Jul 25, 2017
Executives
Doug VanOort - Chairman and CEO Steve Jones - EVP George Cardoza - SVP and CFO Bill Bonello - Treasurer and Director of Corporate Development Fred Weidig - VP of Finance Jessica King - Director of External Reporting Rob Shovlin - President of Clinical Services Division Jennifer Balliet - VP and Chief Culture Officer Maher Albitar - SVP, Chief Medical Officer, and Director of R&D
Analysts
Amanda Murphy - William Blair Drew Jones - Stephens, Inc. Kevin Ellich - Craig-Hallum Nicholas Jansen - Raymond James Paul Knight - Janney Montgomery Scott Joe Munda - First Analysis Raymond Myers - The Benchmark Company Chris Lewis - ROTH Capital Partners
Operator
Greetings, and welcome to the NeoGenomics' Second Quarter 2017 Financial Results. At this time, all participants are in a listen-only mode.
A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Doug VanOort, Chairman and CEO for NeoGenomics. Thank you, Mr.
VanOort, you may begin.
Doug VanOort
Thank you, and good morning. I'd like to welcome everyone to NeoGenomics' second quarter 2017 conference call.
To begin, I would like to introduce the NeoGenomics team here with us today. Joining me in our Fort Myers headquarters is Steve Jones, our Executive Vice President; George Cardoza, our Senior Vice President and Chief Financial Officer; Bill Bonello, our Treasurer, and Director of Corporate Development; Fred Weidig, our Vice President of Finance; Jessica King, our Director of External Reporting; Rob Shovlin, President of our Clinical Services Division; and Jennifer Balliet, our Vice President and Chief Culture Officer.
Dr. Maher Albitar, our Senior Vice President, Chief Medical Officer, and Director of R&D is joining us from our Aliso Viejo lab in California.
Before we begin our prepared remarks, Steve Jones will read the standard language about forward-looking statements.
Steve Jones
This conference call may contain forward-looking statements, which represent our current expectations and beliefs about our operations, performance, financial condition, and growth opportunities. Any statements made on this call that are not statements of historical fact are forward-looking statements.
These statements, by their nature, involve substantial risks and uncertainties, certain of which are beyond our control. Should one or more of these risks or uncertainties materialize or should the underlying assumptions prove incorrect, actual outcomes and results could differ materially from those indicated in the forward-looking statements.
Any forward-looking statement speaks only as of today, and we undertake no obligation to update any such statements to reflect events or circumstances after today. Before turning it back to Doug, I want to let everyone know that we will be making a copy of our transcript for this morning's call available on the Investor Relations section of our Web site shortly after the call is completed.
We also want to let everyone know that we are going to limit the number of questions to two per person in order to give more people a chance to ask questions within the one hour we have allotted for this call.
Doug VanOort
Good, thank you, Steve. In this morning's conference call I will focus my comments on the company's second quarter performance, and then briefly discuss a few key dynamics related to our expectations for the second half of the year.
We reported very good second quarter financial results this morning. Second quarter revenue was at record $66.1 million, and exceeded the guidance we provided just three months ago.
This was driven by strong 16.2% year-over-year volume growth in our core clinical genetic testing business, and accelerating momentum in our pharma services business. Sequential growth was also strong, with revenue growing by 7% from quarter one.
We're also pleased with the improvement in profitability compared with last quarter. Gross profit increased by $4 million on a revenue increase of $4.4 million.
In fact, gross margin of 47.2% was the highest we have achieved since 2014. Also, adjusted EBITDA, of $9.2 million, was a 30% improvement over last quarter, and represented a 47% contribution on a sequential revenue growth.
The improvement compared with last quarter was driven by dramatic improvements in service, productivity, and cost, with nearly every measure of quality and service improving significantly. At the same time that service improved, we drove efficiencies in our lab.
Cost per test declined by 13.4% compared with last year to a record low, and lab productivity increased by 6.1% to a record high. We are realizing synergies in our laboratories, and we have more opportunities to pursue.
We've also made very good progress in our billing process and function. Cash collections were strong as cash from operations totaled $6.5 million in the quarter, and days sales outstanding were reduced by five days from March 31st.
We're very pleased with our quarter two performance, and are looking forward to more improvement as the year progresses. In this regard and anticipating questions you may have, there are a few dynamics and special areas of interest I would like to comment on.
I'd like to begin by talking about a hallmark of our company's success, and that is our passion to deliver exceptional service to clients. As part of our quality [process] [ph], like many companies, we regularly survey our clients, and ask for their feedback as to their satisfaction with our service and performance.
Just two weeks ago we received results from our semiannual client satisfaction survey, which was initiated by May 23rd. Honestly, we were worried about the feedback after coming through a rapid and challenging integration.
