictive tests are typically individualized for a small sub-set of patients with a specific subtype of cancer. The therapeutic target in the genomic pathway is typically a small molecule found at the level of the cell surface, within the cytoplasm and/or within the nucleus. These genomic pathways, known as the “Hallmarks of Cancer”, contain a target-rich environment for small-molecule anti-therapies. These anti-therapies target specific mutations in the major cancer pathways such as the Proliferation Pathway, the Apoptotic Pathway, the Angiogenic Pathway, the Metastasis Pathway, and the Signaling Pathways and Anti-Signaling Pathways.

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Seasonality

The majority of our testing volume is dependent on patients being treated by hematology/oncology professionals and other healthcare providers. The volume of our testing services generally declines modestly during the summer vacation season, year-end holiday periods and other major holidays, particularly when those holidays fall during the middle of the week. In addition, the volume of our testing tends to decline due to extreme adverse weather conditions, such as excessively hot or cold spells, heavy snow, hurricanes or tornados in certain regions, consequently reducing revenues and cash flows in any affected period. During the third quarter of 2017, Hurricane Harvey forced the closure of our Houston laboratory for three days and Hurricane Irma forced the closure of our Fort Myers facility for five days.  Therefore, comparison of the results of successive periods may not accurately reflect trends for future periods.

 

Please see the section captioned Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2016; as filed with the SEC on March 14, 2017 for a detailed description of our business.

Results of Operations for the Three and Nine Months Ended September 30, 2017 as Compared to the Three and Nine Months Ended September 30, 2016

The following table presents the consolidated statements of operations as a percentage of revenue:

 

The following table presents consolidated net revenue by type for the periods indicated ($ in thousands):

 

Revenue

Clinical testing revenue increased for both the three and nine month periods ending September 30, 2017 as compared to the same periods in 2016.  Testing volumes also increased in our clinical genetic testing business by approximately 16.6% and 16.0% for the three and nine month periods ended September 30, 2017, respectively.  The increases in revenue and volume were due to strong growth in molecular and histology testing as well as growth in immuno-histochemistry tests due to demand for the PD-L1 test as a result of the FDA approving Pembrolizumab (Keytruda) in October 2016 as first-line treatment for PD-L1 positive non-small cell lung cancer.  We have also seen accelerating growth in flow cytometry and FISH.  While revenues and volumes increased quarter over quarter and year over year, we believe the impact of hurricanes Harvey and Irma depressed our revenues by approximately $1.0 million and volumes by approximately 1.5% during the third quarter of 2017.  Our sales team has largely finished integration related

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activities, which was a distraction from their efforts to sell new business.  We believe the team can now be re-focused on growth and selling the benefits of the combined company.    

 

Pharma Services revenue increased approximately 37% and 7% for the three and nine month periods ended September 30, 2017 as compared to the same periods in 2016.  In addition, our backlog of signed contracts has continued to grow from $46.5 million as of June 30, 2017 to $58.0 million as of September 30, 2017.  We expect this backlog to result in higher revenues in future quarters.  We also expect to see growth in our Pharma Services division due to our international expansion into Geneva, Switzerland.  This facility will be operational in the fourth quarter of 2017 and already has a backlog of approximately $1.5 million.  

 

Revenue was also impacted due to an error that we identified during an internal analysis in the third quarter of 2017.  The error impacted revenue reported in our Form 10-K for the year ended December 31, 2016, Form 10-Q for the quarter ended March 31, 2017 and Form 10-Q for the quarter ended June 30, 2017.  Specifically, we determined that certain unbillable tests were inadvertently included in the revenue accrual recorded for these periods.  The Company assessed the extent of this error and it was corrected in the third quarter of 2017, resulting in an understatement of revenue of $2.4 million and $0.6 million for the three and nine months ended September 30, 2017, respectively.  See Item 4. Controls and Procedures for additional details regarding this error.

