Labcorp Holdings Inc (LH) 2015 Q2 法說會逐字稿

Good day, ladies and gentlemen. And welcome to the Laboratory Corporation of America Holding's reporting for second-quarter 2015.

(Operator instructions)

As a reminder, this call is being recorded. I'd now like to turn the conference over to Mr. Paul Surdez, Vice President of Investor Relations. Sir, you may begin.

Good morning, and welcome to LabCorp's second-quarter 2015 conference call. As detailed in today's press release, there will be a replay of this conference call available via telephone and internet. With me are Dave King, Chairman and Chief Executive Officer; Glenn Eisenberg, Executive Vice President and Chief Financial Officer; Jay Boyle, Chief Executive Officer of LabCorp Diagnostics; Joe Herring, Chief Executive Officer of Covance Drug Development; and Deborah Keller, incoming CEO of Covance Drug Development.

In addition to our press release we also filed a Form 8-K this morning that includes additional financial information. Both are available in the Investor Relations section of our website at www.LabCorp.com and include a reconciliation of non-GAAP financial measured during today's call to GAAP.

Finally, we are making forward-looking statements during today's call. These forward-looking statements include, among others, statements about our expected financial results, the implementation of our business strategy and the ongoing benefits from acquisitions. These statements are based upon current expectations and are subject to change based upon various factors that could affect our financial results. Some of these factors are set forth in detail on our 2014 10-K and our subsequent filings with the SEC. We have no obligation to provide any updates to these forward-looking statements, even if our expectations change.

Now, I'll turn the call over to Dave King.

Thank you Paul, and good morning. We had an outstanding quarter in which we delivered impressive top-line growth as well as record revenue, earnings, and cash flow. We began to see the power of the combined businesses, which extend far beyond merely combining central lab capabilities. Our results demonstrate the soundness of our decision to acquire Covance and create the world's leading healthcare diagnostic company, and strengthen our conviction in our ability to create long-term value for patients, customers, and shareholders through integrated lab testing, our global drug development capabilities and technology-enabled solutions.

Overall I am very pleased with our execution and our results in the quarter. Each of our businesses performed well. LabCorp Diagnostics reported another exceptional quarter. We continue to drive strong revenue growth led by increased organic volume. During the quarter we observed solid growth in both esoteric and core testing, and revenue for requisition was positive for the first time in over two years.

LabCorp Diagnostics strong top-line growth converted into attractive profit growth. Adjusted operating income excluding amortization of nearly $350 million, or 22% of net revenue, translated to a 130 basis point year-on-year margin improvement. This increase in profitability was driven by strong volume growth and improved productivity founded on Project LaunchPad. Through LaunchPad we continue to progress with multiple initiatives to re-engineer our Company to deliver the highest quality services in the most efficient manner.

Covance Drug Development reported revenue growth on a constant currency basis of 1.8% over last year's pro forma revenue. Early development had strong growth and margin expansion as the toxicology market continues to improve. Central lab's revenue increased nicely on a sequential basis due to higher kit receipts, as we predicted on our first-quarter call. Central labs also contributed strong new orders in the quarter. Clinical business net orders were lower than expected, which combined with slower than typical revenue conversion resulted in growth below our expectations. We are focused on restoring growth in this important service line and expect to see results from these efforts in future quarters.

Looking ahead we see multiple drivers of future profitable growth. First, the trajectory of our central labs business is encouraging. We had very strong levels of outbound kit shipments throughout the quarter, and our average kit receipts over the last two months have increased. Second, we are encouraged by positive momentum in the early development business fueled by continuing strength in biotech funding levels. Third, we will benefit over time from investing and growing the clinical business. Fourth, we to capture cost synergies from our acquisition.

Now I would like to comment on our progress with the development of new business models that leverage our combined capabilities. The integration of our businesses continues to go well. I am enthusiastic about the coordinated efforts of our sales force and scientific leadership teams. We have dedicated teams focused on driving more than $300 million in incremental annual revenue by 2018 through accelerated clinical trial enrollment, end-to-end capabilities in companion diagnostics and broad use of real-world evidence in support of clinical trials. Our clinical team is featuring the utility of our patient database as a competitive differentiator to enhance patient enrollment. And this initiative has generated a consistently positive response from our clients.

Furthermore, we are deploying our differentiated offerings to win business. Earlier this month we were rewarded a life cycle management Phase III(b) study for uncommon chronically ill patients that present a difficult population to recruit. Using diagnosis codes in our patient database, we obtained unique insights that allowed us to identify eligible patients and their treating physicians, which gave our client confidence in our ability to timely enroll the study. We will next be contacting treating physicians to recruit patients that meet the selection criteria for this important trial.