We received a lot of feedback, nearly 1,000 people responded, and we received over 2,000 write-in comments. What surprised us was the score.
Our Net Promoter Score or NPS was a record high 54. You may be aware of the Net Promoter Score; it was developed by Bain & Company, and is a tool for gauging the loyalty of a firm's customer relationships.
It's based on a survey question asking how likely are you to recommend NeoGenomics to a friend or a colleague on a scale of one to 10. The NPS is the percentage of customers who are promoters that give scores of nine or 10 minus the percent who are detractors that give scores of zero to six.
Passive scores of seven or eight are ignored. Fully 63% of responders were promoters that rated NeoGenomics a nine or 10, and only 9% were detractors.
The resulting score of 54 is considered world class by proponents of the NPS system. Now, achieving world-class client satisfaction is important, and we're pleased to once again deliver consistently exceptional service.
It gives our sales team confidence that we will consistently meet or exceed client requirements, and it allows us to grow by taking market share. Our sales team's current pipeline of new accounts is very long, and it's healthy.
As we progress through the sales cycle with these new accounts we expect to increase revenue growth momentum in the second half of the year and beyond. I also want to comment on our pharma services division.
As we've discussed in prior public statements, we have been investing in the pharma services division as an important area of future growth. We've built a strong team which is working well together, and we are building the infrastructure to accelerate growth.
We're starting to see results. After three straight quarters of relatively flat pharma division revenue, second quarter revenue increased by approximately 26% from the first quarter.
We also closed a number of new contracts. Backlog increased once again to its highest level ever at $46.5 million, and is nearly 80% higher than in quarter two of last year.
As is the case with our clinical division, our team is working hard to close a large pipeline of projects, and there is excitement about our growing capabilities. We're also excited to expand our business outside the U.S., and we're making great progress on opening our new facility just outside of Geneva, Switzerland.
We've moved forward on this project at the request of several customers. One of those customers has already approved a $1.5 million project for the lab before the facility is even opened.
I also want to comment briefly on our product line and test mix. One of the important attributes of our company is our test menu, which we believe to be the most comprehensive oncology test menu in the country.
Certainly our ability to offer comprehensive multimodality testing all-in-one lab is relatively unique in our industry. During the quarter we continued to see strong growth in molecular testing and in immunohistochemistry.
In each of these technologies our advanced test menu is unparalleled. These tests in particular are in high demand as a result of the need to profile tumors precisely, and to determine a patient's responsiveness to exciting new immunotherapies.
Testing for PD-L1, an important biomarker for immuno-oncology continued to grow in quarter two, however we are also now beginning to see an increasing demand for other tests related to immuno-oncology, such as microsatellite instability, DNA mismatch repair, and tumor mutation burdens. These tests are being sought after by pharma companies as well as by pathologists and clinicians.
One new testing technology that's growing quickly for us is our proprietary MultiOmyx testing service. This unique technology, for which we have an exclusive license from GE, is particularly useful to formal researchers as they attempt to more fully understand how the immune system may be harnessed to kill cancer.
We're investing to build our MultiOmyx capabilities to meet the increased demand. Many investors ask about trends and dynamics in test mix, and clinical genetic test revenue per test, and we want to comment briefly about that.
We're pleased that after a reduction in revenue per test over the past five straight quarters, revenue per test was nearly unchanged in quarter two compared with quarter one. Looking forward to 2018, we continued to believe that pricing will be relatively stable, the preliminary 2018 physician fee schedule was released by CMS on July 13th, and there are no surprises for us.
In fact, we estimate the impact of these Medicare reimbursement changes which will also impact certain Medicare Advantage plans to be less than 1% of our clinical testing revenue. The clinical lab fees schedule is expected to change in 2018, because of the implementation of the Protecting Access to Medicare Act, which is referred to as PAMA.
Currently, we only built two types of tests using the CPT codes that fall on the clinical lab fees schedule: cytogenetics and molecular testing, which together represent about 28% of our clinical revenue. If PAMA moves forward, rate cuts would be limited to a maximum of 10% for any given test in any given year.
We estimate that a worst case impact would be less than $1 million or approximately 0.4% of clinical test revenue for us in 2018. Investors often inquire about the status of synergies resulting from the Clarient acquisition.
It's sometimes difficult to differentiate between a synergy and a normal cost reduction activity, and also productivity increases. The 13.5% reduction in cost per test we realized in quarter two is partially attributable to a lower cost mix of testing, but primarily to the realization of cost synergies.
After the Irvine lab was vacated at the end of quarter one, we began to realize some of the scale benefits of consolidating testing in one facility. We expect that benefit to increase over time as we more fully settle in and optimize a variety of our processes.