 

The following table shows clinical genetic testing revenue, cost of revenue, requisitions received and tests performed for the three and nine months ended September 30, 2017 and 2016.  This data excludes tests performed for Pharma customers and tests performed by Path Logic, which was sold on August 1, 2017.  Testing revenue and cost of revenue are presented in thousands below:

 

We continue to realize growth in our clinical testing revenue which we believe is the direct result of our efforts to innovate by developing and maintaining one of the most comprehensive cancer testing menus in the industry.  Our broad test menu enables our sales teams to identify opportunities for increasing revenues from existing clients and allows us to gain market share from competitors. New immuno-histochemistry tests such as Micro Satellite Instability, DNA Mismatch Repair, PD1 and PD-L1 have continued to show solid growth and have increased our volume and revenue growth in the third quarter.  We believe the field of immuno-therapy will continue to show substantial growth in coming years and our ability to offer multi-modality testing in one lab will allow us to capitalize on this increased demand.  

 

Average revenue per test decreased for both the three and nine month periods ended September 30, 2017 as compared to the corresponding periods in the previous year.  These decreases are primarily due to the change in test mix, specifically the increase in PD-L1 testing which has a lower average unit price (“AUP”) than our overall Company AUP.  The 19% Medicare cut in Flow Cytometry reimbursement as a result of the 2017 Medicare Physician Fee Schedule also contributed to the lower revenue per test.

 

These decreases to our average revenue per test were offset by our higher volumes and reductions in cost per test.  The cost per test reductions were partially a result of the change in test mix, specifically the higher mix of lower cost histology tests.  In addition, we continue to have success in reducing costs in the laboratory as synergies are being realized from the consolidation of our Irvine and Aliso Viejo, California laboratories.  We have also seen a reduction in send-out costs, as our extensive menu makes it rare for us to need to send a test to another laboratory.  

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NEOGENOMICS, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Cost of Revenue and Gross Profit

Cost of revenue includes payroll and payroll related costs for performing tests, maintenance and depreciation of laboratory equipment, rent for laboratory facilities, laboratory reagents, probes and supplies, and delivery and courier costs relating to the transportation of specimens to be tested.

The consolidated cost of revenue and gross profit metrics are as follows ($ in thousands):

Consolidated cost of revenue in dollars increased for the three and nine months ended September 30, 2017 when compared to the same periods in 2016 while cost of revenue as a percentage of revenue decreased slightly year-over-year.  These increases in cost of revenue are largely due to the increase in our testing volumes and additional costs incurred with the consolidation of our two largest testing facilities in southern California, specifically increased overtime and associated costs.  

Gross profit margin increased slightly for both the three and nine months ended September 30, 2017, as compared to the same period last year.  These increases were achieved despite the reduction in our revenue per test over these time periods.  We were able to increase gross profit margin due to our laboratories processing the increased test volumes more efficiently.  We had only limited staffing increases in the laboratory to handle the increased volumes, and our laboratory teams have been extremely focused on reducing their cost per test across all departments. As a result of the correction of the aforementioned error in the third quarter of 2017, gross profit was understated by $2.4 million and $0.6 million for the three and nine months ended September 30, 2017, respectively.

General and Administrative Expenses

General and administrative expenses consist of employee-related costs (salaries, fringe benefits, and stock based compensation expense) for our billing, finance, human resources, information technology and other administrative personnel. We also allocate professional services, facilities expense, IT infrastructure costs, bad debt expense, depreciation, amortization and other administrative-related costs to general and administrative expenses.

Consolidated general and administrative expenses for the periods presented are as follows:

 

 

The increase in our general and administrative expenses for the three and nine months ended September 30, 2017 compared to the same periods in 2016 was largely due to increased expenses in the following areas:  bad debt, professional fees and personnel fees (including stock based compensation).    