In addition, our joint analytics team is responding to multiple client requests to use de-identified patient data for commercial purposes, usually in combination with other data sets. Examples include market sizing, comparative effectiveness, deploying a personalized approach to therapy administration, assessing safety signals, and identifying opportunities to improve patient adherence.

Through the interest generated from our combination, we have expanded conversations with existing clients and initiated dialogue with new potential clients. We also continue to speak with drug sponsors that express interest in consolidating R&D outsourcing from multiple vendors across multiple areas of development to a preferred partner to improve efficiency and reduce the costs of bringing a new drug to market. We see a growing awareness that we can deliver unique solutions that will further validate our decision to deploy capital for this highly strategic combination.

Finally, we continue to develop and commercialize technology-enabled solutions that use data to enhance decision-making, provide scalable platforms and applications for our customers and change the way care is delivered. We have long been committed to helping achieve better patient outcomes at lower costs, and we have two services in flight toward that end: Beacon LBS and Enlightened Health.

Beacon LBS is an innovated technology-enabled solution that is modernizing delivery of laboratory services. Beacon LBS connects physicians with evidence-based clinical guidelines during the ordering process, providing physicians with access to rich clinical content within existing workflows. The application promotes use of the appropriate tests with the appropriate patient at the appropriate time to enhance the delivery of optimum care.

Last quarter the Beacon LBS team achieved its goal of full implementation. And this quarter Beacon LBS contributed 1.1% to our organic revenue growth. I congratulate the entire Beacon LBS team on achieving an outcome that was little more than a dream when they began work on this project some five years ago. The Beacon LBS team remains engaged in discussions with existing and prospective clients about expanding Beacon LBS' utilization, and we look forward to providing updates in the future.

Enlightened Health is utilizing the combined Companies' infomatics and analytics tools to develop customer solutions and partnerships, such as data integration and data visualization applications. This business is implementing our data strategy and allows us to capture the value of our database and technological skills.

To close, I am profoundly grateful to our 48,000 employees around the globe for their efforts during this quarter, as well as to their leadership. We have asked a great deal of our people on multiple fronts and they have responded with energy and enthusiasm. Most of all, they have delivered impressive results. And I am proud of each of them, and proud to have the honor of leading this great team. As the world's leading healthcare diagnostics company, we are well positioned to drive profitable growth and create long-term patient, customer, and shareholder value by delivering world-class diagnostics, bringing innovative new drugs to market and using data to change the way care is delivered.

Now, I'll turn the call over to Glenn.

Thank you, Dave. I'm going to start my comments with a review of our consolidated second-quarter results, followed by a discussion of our LabCorp Diagnostics and Covance Drug Development segments, and conclude with an update on our 2015 guidance. Revenue for the quarter was $2.2 billion, an increase of 46% over last year. The acquisition of Covance contributed $621 million during the quarter, driving 41% year-over-year revenue growth, with the other 5% primarily due to strong organic volume across both core and esoteric testing, Beacon LBS, and tuck-in acquisitions, partially offset by currency.

Gross profit for the quarter was $775 million, or 34.9% of revenue, compared to $569 million, or 37.5% last year. The increase in gross profit dollars was due primarily to the acquisition of Covance, as well as organic volume and productivity. The decline in gross margin was due to the mix impact from Covance. Excluding Covance gross margin would have been 38.2%, an increase of 70 basis points over last year.

SG&A for the quarter was $392 million, or 17.7% of revenue, compared to $298 million, or 19.6% last year. Excluding special charges of $9 million related to the acquisition of Covance and project LaunchPad, SG&A in the quarter was $384 million, or 17.3% of revenue, a 200 basis point reduction versus last year's adjusted SG&A. The increase in SG&A was primarily due to Covance and personnel cost, partially offset by project LaunchPad savings. The favorable reduction in SG&A as a percentage of revenue benefited from Covance and the reduction in our bad debt rate. Excluding Covance and special charges, SG&A as a percentage of revenue would have been 19%, an improvement of the 30 basis points over last year.

During the quarter we recorded $23 million of restructuring charges and special items, primarily relating to facility closures, severance, Project LaunchPad and the acquisition of Covance. Amortization expense for the quarter was $47 million, up from $22 million a year ago, due to the impact of acquisitions.