We are also beginning to realize synergies from supply cost reductions. Similarly, we expect to see further reductions in supply costs as we optimize processes and renegotiate agreements with suppliers as contracts end.
We expect other synergies and cost reductions to be realized in our labs as we optimize logistics, move testing to the most cost effective site, automate processes, reduce paper in our labs, increase the use of our online ordering system, and continually improve our processes. In SG&A, we have clearly realized synergies in sales, information technology, and in many administrative areas.
These gains have been somewhat offset by investments we've made to improve our marketing, increase our IT security, build a new IT system for pharma, invest in our Geneva operation, and to build our culture, and retain our great people and teams. Synergies in selling, general and administrative expenses were also offset by much higher bad debt expense in quarter two related primarily to moving all Clarient accounts to the NeoGenomics billing system, and associated changes in our processes.
It's important to note that Clarient's level of DSO prior to the acquisition was 108 days, and now our entire company's DSO is 85 days. Clearly, we are realizing synergies in our billing process, but the result hasn't been realized yet in bad debt expense.
We expect bad debt expense to decline as a percentage of sales as the year progresses, and believe we can drive day sales outstanding down to approximately 80 to 82 days. Investors have also inquired about Path Logic, and clearly, our results continue to be impacted by poor results from Path Logic.
Finally, after exploring a variety of strategic options, we're very close to a resolution. Path Logic generated approximately $1.6 million of revenue, zero gross margin, and lost approximately $600,000 of adjusted EBITDA during the quarter.
We expect to be able to announce a resolution for this in August. In summary, we saw a very solid improvement during the second quarter.
Our lab teams have come together, and services improved, and has returned to the levels we're used to seeing at NeoGenomics. Our NPS score shows that our customers are also seeing the improvement.
Our lab teams are making progress, reducing our cost for test, and our billing team is making progress reducing our DSOs and driving cash collections. With the integration over, our sales teams are now back to being completely focused on growth, and we're starting to see if reflected in accelerating revenue growth.
[Technical difficulty] our progress as an organization in the second quarter and we look forward to continuing that in future quarters. Now, we're going to turn the floor over to Steve Jones, our Executive Vice President and Director of Investor Relations to review second quarter results in more detail and read us through our Q&A session.
Steve?
Steve Jones
Thanks, Doug. Before we open it up for questions, I would like to briefly touch on a few financial highlights from the quarter.
Second quarter consolidated revenue was $66.1 million a 5% increase over the prior year. Clinical generic testing revenue increased by 7.1%, Path Logic revenue decreased 18.8% and pharma service revenue decreased 7.7% versus the prior year.
As Doug noted, we expected to have a resolution for Path Logic shortly. Although pharma services posted a modest decline in revenue yea-over-year, there was a 26% sequential growth from Q1.
As we have discussed previously, pharma services revenue can be a bit lumpy. Average revenue per clinical generic test was $355 a 7.8% reduction from the prior year but a $1 increase relative to the quarter one level.
Sequential growth in PD-L1 testing moderated to 10% in Q2 which lessened some of the pressure on average unit price as a result of mix shifts that we've seen in recent quarters. We continue to believe that is appropriate use estimates of average revenue per test in the range of $345 to $355 for the balance of the year.
Consolidated gross margin was 47.2%, 190 basis point increase from the 45.3% reported in quarter two 2016 and a 310 basis points sequential increase from the 44.1% reported in quarter one. Fully 90% of the sequential $4.4 million increase in revenue from quarter one drop to gross margin in quarter two.
This level of incremental contribution was a result of increasing lab productivity and unlocking costs synergies. In addition the increased revenue in pharma services division improved pharma margins as many of the pharma services costs are fixed and more revenue can have a dramatic impact on margins in this business.
We expect gross margin to continue to increase during the balance of the year. As we unlock additional synergies further grow the pharma services division and resolve Path Logic.
Consolidated selling, general administrative cost increase by 13.1% or $3.5 million from Q2, 2016 primarily as a result of increased personnel, bad debt and non-cash stock based compensation expenses. In addition, we incurred approximately 264,000 of one-time expense related to the facility moved in the second quarter which was removed from adjusted EBIDTA as Well.
We also incurred approximately $300,000 of expense associated with opening the Geneva facility which was not moved from adjusted EBITDA. As we've discussed on last call bad bed expense has been running higher than normal for the past two quarters as a result of normalizing the reserves for pharma occurring clients now there on the NeoGenomics billing system.
We expect bad debt reserves as a percent of revenue to return to historical levels by the end of 2017 but we do expect bad debt in quarter three to be in the 6% of revenue range. Adjusted EBITDA was flat last year second quarter but increased $2.1 million relative to the first quarter.