Bad debt expense for the three months ended September 30, 2017 increased by approximately $2.3 million when compared to the same period in 2016.  Bad debt as a percentage of revenue was 7.9%, which was higher than last year’s rate of 4.5%.  Bad debt expense for the nine months ended September 30, 2017 increased by approximately $4.8 million when compared to the same period in 2016.  Bad debt as a percentage of revenue was 6.8%, which was higher than last year’s rate of 4.5%.  The increases in bad debt for both periods are primarily related to changes in payer dynamics including pre authorization denials as well as increased denials for next generation sequencing tests and disease specific multi-gene panels.  In addition, there was an impact from the integration of Clarient into our billing system, which began in July of 2016. Clarient had higher bad debt rates than did NeoGenomics’ legacy business.   Billings of the legacy Clarient billing system have now been either fully collected or written off.  The performance of our billing team was also impacted by the integration which ultimately contributed to certain receivables not being collected and increased bad debt expense.

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Professional fees increased by approximately $616,000 for the three months ended September 30, 2017 and $1.4 million for the nine months ended September 30, 2017 when compared to the same periods in 2016, primarily due to fees in 2017 related to the Pharma Services facility in Geneva, Switzerland opening in November of 2017 and an increase in legal reserves for the three months ended September 30, 2017 related to a lawsuit brought against Clarient.

Payroll expenses increased for the three and nine months ended September 30, 2017 when compared to the same periods in 2016.  This increase is partially due to additional staff hired for certain functions such as billing, IT and accounts payable that were performed by outside vendors or by General Electric in early 2016 under the Clarient “Transition Services Agreement”.  We have also seen an increase in stock based compensation which has increased from $3.5 million for the nine months ended September 30, 2016, to $5.0 million for the nine months ended September 30, 2017.  This increase is due to the increase in NeoGenomics stock price as well as increase in stock option grants and restricted stock awards.

We expect our general and administrative expenses to increase as we add personnel and equity-related compensation expenses, increase our billing and collections activities; incur additional expenses associated with the expansion of our facilities and backup systems; incur additional bad debt expense as sales increase and as we continue to expand our physical infrastructure to support our anticipated growth.  A significant portion of our stock based compensation is for non-employee options which are subject to variable accounting, and our expenses will fluctuate based on the performance of our common stock.  A rise in the price of our stock will increase our stock compensation expense, and a decline in our stock price will reduce this expense.  However, we anticipate that general and administrative expenses as a percentage of consolidated revenue will drop over the coming years as we continue to grow.  

Research and Development Expenses

Research and development expenses relate to cost of developing new proprietary and non-proprietary genetic tests, including payroll and payroll related costs, maintenance and depreciation of laboratory equipment, laboratory supplies (reagents), and outside consultants and experts assisting our research and development team.    

Consolidated research and development expenses for the periods presented are as follows:

 

 

Research and development expense increased for the three months ended September 30, 2017 as compared to the same period in 2016.  This increase is attributable to non-employee stock options which are subject to variable accounting and the increase in our stock price during the third quarter of 2017.  Excluding stock based compensation expense of approximately $531,000 and $187,000 for the three months ended September 30, 2017 and 2016, research and development expense was approximately $739,000 and $780,000.  This decrease is largely due to a decrease in amortization expense for the Health Discovery Corporation license agreements which were being amortized as intangible assets, but were fully impaired in the fourth quarter of 2016.

 

Research and development expense decreased for the nine months ended September 30, 2017 as compared to the same period in 2016.  This decrease is partially attributable to the reduction in the balance of unvested options outstanding in 2017 as compared to 2016 in addition to the decrease in amortization expense for the Health Discovery Corporation license agreements.  Excluding stock based compensation expense of approximately $858,000 and $550,000 for the nine months ended September 30, 2017 and 2016, research and development expense was approximately $2.2 million and $3.2 million.  The increase in stock based compensation recorded in G&A expense is attributable to non-employee stock options which are subject to variable accounting and the increase in our stock price during the third quarter of 2017.