Operating income for the quarter was $321 million, or 14.5% of revenue, compared to $247 million, or 16.3% last year. Excluding amortization, restructuring and special items of $70 million, adjusted operating income was $391 million or 17.6% of revenue, compared to $275 million, or 18.2% last year. The increase in adjusted operating income is primarily due to the Covance acquisition, organic volume growth and productivity, partially offset by currency. Excluding the mix impact from Covance, adjusted operating margin would have been 19.2%, an increase of 100 basis points over last year.

Interest expense for the quarter was $58 million compared to $26 million last year. The increase was due to higher debt balances following the acquisition of Covance. The tax rate for the quarter was 36.2%, lower than last year's 39.1% rate, driven by the mixed impact of Covance. The tax rate for the quarter was higher than our expected rate of 35% as we had a greater percentage of our earnings generated in the US. For the remainder of the year we expect an effective tax rate of approximately 36%.

As a result, net earnings for the quarter were $168 million, or $1.64 per diluted share, compared to $141 million, or $1.64 per diluted share last year. Excluding amortization, restructuring, and other special items, adjusted EPS were $2.09 in the quarter, up 14% from $1.84 last year.

During the quarter operating cash flow was $397 million compared to $207 million last year, with the increase due to the acquisition of Covance as well as improved earnings and working capital. Capital expenditures totaled $69 million compared to $48 million last year, due to Covance. As a result, free cash flow was $328 million compared to $159 million last year.

At quarter end our cash balance was $619 million compared to $446 million at the end of the first quarter. Total debt was approximately $6.8 billion. Our liquidity was approximately $1.6 billion, consisting of cash and available credit. During the quarter, we invested $62 million in acquisitions and paid down $145 million of debt, reducing the Company's leverage to 3.6 times net debt to last 12 months pro forma EBITDA.

Now I'll review our segment performance. For comparative purposes, segment results are presented on a pro forma basis for all periods as if the acquisition of Covance closed on January 1, 2014, and exclude amortization, restructuring, special items and unallocated corporate expenses. Reconciliations of segment results to historically reported results are included in today's press release and the current report filed today on form 8k. In addition, during the quarter, we substantially completed our fair market value adjustments in accordance with purchase price accounting associated with the acquisition of Covance. This resulted in reduced depreciation expense of approximately $5 million in the quarter. We expect to complete our fair market value adjustments related to the acquisition by the end of the year.

Now I'll review the performance of LabCorp Diagnostics. Revenue for the quarter was $1.6 billion, an increase of 5.4% over last year. The increase in revenue was the result of strong organic volume, measured by requisitions, Beacon LBS and tuck-in acquisitions, partially offset by currency. The increase in revenue of 5.4% includes the benefit from Beacon LBS of 1.1% and an unfavorable foreign currency translation of 0.7%. Total volume measured by requisitions increased by 4.7%, of which organic volume was 4.3% and acquisition volume was 0.4%. Revenue per requisition increased by 0.2%.

LabCorp Diagnostics' adjusted operating income for the quarter was $347 million, or 22% of revenue, compared to $309 million, or 20.7% last year. The increase was primarily due to strong volume growth in productivity. Improvement in productivity was driven in part by Project LaunchPad, which delivered approximately $15 million in savings in the quarter. We remain on track to deliver approximately $50 million of LaunchPad savings in 2015.

Now I'll discuss the performance of Covance Drug Development. Revenue for the quarter was $644 million, a decrease of 2.7% from last year. The strengthening US dollar negatively impacted revenue growth by approximately 450 basis points. On a constant currency basis revenue increased 1.8% over last year due to volume growth, partially offset by unfavorable mix. The business experienced broad-based volume growth led by early development. We saw sequential improvement in the central lab business, but demand was lower than expected in our clinical business.

Adjusted operating income was $90 million, or 14% of revenue, compared to $85 million, or 12.8% last year. The increase in profit and margin was primarily due to increased volume, lower depreciation expense, and cost synergies of approximately $10 million, partially offset by currency and mix. We're on track to deliver cost synergies in 2015 of approximately $35 million. Net orders during the quarter were $737 million, representing a net book to bill of 1.15, while backlog at quarter end was $6.6 billion.

Now I'll update our 2015 guidance. We expect revenue growth of 40% to 42%, inclusive of Covance as of February 19, after the impact of approximately 190 basis points of negative currency. We have assumed that foreign exchange rates stay at June 30, 2015 levels for the remainder of the year. We expect LabCorp Diagnostics to grow 3.5% to 5.5% in 2015, after the impact of approximately 70 basis points of negative currency. This is an increase from our prior guidance of 3% to 5% primarily due to better than expected organic growth, as well as the additional revenue from tuck-in acquisitions.