Our revenue growth in gross margin were higher than expected in quarter two. Adjusted EBITDA margin was a little below our expectations primarily due to continued investments in our pharma services business and higher bad debt expense.
Given these incremental expenses which we expect will carry into the second half of the year at higher than normal levels, we expect full year adjusted EBITDA to be near the lower end of our previously issued guidance range with quarter three adjusted EBITDA at levels that are consistent with quarter two levels. As we continue to unlock more synergies, our Geneva operations begin generating revenue and our bad debt expense becomes more normalized with historical levels.
We expect adjusted EBTIDA margin to improve considerably. Second quarter GAAP net loss available to common shareholders was negative $2.7 million, compared to negative $5.2 million in the second quarter of last year.
And diluted EPS was negative $0.03 per share versus negative $0.07 per share last year. These reductions were largely driven by a reduction of preferred stock charges as a result of redeeming 55% of the Series A preferred stock last December.
As disclosed in the press release and in previous earnings calls, we believe that in order to compare the net income related to the true operations of the company on a more consistent basis across periods, it is appropriate to adjust GAAP net loss available to common shareholders to exclude certain non-cash items, and if applicable one-time costs. We refer to this measure as adjusted net income, and on a per-share basis, adjusted diluted earnings per share.
And we have included a table with how this is calculated in our earnings release. In the second quarter In the second quarter, adjusted net income was $3.9 million, a 5.8% increase from the $3.7 million reported in last year's second quarter, and adjusted diluted EPS was $0.04 per share compared to $0.04 per share in quarter two, 2016.
We finished the second quarter with 1024 full-time equivalent employees, contract doctors, and temps, versus 1012 as on March 31, 2017, and 969 as of December 31, 2016. At this point, I would like to close down our formal remarks and open it up for questions.
Incidentally, if you are listening to this conference call via webcast only and would like to submit a question, please feel free to email us at [email protected] during the Q&A session, and we will address your questions at the end if the subject matter hasn't already been addressed by our call-in listeners. As mentioned in the beginning of this call, we would like to ask each person to limit their questions to two so that we may hear from everyone and still keep within the hour allotted for this call.
Operator, you may now open up the call for questions.
Operator
Thank you. Ladies and gentlemen, at this time we will be conducting a question-and-answer session.
[Operator Instructions] Our first question comes from the line of Amanda Murphy with William Blair. Please proceed with your question.
Amanda Murphy
Hi, thanks. Good morning.
So…
Doug VanOort
Good morning.
Amanda Murphy
So, the PD-L1 commentary was helpful just in terms of thinking about Q1 to Q2 trends. I was curious if you could talk a bit more about sort of your general lab pipeline.
I think you had mentioned in the past larger hospital wins. Do we see that come through in the quarter at all?
Doug VanOort
Well, Amanda, this is Doug. Thanks for the question.
PD-L1 continued to grow a little for us. And we're happy that we're a leader in this kind of testing because we believe that there will be more different types of oncology testing coming to us as a result of that.
In terms of the pipeline, as you know, it takes a little while to go through the sales cycle with hospitals. And we think the progress is very good.
The pipeline is very, very healthy. We're moving through the process very well.
There were a lot of new account closes in the last couple of months after we finished the integration, but we're expecting that that momentum in closing new hospital accounts is going to pick up as we go through the year.
Amanda Murphy
Okay, got it. And then I've got a question just in terms of the guidance.
So obviously you have talked about being kind of the lower end of EBITDA, and I'm sure you established a range, and there's different outcomes there, I'm just trying to understand a bit better what's kind of changed relatively. I mean, I think the points you made make sense in terms of investment, and then obviously the bad debt point, but just trying to get an idea of kind of what changed, I guess, in terms of expectations relative to Q1, if anything, on the EBITDA line?
Doug VanOort
Okay, let me give you a little bit of editorial about that, and I think Steve is going to give you a little bit more detail. As we though about this there were a number of things that we'd like to put in context.
First of all, our labs are doing great. And the improvement in our lab operations was actually better than we expected it to be at this point.
Also doing better than we expected, frankly, is sales momentum. We think the pipeline is very strong, although it does take a little time to go through the cycle, we're happy that prices are stable.
And that's good. What's a bit worse is really two areas, one is bad debt expense, and which is a little unusual because our billing process is terrific.
We have a great billing team, cash collections are strong, but the expense relates to activity last year. And we had higher debt expense in quarter two, and we think that'll come down as the year goes on, but still it's a little higher than we expected.
The other area that's a bit worse, frankly, is G&A spending. Frankly we're spending too much in admin.
And we're spending a little bit more in the last quarter because we're still focused on stabilizing our service. But at this point we've instituted tighter controls, we're toughening up, and our focus is moving from a focus on service to a focus on business process improvement.