 

We expect our research and development expenses to fluctuate in future quarters because of increases or decreases in our stock price and the corresponding stock based compensation expense for non-employee stock options. Increases in our stock price result in additional expense and decreases in our stock price can result in recovery of previously recorded expense.  We anticipate research and development expenditures will increase over time as we continue to invest in innovation projects and bringing new tests to market.

Sales and Marketing Expenses

Sales and marketing expenses are primarily attributable to employee-related costs including sales management, sales representatives, sales and marketing consultants and marketing and customer service personnel.

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Consolidated sales and marketing expenses for the periods presented are as follows:

 

 

Sales and marketing expenses increased for both the three and nine months ended September 30, 2017 as compared to the same period in 2016.  This increase is primarily attributable to higher commissions due to our increase in revenues. We expect higher commissions expense in the coming quarters as the sales representatives’ focus on generating new business and increasing revenue.  In addition, we have increased our investment in marketing related activities in 2017 including trade shows and on-line marketing.  We expect our sales and marketing expenses over the long term to increase as our test volumes increase, but to remain stable as a percentage of our overall sales.  

Interest Expense, net

Interest expense, net is comprised of interest incurred on our term debt, revolving credit facility and our capital lease obligations offset by the interest income we earn on cash deposits.  Interest expense, net decreased in both the three and nine month periods ending September 30, 2017 compared to the same periods in 2016. The decreases in interest expense, net of $70,000 for the three month period and $336,000 for the nine month period reflect the significantly lower borrowing rate in the Loan Agreement entered into in December of 2016.  Due to these lower interest rates, while total borrowings have been higher in 2017 compared to 2016, interest expense has been lower.  In addition, we have entered into a swap agreement to hedge a significant portion of the interest on our term loan, however part of that loan is not hedged and will continue to fluctuate as the LIBOR rates change.  

Net Income

The following table provides consolidated net loss available to common stockholders for each period along with the computation of basic and diluted net loss per share for the three and nine months ended September 30, 2017:

 

 

Non-GAAP Measures

 

Use of non-GAAP Financial Measures

 

The Company’s financial results are provided in accordance with accounting principles generally accepted in the United States of America (GAAP) and using certain non-GAAP financial measures.  Management believes that presentation of operating results using non-GAAP financial measures provides useful supplemental information to investors and facilitates the analysis of the Company’s operating results and comparison of operating results across reporting periods and between entities. Management also uses non-GAAP financial measures for financial and operational decision making, planning and forecasting purposes and to manage the Company’s business. Management believes that Adjusted EBITDA is a key metric for our business because it is used by our lenders in the calculation of our debt covenants.  Management also believes that these non-GAAP financial measures enable investors to evaluate our operating results and future prospects in the same manner as management.  The non-GAAP financial measures do not replace the presentation of GAAP financial results and should only be used as a supplement to, and not as a substitute for, the Company’s financial results presented in accordance with GAAP.  There are limitations inherent in non-GAAP financial measures because they exclude charges and credits that are required to be included in a GAAP presentation, and do not therefore present the full measure of the Company’s recorded costs against its net revenue.  In addition, the Company’s definition of the non-GAAP financial measures below may differ from non-GAAP measures used by other companies.  

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NEOGENOMICS, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Definitions of non-GAAP measures

 

Non – GAAP EBITDA

 

We define “EBITDA” as net income from continuing operations before: (i) interest expense, (ii) tax expense, (iii) depreciation and amortization expense.

 

Non – GAAP Adjusted EBITDA

 

We define “Adjusted EBITDA” as net income from continuing operations before: (i) interest expense, (ii) tax expense, (iii) depreciation and amortization expense, (iv) non-cash, stock-based compensation expense, and if applicable in a reporting period (v) acquisition-related transaction expenses and other significant non-recurring or non-operating (income) or expenses.