We expect a change in Covance Drug Development net revenue to be in a range of minus 1.5% to plus 0.5% versus full-year 2014 after the impact of approximately 320 basis points of negative currency. This is a decrease from our previous range of 0% to 2%. The lower guidance for Covance reflects lower than expected revenue conversion and orders in the clinical business, partially offset by 120 in basis points improvement in currency.

We expect 2015 adjusted EPS of $7.75 to $8 compared to prior guidance of $7.55 to $7.90. The increase in our guidance reflects strong second quarter performance and outlook for the year, as well as lower depreciation expense of approximately $0.10 per share due to purchase price accounting that was updated during the quarter. We expect operating cash flow in 2015 to be $990 million to $1.015 billion versus our prior guidance of $1.045 to $1.07 billion.

Capital expenditures are expected to be $270 million to $295 million versus prior guidance of $325 million to $350 million. As a result free cash flow remains unchanged from our prior guidance of $695 million to $745 million. Excluding net nonrecurring acquisition items of approximately $120 million, we expect free cash flow of $815 million to $865 million, unchanged from our prior guidance.

Now I'll turn the call back over to Dave before we take questions.

Thank you, Glenn. At this time I would like to comment on our announcement this morning that Joe Herring will retire at the end of this month and that Deborah Keller will succeed Joe as Chief Executive Officer of Covance. First, I would like to thank Joe for his leadership, which helped make Covance the respected drug development organization that it is today, as well as for the critical role he played during the merger and integration. During Joe's tenure as CEO he successfully steered Covance through periods of strong growth and volatility.

He led the expansion of Covance's drug development offerings and the infomatics capabilities. And he remained steadfast in his dedication to the core principles of Covance: people, process, clients and science. I have great personal respect for Joe, and I thank him for his many contributions to Covance. We all wish Joe well in his planned retirement.

I am very pleased that Deb has accepted our offer to succeed Joe. Deb has been with Covance for 27 years, most recently serving as Executive Vice President and Group President of Covance R&D Laboratories, where she led an organization of more than 6000 employees at 18 facilities across the globe, generated nearly two-thirds of Covance's revenue. She is a terrific leader who is well respected by our employees and clients, with a clear commitment to bringing innovative new medicines to patients.

Deb is absolutely the right candidate for this important role, and she distinguished herself during our succession process in which we considered both internal and external candidates. Given the strong working relationship that Deb and I have developed, I am confident that the leadership transition will be seamless.

This concludes our formal remarks, and we are now ready to take your questions.

(Operator Instructions)

Robert Willoughby of Bank of America.

Thank you.

Dave or Glenn, why the change in how you are thinking about the volume numbers? I see you break out the Beacon LBS moves. If I were a Florida United member left to sample prior to Beacon versus now, is there a different revenue model here, why you call this out separately?

Bob, good morning. It's Dave.

The revenue model for Beacon LBS is that there is a payment for all lab services that are delivered in the market to Beacon LBS. Some of that lab services will go through LabCorp; some of it will go through the other network labs. The reason that we broke out the 1.1% contribution is that is the revenue that Beacon LBS received that essentially is passed through to other network participants. Whereas the revenue that Beacon LBS receives that is paid for LabCorp is reported in the diagnostics volume.

So had we included essentially the pass-through revenue in our volume numbers, it would have given you a distorted perspective on either volume or price, wherever we put it. And that is why you see it separate.

I got you. That makes a lot of sense then.

Any color on your deal pipeline? I see you are back to doing tuck-ins. Can you comment on the kinds of things you are looking at in the lab sector and possibly outside the lab sector?

Yes. So in the lab sector, the pipeline is very robust. And we are looking at a wide variety of potential acquisition opportunities, Always thinking, as we've said many times, about broadening the esoteric testing menu; broadening our geographic footprint; and anything else that would be important from a strategic perspective.

On the Covance side, we are looking at a variety of potential acquisitions that could either complement some of the existing businesses; support the continued data innovation efforts; or otherwise round out the capabilities that we have and that we are committed to continuing to invest to grow.

That's great. Thank you.

Michael Cherny of Evercore.

Good morning.

Morning.