And I think that that G&A expense will come down as the year goes on as well. But a combination of all those factors led us to point to the lower end of the guidance range.
Steve Jones
So, Amanda, just to fill in a few gaps for you and for others on the call, the selling, general, and administrative expense has actually increased by about $2.6 million from Q1 to Q2. $600,000 of that was selling expense -- sales and marketing expenses, and that's a reflection of the higher revenue and higher marketing expenses.
We've really ramped up our marketing activities this year. $550,000 of that was stock-based compensation which is in fact a non-cash item and is adjusted out for adjusted EBITDA, and that's a reflection of the higher stock price.
And additionally the Board goes through a annual award period for stock options in April of every year. Bad debt was $460,000 higher than in Q1, and that's purely a reflection of normalizing our reserves.
We're seeing some of the carryover effects of the integration. We want to build our reserves back up to the levels that we have operated at historically.
Travel was up a couple of hundred thousand bucks in the quarter, and that's due to integration-related activities of which were fast and furious. The facility move of $264,000 is a one-time item, that goes away in adjusted EBITDA, and it goes away in quarter three.
And then the Geneva one-time professional fees and other setup fees was about $300,000, and that will moderate considerably as the year goes on. And once we have revenue all of the Geneva expenses will be moved back into cost of goods sold.
So $2.4 million of the $2.6 million is either growth or one-time related. We do believe that by the end of the year the bad debt expense as a percentage of revenue will begin to moderate back down and some of these one-time growth investments will be moderated and out of the equation.
But we are still going to continue to invest in growth where opportunities present themselves.
Amanda Murphy
Got it; super helpful. Thank you.
Operator
Our next question comes from the line of Drew Jones with Stephens. Please proceed with your question.
Drew Jones
Thanks. Good morning guys.
Doug VanOort
Good morning.
Drew Jones
You talked a little bit about Path Logic and a resolution there being reached in August. If you could give any more color there?
And then is the impact going to be felt in time for 4Q? And also maybe could you tell us what's been the Path Logic drag on EBITDA year-to-date?
Doug VanOort
Okay, Drew, let me try to give you some comments and context about that. Path Logic really is an easy answer.
We will have this resolved, and it will be resolved shortly. And then I can promise that.
What we're trying to do is to be responsible about the resolution. Path Logic and the NeoGenomics core business share certain customers.
And we need to go through this process deliberately. We are near an end, and we will be announcing this within the next several weeks.
In terms of the drag and when it will be resolved, this will be resolved for quarter four. In terms of the impact in quarter two, I think we had about a $600,000 adjusted EBITDA loss, and that will go away as the year goes on.
Steve Jones
Similar amounts in quarter one as well.
Drew Jones
Okay, great. And then on pharma services, nice to see the uptick there, are we at a point where the momentum with the backlog build and kind of sales momentum there that we can say that's going to flow through to revenue quarter-to-quarter?
And understanding the lumpiness, but should we see sequential uptick there? And then lastly, just kind of what are the margins there and how should we exit the year for pharma services post Geneva?
Doug VanOort
Yes, the pharma services momentum is very strong. And we were happy with the 36% increase in revenue.
The 80% increase in backlog is certainly gives us a lot of confidence. And the path there is very positive.
But as you know, the timing of revenue recognition in this area is somewhat uncertain. I would expect because of that backlog and because we have tighter visibility on the business in general that we will see an uptick in revenue.
Again, timing is a bit uncertain. I would say the bottom line on this business is strategically we like this business.
It's a good business for a lot of reasons. One is that it leads us to see what's going on in terms of innovation with the pharma companies.
It's an area that we think will grow even faster than our core business, and it's also a bit of a diversification for us. And we like it.
George Cardoza
And, Drew, in terms of pharma gross margin you can actually calculate this by backing out the clinical genetic stuff in the last table in the press release. But the margin increased in that business from 24.2% to 37.7%.
I need to caution everybody that we do not do full allocations on that business, so that wouldn't survive a gap on it, but directionally it gives us a feel for the power of incremental revenue in the gross pharma margins. Fully 90% of the incremental increase in pharma services revenue dropped to the pharma services gross margin.
And just to put things into context for you, last year we did $6.8 million in quarter two, and he had a high 40s gross margin in that area. Now, we've made some hires and some other investments in pharma, but we do expect the pharma services margin contribution to increase considerably as the revenue goes up there.
Drew Jones
Thank you, guys.
Doug VanOort
Thank you, Drew.
Operator
Our next question comes from the line of Kevin Ellich from Craig-Hallum. Please proceed with your question.
Kevin Ellich
Good morning. Thanks for taking the question.