 

Basis for Non-GAAP Adjustments

 

Our basis for excluding certain expenses from GAAP financial measures, are outlined below:

 

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NEOGENOMICS, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

We believe that EBITDA and Adjusted EBITDA provide more consistent measures of operating performance between entities and across reporting periods by excluding cash and non-cash items of expense that can vary significantly between companies.  In addition, adjusted EBITDA is a metric that is used by our lenders in the calculation of our debt covenants.  Adjusted EBITDA also assists investors in performing analyses that are consistent with financial models developed by independent research analysts.

 

EBITDA and Adjusted EBITDA (as defined by us) are not measurements under GAAP and may differ from non-GAAP measures used by other companies.  We believe there are limitations inherent in non-GAAP financial measures such as EBITDA and Adjusted EBITDA because they exclude a variety of charges and credits that are required to be included in a GAAP presentation, and do not therefore present the full measure of NeoGenomics recorded costs against its net revenue.  Accordingly, we encourage investors to consider both non-GAAP results together with GAAP results in analyzing our financial performance.

 

The following is a reconciliation of GAAP net income (loss) to Non-GAAP EBITDA and Adjusted EBITDA for the three and nine months ended September 30, 2017:

 

As discussed above and in Item 4, revenue recognized from the fourth quarter of 2016 through the second quarter of 2017 was impacted due to an error relating to revenue accrued for unbilled tests. We assessed the extent of this error and it was corrected in the third quarter of 2017, resulting in a reduction of revenue, and thus a corresponding reduction in Adjusted EBITDA of $2.4 million and $0.6 million for the three and nine months ended September 30, 2017, respectively. See Item 4. Controls and Procedures for additional details regarding this error.

 

Trade Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable are reported net of an allowance for doubtful accounts, which is estimated based on the aging of accounts receivable with each payer category and the historical data on bad debts in these aging categories.  In addition, the allowance is adjusted periodically for other relevant factors, including regularly assessing the state of our billing operations in order to identify issues which may impact the collectability of receivables or allowance estimates.  Revisions to the allowance are recorded as an adjustment to bad debt expense within general and administrative expenses.  After appropriate collection efforts have been exhausted, specific receivables deemed to be uncollectible are charged against the allowance in the period they are deemed uncollectible.  Recoveries of receivables previously written-off are recorded as credits to the allowance.

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following tables present the Company’s gross outstanding accounts receivable ($ in thousands) by payer group at September 30, 2017 and December 31, 2016:

AGING OF RECEIVABLES BY PAYER GROUP

September 30, 2017

 

 

AGING OF RECEIVABLES BY PAYER GROUP

December 31, 2016

 

 

The following table represents the balance in allowance for doubtful accounts (in thousands) and that allowance as a percentage of gross accounts receivable at September 30, 2017 and December 31, 2016:  

 

 

The allowance for doubtful accounts as well as the allowance as a percentage of gross accounts receivable has decreased for the period ended September 30, 2017 as compared to the period ended December 31, 2016.  In December of 2016, due to the Clarient acquisition and integrated related activities; NeoGenomics did not perform a year-end write off of uncollectible receivables as had been done in previous years which resulted in a higher balance in accounts receivable and the allowance as of December 2016.  The decreases are also due to changes in the timing of when items are written off and decisions to accelerate certain write-offs in 2017.  In 2017, our mix of client billed accounts receivable has increased substantially which tends to lower our allowance as a percentage of gross receivables since client billed accounts receivable have historically had a lower percentage of bad debt than commercial insurance.  

 

Days Sales Outstanding (“DSO”) has increased from 84 days at December 31, 2016 to 91 days as of September 30, 2017.  The increase in DSO was partially attributable to an increase in client billed accounts receivable during the third quarter of 2017.  Additionally Pharma Services DSO’s were 93 days on December 31, 2016 compared to 104 days on September 30, 2017.  

