NeoGenomics Pours Money Into Next-Generation Sequencing Capabilities

Another quarter, another 50% year-over-year increase in revenue. 

NeoGenomics (NEO 5.51%) kept up its impressive streak of growth in the third quarter of 2019 with another solid operating performance. The cancer-focused genetic testing provider continued to reap rewards from its clinical services division, which was responsible for over 88% of total revenue. But the company also hinted that its pharmaceutical services segment is poised for significant growth of its own. 

The strong quarterly performance allowed management to increase full-year 2019 guidance for three financial metrics. It also gave NeoGenomics confidence to invest heavily in its next-generation sequencing (NGS) capabilities, which will help to provide even more value to customers. Here's what investors need to know about the company's latest operating results.

Image source: Getty Images.

Can NGS keep revenue growth at 50%?

NeoGenomics operates two segments: clinical services and pharma services. The former serves as a reference lab for oncologists, pathologists, and hospitals, processing genetic tests in quality-controlled settings and relaying the results back to the point of care. The latter helps pharmaceutical companies generate and interpret genetic data from pre-clinical research all the way through market launch of a new drug product.

NeoGenomics generates most of its revenue from clinical services. The segment is also responsible for most of the company's growth. Clinical services revenue jumped 56% in the third quarter of 2019 compared to the year-ago period, while pharma services increased 26%. 

That's not quite indicative of the growth potential that resides in partnering with pharmaceutical companies, however, as the segment has grown revenue 41% in the first nine months of 2019 compared to the year-ago period and ended September with a record backlog of $118 million. Rather, it's a reminder that the project-based nature of pharma services will result in choppy revenue generation until the business reaches sufficient scale.

The lull didn't quite hurt NeoGenomics. The company leveraged its expanding scale to grow gross profit, which helped it to generate quarterly operating income of $3.7 million and net income of $2.1 million. That actually wiped out a small net loss from the first half of the year. 

Data source: Press release. YOY = year over year.

Investors may be accustomed to relatively low operating margins for NeoGenomics by now, but, despite healthy revenue growth, that figures to be the reality for the foreseeable future. As executives discussed on the third-quarter 2019 earnings conference call, the company hired nearly 200 full-time employees during the period and announced investments to expand its NGS capabilities. 

While those moves are expected to drive long-term growth, they'll weigh on both companywide operating margin (increased salaries will be more expensive) and per-test margin (NGS tests are higher margin but have higher costs, and it will take time to ramp workflows) in the near term. Investors with a long-term mindset likely can see the value. 

For example, NeoGenomics upgraded its laboratory instruments to allow for more seamless automation and higher processing volumes. It also added new capabilities to its NGS panels, such as incorporating microsatellite instability (MSI) and tumor mutational burden (TMB) into its reporting. Those are metrics that help oncologists, pathologists, and pharmaceutical companies to better understand the data contained within the biological samples they collect. The more comprehensive view of a tumor can lead to more effective treatment plans, lower healthcare costs, and better patient outcomes. 

The upgrades and investments increase the value provided to customers by NeoGenomics and position the company to remain highly competitive as the NGS space expands and evolves. They should also keep growth humming along for the foreseeable future, as evidenced by increased full-year 2019 guidance, which marks the fourth consecutive quarter the company has raised guidance.

Data source: Press release. EBITDA = earnings before interest, taxes, depreciation, and amortization.

If NeoGenomics can convert its large backlog in pharma services into revenue growth, then the business should have no trouble keeping its revenue growth rate near 50%. Significant profit growth may be a little more difficult to come by.

A leading genetic testing stock

NeoGenomics remains virtually the only dedicated oncology reference lab with a comprehensive testing menu. It continues to leverage its national footprint to serve 500,000 patients each year, a number that should grow as the business increases processing volumes. Then again, even without significant test volume growth, there's meaningful value to be unlocked by providing higher-quality data from the same biological samples. NeoGenomics is investing heavily in those capabilities -- and investors cannot overlook the significance.