I guess going back to the costs and the bad debt. I guess it looks like on the balance sheet your net allowance for doubtful accounts reserve dropped by about $3 million sequentially.
It's now down to $11.6 million. I guess how did that impact or flow through the income statement or P&L?
George Cardoza
Well, keep in mind that that is really a reflection of how we write things off. So one of the things we have been doing is working with the billing team.
And we did take a lot of write-offs in the second half, so clearly that did -- in the second quarter, excuse me. So clearly that did impact our bad debt expense with what you see roll through.
But the fact is we didn't do as many adjustments in the first quarter, so it's a function of when we write off is when it actually hits the balance sheet. The expense reserve is when we actually don't believe it's collectable.
So that tends to be more upfront. But when things are written off then actually it does hit the balance sheet.
But we have accelerated some of our write-offs. So I don't believe that balance will be as high as it's been historically since we're trying to write things off a little bit faster than we have historically.
Kevin Ellich
And then that's just based on -- that's just based on the [technical difficulty] of the receivables, or how do you determine what to write off?
George Cardoza
A lot of things, it's when items are not collectable. Certainly we have a lengthy review.
Historically our policy has been at 360 days, it's fully reserved. Our reserves do step up from that point.
So again, as things age out the reserve balances and our bad debt expense basically increase over time. Again, but if our team knows something is uncollectible or if a client declares bankruptcy or something certainly we would accelerate that write-off based on known items.
Doug VanOort
So, Kevin, you're correct, we're at about 15.8 [technical difficulty] in Q2. We've historically run sort of 16% to 18%.
And that is exactly why you guys should expect us to see increased bad debt expense in Q3 and Q4 relative to historical norms so that we can build that reserve back up again, so it all kind of ties together.
Kevin Ellich
Understood. And then a quick one for Doug, so in your prepared remarks you talked about MMR, MSI.
What was the contribution in the quarter, and what should we expect from that going forward?
Doug VanOort
Well, we just began to have an uptick, particularly in MSI testing during the quarter. We don't disclose the number of tests at that level of detail, but it's clearly growing.
And we would expect it to grow as we go forward here.
Operator
Our next question comes from the line of Nicholas Jansen from Raymond James. Please proceed with your question.
Nicholas Jansen
Hi guys, congrats on a strong quarter. A couple ones for me, and just in terms of your guys' bigger picture thinking on capital allocation from here.
I thought the interesting thing about the Clarient deal which had added a lot more infrastructure and scale for you guys to perhaps be more aggressive on the M&A front. And now that the integration is almost towards the end of that lifecycle, how do we think about your guys' appetite from a capital perspective as you look at your strong cash flow heading out into '18?
Thanks.
Doug VanOort
Well, you see that we've invested a lot in capital for organic growth. We have a lot of organic growth opportunities.
Geneva is one; we're investing in our Houston lab to grow our capacity there. So right now we're putting a lot of our cash, and particularly in 2017, into investments of an organic growth nature.
In terms of M&A, we're pretty actively looking at possibilities. As you know, we've had our plate full.
And so over the last year-and-a-half we've not as actively looked. There are some opportunities available.
We're starting to talk with people. I think at this point we would be interested in maybe acquiring where there are quick synergies.
And that's really our focus at this point.
Nicholas Jansen
That's helpful. Maybe just from a numbers perspective, I think if I heard you correctly about the third quarter adjusted EBITDA being similar to what you guys just reported to 2Q, and to get to the well end of the range, which is the guidance you talked about for the full-year, would cause for a pretty sizable sequential delta between 3Q and 4Q.
And I'm just trying to better understand maybe some of the specific drivers behind that. I would assume bad debt is a little bit lower.
I assume some of these expenses ramped down. But it would still need to be a pretty healthy incremental contribution margin sequentially.
So any helpful color will be there would be great. Thanks.
George Cardoza
Sure. We would advise you to take the Q2 level and remove the $264,000 of one-time expense, and run it at about that level.
The reason for that is we're going to have - we typically have flattish revenue from Q2 to Q3. There's not a lot of growth there because of seasonality.
And we're continuing to make investments in Geneva, and some of the other things we're going to continue to run bad debt at a higher level. So until we get normalized here we think the most conservative way to do this is just to assume total SG&A is somewhere on the order $29.5 million which would eliminate that one-time moving expense.
Doug VanOort
Just to add a little bit more color on that, what you've seen here is -- and then this is really the historic performance of NeoGenomics, we have pretty good incremental gross profit. And you saw that in quarter two versus quarter one.
And we would expect to maintain pretty high levels of incremental profit going forward. That's driven by a few things, one is we are continuing to reduce our cost per test.