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NEOGENOMICS, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Liquidity and Capital Resources

To date, we have financed our operations primarily through cash generated thorough operations, public and private sales of equity securities, borrowings against our accounts receivables balances and private debt.

The following table presents a summary of our consolidated cash flows for operating, investing and financing activities for the nine months ended September 30, 2017 and 2016 as well as the period ended cash and cash equivalents and working capital (in thousands).

 

 

(1) Defined as current assets less current liabilities.

Cash Flows from Operating Activities

During the nine months ended September 30, 2017, cash flows from operating activities was $12.3 million, a $9.4 million decrease compared to the same period in 2016.  The decrease was primarily due to an $11.5 million increase in our accounts receivable partially offset by increases in accrued expenses.  Our receivables have increased over this period due to growth as well as our higher DSO.  We have experienced reimbursement delays due to changes in payer dynamics for Medicare and insurance companies, specifically the increase in these payers requiring pre-authorization and the additional time it may take to get the required authorizations.  We have enhanced procedures in our labs to identify requisitions that require pre-authorizations and also educate our clients in order to secure pre-authorizations before the samples arrive in our lab.

Cash Flows from Investing Activities

During the nine months ended September 30, 2017, cash used in investing activities increased by approximately $4.8 million compared to the same period in 2016.  This increase was due to equipment purchases and building improvements, which were necessary to support our continued growth and efficiency.  Specifically, we have remodeled and upgraded our laboratory facilities in Aliso Viejo, California, expanded our Houston, Texas facility, invested in additional laboratory equipment to accommodate our growth and update existing equipment that was acquired with the purchase of Clarient.  Our Geneva laboratory was substantially finished at the end of the third quarter of 2017 and we have made significant investments in this laboratory facility.  We have also invested in a new trade show booth as well as upgrades to our IT security environment and our next generation Laboratory Information System (LIS).  

Cash Flows from Financing Activities

During the nine months ended September 30, 2017, cash flows from financing activities decreased by approximately $8.5 million compared to the same period in 2016, primarily due to a $10.0 million repayment on our 2016 revolving credit facility in the first quarter of 2016.  The decrease also reflects $5.0 million in advances on our revolving credit facility during the first quarter of 2017, partially offset by a $2.5 million repayment on our revolving credit facility during the third quarter of 2017. The 2016 revolving credit facility was originally used to finance the acquisition of Clarient.

Cash flows from financing activities also include cash received for the issuance of our common stock upon exercise of stock options as well as cash received to purchase shares of our common stock through the Employee Stock Purchase Plan.  These sources of cash were offset in 2017 as we made three quarterly repayments of $0.9 million each on our Term Loan as well as payments for various capital lease obligations in both 2016 and 2017.  We will continue to have quarterly term loan repayments of $0.9 million in the fourth quarter of 2017 and throughout 2018.  

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Credit Facility

During December of 2016, we entered into a new senior secured credit facility in order to reduce our exposure to interest rate fluctuations on this floating rate debt obligation, we also entered into an interest rate swap agreement.  For more information on this hedging instrument, see Note E to Consolidated Financial Statements herein.  The interest rate swap agreement effectively converts a portion of our floating rate debt to a fixed obligation, thus reducing the impact of interest rate changes on future interest expense.  We believe this strategy will enhance our ability to manage cash flow within our Company.

Liquidity Outlook

We had approximately $12.2 million in cash and cash equivalents as of September 30, 2017.  In addition, we have a revolving credit facility which provides for up to $75 million in borrowing capacity of which at September 30, 2017, based on our level of adjusted EBITDA, approximately $9.3 million was available.  We believe that the cash on hand, available credit lines and positive cash flows generated from operations will provide adequate resources to meet our operating commitments and interest payments for at least the next 12 months from the issuance of these financial statements.  

Our Series A Preferred Stock has certain restrictions that will result in the Company having to dedicate fifty percent of the net proceeds from any future equity raise, to redeeming shares of the Series A Preferred Stock until such time as all of the shares of Series A Preferred Stock have been redeemed. In addition, our Credit Agreement contains certain provisions beginning with the Annual Compliance Certificate for the fiscal year ended December 31, 2017 (to be filed no later than March 31, 2018), that would require a portion of the excess cash flow (as defined) to be repaid to our lenders.  The debt repayment would be required five business days after the filing of our Annual Compliance Certificate.

Capital Expenditures

We currently forecast capital expenditures in order to execute on our business plan and keep up with the growth in our testing volumes, although the actual amount and timing of such capital expenditures will ultimately be determined by the volume of our business.  We currently anticipate that our capital expenditures for the year ended December 31, 2017 will be in the range of $16.0 million to $18.5 million.  During the nine months ended September 30, 2017, we purchased approximately $10.2 million of capital equipment, software and leasehold improvements and an additional $3.2 million was acquired through capital lease obligations.  We have in the past funded and plan to continue funding these capital expenditures with capital lease financing arrangements, cash, and through bank loan facilities if necessary.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions and select accounting policies that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

While many operational aspects of our business are subject to complex federal, state and local regulations, the accounting for our business is generally straightforward with net revenues primarily recognized upon completion of the testing process. Our revenues are primarily comprised of laboratory tests, and approximately one-half of total operating costs and expenses consist of employee compensation and benefits. Due to the nature of our business, several of our accounting policies involve significant estimates and judgments. These accounting policies have been described in our Annual Report on Form 10-K for the year ended December 31, 2016.

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Related Party Transactions

Consulting Agreements

During each of the three and nine month periods ended September 30, 2017 and 2016, Steven C. Jones was an officer, director and shareholder of the Company.  In connection with his duties as Executive Vice President, Mr. Jones earned approximately $46,000 and $66,000 for the three months ended September 30, 2017 and 2016, respectively.  In addition, as compensation for his services on the Board, Mr. Jones earned approximately $13,000 and $0 for the three months ended September 30, 2017 and 2016, respectively.  During the nine months ended September 30, 2017 and 2016, Mr. Jones earned approximately $164,000 and $197,000, respectively in connection with his duties as Executive Vice President.  Mr. Jones also received approximately $85,000 and $79,000 during the nine months ended September 30, 2017 and 2016, respectively, as payment of his annual bonus compensation for the previous fiscal years.  In addition, as compensation for his services on the Board, Mr. Jones earned $25,000 and $0 for the nine months ended September 30, 2017 and 2016, respectively.

During each of the three and nine month periods ending September 30, 2017 and 2016, Kevin Johnson was a director and shareholder of the Company.  In May of 2017, the Company engaged Mr. Johnson to provide services as a consultant, this engagement ended in June of 2017.  In connection with his role as a consultant, Mr. Johnson earned approximately $0 and $0 for the three months ended September 30, 2017 and 2016, respectively.  In addition, as compensation for his services on the Board, Mr. Johnson earned approximately $14,000 and $15,000, for the three months ended September 30, 2017 and 2016, respectively and approximately $44,000 and $45,000 for the nine months ended September 30, 2017 and 2016, respectively.

On May 25, 2017, the Company granted stock options and restricted stock to each of its board members as part of its annual board compensation process.  Mr. Jones and Mr. Johnson were each granted 10,000 stock options and 8,667 shares of restricted stock for their Board services.  The options were granted at a price of $7.27 per share and had a weighted average fair market value of $2.38 per option.  The options vest ratably over the next three years.  The restricted stock has a weighted average fair value of $7.27 per share and vests ratably on the last day of each calendar quarter up to March 31, 2018.

Off-balance Sheet Arrangements

 

We do not use special purpose entities or other off-balance sheet financing techniques that we believe have, or are reasonably likely to have, a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity or capital resources.