In the lab, I mentioned our labs are doing very well, and we see a continuation of that trend as we pull on the levers of supply cost and performance improvements, and so forth that I've mentioned. I think SG&A, particularly bad debt expense; we should see that coming down over time.
And we think the incrementals that are projected from quarter three to quarter four are very doable.
Nicholas Jansen
Congrats again on a good quarter.
Doug VanOort
Thank you.
Operator
Our next question comes from the line of Paul Knight with Janney Montgomery. Please proceed with your question.
Paul Knight
My first of two is, Steve, on the taxes, where are we with the full year, I mean, the Q or your last filing shows seven-ish or more, but more specifically are you a taxpayer in Q3 and Q4?
Steve Jones
Yes. Let's be clear, and this is actually in our 10-K document, we have over $50 million of NOL.
So the vast majority of what you see on the tax expense line is really going into deferred taxes barring some alternative minimum taxes that we wound up paying, but our cash taxes we do a list in the cash flow statement, but even for future years with $50 million of NOLs, we do not expect to be a cash taxpayer for several years.
Paul Knight
And then lastly, regarding the hope, Doug, there is a question for you, the selling of Clarient IHC and vice versa on molecular test, how is that traction going?
Doug VanOort
Thanks, Paul. I mentioned that those are our two fastest growing areas.
And so, one of the -- part of the thesis behind the acquisition of Clarient was that there are lot of cost synergies, but there were also some cross-selling opportunities for the old Clarient accounts to be able to take advantage of the extensive molecular menu of NeoGenomics and vice versa for the old NeoGenomics accounts to take advantage of the very comprehensive digital pathology and immunohistochemistry of Clarient. That is happening, and you can see that molecular and immunohistochemistry are growing faster than our other tests at the present time.
Now, I think that we've got a lot of room to continue to grow that particularly on a molecular side. And molecular, we have a terrific menu there and a lot of these new tasks for immune-oncology we think are molecular-based.
And as we continue to educate our sales team and educate our client base, we think that we've got room to grow particularly in that area.
Paul Knight
Thank you.
Operator
Our next question comes from the line of Joe Munda with First Analysis. Please proceed with your question.
Joe Munda
Good morning, guys. Thanks for taking the questions.
Can you hear me okay?
Doug VanOort
Yes. Thanks, Joe.
Joe Munda
So my first of two here, Doug, looking back at the Analyst Day a couple weeks -- well, now two months ago, right about, I guess went into detail about the backlog roughly 50% class that is preclinical, the other 50% in Phase 1 or 2 or 3, you talked about roughly 400 active projects, new client engagements, I guess, can you give us a little bit more color, if there has been a change, or is that a good I guess backdrop to work off of -- or think of in terms of where you guys are out with Pharma services? In addition, you talked about roughly 10% of the backlog coming from MultiOmyx, so any color or updates there would be great.
Doug VanOort
Sure, Joe. The backlog in pharma services, we think is a good indicator of the future growth potential.
And that number is -- now we're scrubbing that number increasingly, so in the quarter, the net increase to backlog is really net of what we think our contracts that might not occur. So, we think the $46.5 million of backlog that we reported is a good number.
And the growth there is pretty broad based, but MultiOmyx is growing faster than the other areas. We've got a lot of interest in MultiOmyx Technology.
I think you and others have seen it in action. We demonstrated it during the Analyst Day tour.
And it's getting a lot of good attention. We've got more and more pharma companies are interested in it.
So, the backlog is a good number, and it indicates a lot of good future growth there in pharma.
Joe Munda
Doug, allow me to just add one quick question to that, yes, you mentioned in your prepared remarks a new IT system for pharma, I was wondering if you could give us some details regarding that. And I mean, was that sort of the hindrance, or I guess the reason that held back pharma services, I mean any thoughts there would be great.
Doug VanOort
Sure. Pharma services has slightly different requirements than our clinical division, particularly in IT.
So, the pharma sponsors require a lab system, which has extraordinary bar coding and tracking capabilities, and we have been working on and have launched a system -- recently we launched a new version of it, have invested in it for quite some time, which is compliant with a rule called 21 CFR Part 11, which is a pharma specification for IT systems. And so, this is an important component of our competitiveness in this area.
And we now have a good system, we've launched it just a few months ago, and we will increase the capabilities in that system over time, but this will allow us to grow we think even perhaps more rapidly than we have in the past.
Joe Munda
Okay. And then switching gears on Path Logic, I think we are beating this one to death, but if you could just remind us what you paid for that, that line, and if a sale were to occur or were that to be the resolution, does the guidance as it stands today include any potential write-downs as a result of it or any potential charges resulting from the sale?
Thank you.
Doug VanOort
Okay. Yes, so I will talk a little bit about Path Logic.
I think we paid $6 million for few years ago. A lot of things have changed since we acquired Path Logic.