 

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ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Market risk is the potential loss arising from adverse changes in market rates and prices, such as foreign currency exchange rates, interest rates and other relevant market rate or price changes. We are exposed to market risk associated with changes in the LIBOR interest rate and foreign currency exchange rates.  We regularly evaluate our exposure to such changes and may elect to minimize this risk through the use of interest rate swap agreements.  For further details regarding our significant accounting policies relating to derivative instruments and hedging activities, see Note B to our Consolidated Financial Statements included in our Annual Report on Form 10-K.  We do not have any material foreign operations or foreign sales and thus have limited exposure to foreign currency exchange rate risk.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures

We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized, and reported within the time periods specified in the SEC rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal  financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.

As required by SEC Rule 15d-15, our management carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, we concluded that disclosure controls and procedures were not effective at a reasonable assurance level as a result of a control deficiency that has been identified as a material weakness in our internal control over financial reporting.  This material weakness in our internal control over financial reporting and our remediation activities are described below.

 

Material Weakness in Internal Control over Financial Reporting

During an internal analysis conducted in the third quarter of 2017, we identified an error in the revenue reported in our Form 10-K for the year ended December 31, 2016, Form 10-Q for the quarter ended March 31, 2017 and Form 10-Q for the quarter ended June 30, 2017.  Specifically, we determined that certain unbillable tests were inadvertently included in the revenue accrual recorded for the periods beginning in the fourth quarter of 2016 through the second quarter of 2017.  These unbillable tests were worked through our laboratory, however we were unable to produce a final result on the sample.  The tests were reported back to the ordering physician as Quantity Not Sufficient (“QNS”) or Test Not Performed (“TNP”).  Although we incur costs attempting to test these QNS and TNP samples, and often attempt to get a result more than once, we cannot bill payors for any tests in which a full result is not reported.  As a result of the inclusion of these unbillable tests in the monthly revenue accrual, revenue was overstated.  This error was corrected in the third quarter of 2017.

We have a policy of writing off any unbilled tests greater than six months old and many of these tests were written off via this process.  We assessed the extent of the error on each reported period.  As a result of the error, the net impact to revenue reported in the 10-K for the year ended December 31, 2016 has been determined to be immaterial.  The net impact of the error in the first quarter of 2017, resulted in an overstatement of revenue by approximately $1.7 million.  The net impact of the error in the second quarter of 2017, resulted in an overstatement of revenue by approximately $0.2 million.  As a result of the cumulative misstatement through the second quarter of 2017, we recorded a correcting entry in the amount of $1.3 million at the end of the third quarter of 2017. This correction, in addition to approximately $1.1 million in revenues that were reversed earlier in the quarter through the automatic six month write off process, resulted in a reduction of revenue by $2.4 million for the third quarter of 2017.  

The management review control that should have detected this error was determined to be ineffective.  Management has concluded that this deficiency constitutes a material weakness in our internal control over financial reporting. Nonetheless, we have concluded that this material weakness does not require a restatement or change in our consolidated financial statements for any prior annual or interim period. We have taken certain remediation steps to address the material weakness referenced above, and to improve our internal control over financial reporting as described below.

 

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Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the three months ended September 30, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

However, as noted above, we will be implementing changes to our internal control over financial reporting to address the material weakness described above.

 

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PART II — OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

From time to time the Company is engaged in legal proceedings in the ordinary course of business.  We do not believe any current legal proceedings are material to our business. No material proceedings were terminated during the quarter ended September 30, 2017.

 

 

ITEM 1A. RISK FACTORS

There have been no material changes in our risk factors from those set forth in Part I, Item 1A, “Risk Factors” contained in our Annual Report on Form 10-K for the for the year ended December 31, 2017; as filed with the SEC on March 14, 2017.  

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None

 

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable

 

 

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable

 

ITEM 5. OTHER INFORMATION

None

 

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ITEM 6. EXHIBITS

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NEOGENOMICS, INC.

 

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

 

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