First is -- probably perhaps most importantly we acquire Clarient. So, in the past when we had just Path Logic we acquire Path Logic to be able to support the Covance clinical trials business.
Covance was acquired by Lab Core, so that affected the Path Logic business. Then we acquired Clarient and we found that we were competing in the same geography as Path Logic was.
Path Logic is more like a client of NeoGenomics. And Path Logic was competing with several clients that Clarient had, and we were gaining in that geographic area.
So, we had a little channel conflict. And the original thesis behind the acquisition wasn't appropriate any longer.
I think in terms of the resolution, I mentioned, we expect a resolution very shortly. We may have a small fixed asset write-off one-time cost, but I think you know that would be relatively…
George Cardoza
We previously wrote off all of the intangible assets related to Path Logic in quarter four.
Operator
Our next question comes from the line of Raymond Myers from Benchmark. Please proceed with your question.
Raymond Myers
Thank you. Just following along out about Path Logic; is Path Logic's resolution included in your reiterated guidance today?
George Cardoza
No. When we set up the guidance we didn't take into consideration the resolution of Path Logic because we weren't in a place where we could talk about that yet.
Obviously it will depend on what month the resolution occurred with $600,000 a quarter of negative adjusted EBITDA with that going away in some point here during quarter three, you know, that will impact certainly quarter four and perhaps some of quarter three.
Raymond Myers
Okay, very good. And the pharma service revenue has been -- it grew nicely this quarter, the backlog of that business has been growing very nicely and continues to, and I believe it outpaces the general slope of revenue growth in that business still.
What can we think about the pharma services revenue trend and how soon will that start to reflect the growth in backlog?
George Cardoza
Well, Ray, we ask this question a lot. So, we have a very healthy backlog for the last three quarters.
Before quarter two we were scratching our heads saying, "Where is the revenue?" It's starting to show up.
It started to show up in quarter two. It will show up in the future.
The timing as I mentioned is uncertain, but you know, fully at $46.5 million of backlog up from $26 million, you know, a year ago at quarter two that is going to result in revenue over the next couple of years. So, it is difficult for anyone in this business to accurately predict when the revenue will fall on a quarter-by-quarter basis, but the trend is clearly up.
Raymond Myers
Okay, thanks. That's my two questions.
George Cardoza
Okay, thank you.
Operator
We have time for one last person to ask a question. Our next question comes from the line of Chris Lewis with ROTH Capital Partners.
Please proceed with your question.
Chris Lewis
Hey, guys. Good morning.
Thanks for adding me in here. I wanted to circle back to the gross margin discussion.
Yes, that number notably topped our expectation despite some of the mix trends. I guess broadly just with the lab consolidation now completed, is this kind of a new reasonable base level to expect going forward?
George Cardoza
Yes, I think so. I think so.
Our gross margins, we looked at a little historical, looked this morning, and back in 2014 before the massive fish cuts we were up around 48%. So, we're acquiring our way back, scale helps, but we've got cost reduction opportunities, we've reduced our cost per test 13% you know in quarter two.
And we think we can continue to reduce our cost per test. And that all result in higher gross margins.
As our cost reductions as you know are outpacing the mix change impact in our revenue per tests, and we certainly think with this more stability in revenue per test going forward as we mentioned that we can make gains in the gross margin by continuing to cost reduces in our last…
Doug VanOort
And keep in mind, Path Logic's gross margin has been operating around 0%. So, after the resolution of Path Logic, that will be additive to us.
Chris Lewis
Right, and I guess just following up on the earlier question around the implied acceleration in EBITDA, in the fourth quarter versus the third, you know the commentary seems to imply another meaningful step up on the gross margin line in the fourth quarter. I guess, any commentary that you can you know provide or potentially quantify where you think gross margins kind of exit the year?
Doug VanOort
We hope Chris that they are going to exit the year higher than where they are for the reasons that we mentioned, but we haven't given specific guidance around that.
Chris Lewis
Okay, thanks.
Operator
That is all the time we have for questions. I'd like to turn the call back over to management for closing comments.
Doug VanOort
Okay, thank you very much. As we end the call here, I'd like to recognize approximately a thousand people at NeoGenomics that are operating around the company for their dedication and commitment to building a world-class cancer genetic testing program.
And so, on behalf of the entire NeoGenomics team, I want to thank you for your time joining us this morning, let you know that our third quarter 2017 earnings call will be held on or around October 25th of 2017. For those of you listening, there are investors or are considering an investment in the NeoGenomics, we thank you for your interest in our company.
Goodbye.
Operator
Ladies and gentlemen that does conclude today's teleconference. Thank you for your participation.
You may disconnect your lines at this time, and have a wonderful day.