So first, Glenn, for you a quick question. Just on clarifying the moving pieces on the guidance. I heard you talk about the performance in the quarter and also the adjustment on the depreciation line. By my math, I believe it looks like your expectations for tax rate, as well as potentially the implied share count, went up. Can you just confirm those two numbers?

Yes. The share count should be the roughly, call it 100 million shares outstanding for the year. So no change there. The tax rate, we did have an estimate out before of around 35%. We moved it up to around 36%, consistent with what we saw in the second quarter. And that was just based upon a mix of geographic earnings, if you will, a little higher tax rate in the US. So those were the only changes there.

And then for the guidance, obviously we've taken it up. We've also narrowed it, given with six months left to go. So that the midpoint, if you will, of our guidance is now around $0.15 higher than what we would have shared in our prior guidance. Due to the performance we had in the quarter, our outlook for the year, as well as the benefit that we get for lower depreciation expense with doing our purchase price accounting.

I appreciate that. I was just trying to get to the true earnings power.

Then I guess, Dave -- and then maybe, Joe or Deb, if you want to opine. You obviously, I think relative to your expectations, you were hoping the clinical business would be performing a little better. You talked about focusing on this as an area to reestablish growth. Can you maybe talk about some of the specific focuses that you are putting in place to ensure that you can get a better close rate on some of those wins and get the order rate at a level that you'd prefer?

Yes, Michael. Thanks for the question.

First, let me say that from an overall order perspective, Central Labs In the first six months of 2015 had all-time record orders. As you think about the two companies coming together, where there is integration and overlap, it's in Central Labs; and the clients are pouring volume in. And kits going out the door and kits coming back in are even starting to pick up during the seasonally-soft summer months, which is how that business generally flows.

Early development, which has been a business that we have been trying to restore growth to, was actually the fastest-growing part of the portfolio. We had margin expansion. And even during the most recent weeks and months, which is seasonally soft, orders are very strong.

Clinical, on the other hand, had orders ramping through the end of last year. But in the first six months of this year, orders were softer. And the backlog conversion has not been as fast as we would have hoped.

One area where we think we can definitely improve is in the small and the mid-size clients. We recognized that early in the year. We have added a dozen sales people. And in fact in the second quarter, proposals in Phase II/III clinical were actually up a little more than 25% sequentially. So the actions we are taking are already making an impact, at least on proposals. And hopefully that flows through as to orders and eventually as revenue.

The other item is that we have been very aggressively carting Dave around the globe and introducing him to our clients, CEOs, heads of R&D. And the person with the longest relationship, whether it's me or Deb or a few other folks, have been introducing Dave. And it has played very, very well. Our clients are not accustomed to seeing someone who has a database with 17 million patients, technology like the Beacon LLBs we've talked about to bring both the drug development investigator site selection, patient identification, as well as new tools on the infomatic side that we have been working on that Dave is totally up-to-speed on.

So I guess my final comment there, Michael, is that the Phase II/III clinical market is very strong. I think you will see as our competitors continue to release results, the success that our clients are having in their pipeline as of late. It's a healthy market that we are serving. And frankly, the combination of Covance and LabCorp bring a tremendous set of tools that will enable us to win. And in the recent industry surveys -- not ours, but ones done by sell-side analysts -- clients repeatedly say they are actually more willing to work with Covance post-merger than before because of some of the things that I mentioned. So we're working it.

Great. Appreciate the color. And, Joe, good luck in retirement.

Thank you.

Lisa Gill of JPMorgan.

Thanks very much and good morning.

Joe, just to follow up on that. Can you maybe just (technical difficulties) someone that hasn't followed the CRO industry for a long time to understand your comment around order softening and slower conversion? Is the market more competitive? Do you expect this to come in over time? How should we think about that?

Yes, Lisa, thank you for your question. I'm going to give you what may be sort of a nuanced answer.

But we have a number of large clients who just happen to have portfolios that are a little bit slower as we go right now. For example, in Central Labs, we have a number of sole-source clients who place every stick of their central lab work with us. And every year for the last seven years, we have had a different largest client. And it's not because we've lost work or gained work or it's more competitive; it's just how the pipeline flows.

And we have a couple of clients who are spending a tremendous amount in launches and a little less in Phase II/III clinical. But they have a strong early clinical pipeline that will bring new volume, hopefully, in the coming quarters and into next year. So it is sort of the vagaries of how pharma pipelines go. And it's just been a little bit softer for us. But again, I think the effort in the small to mid clients, as well as the differentiating tools that we are bringing, position us to do well there. And, again, the market is strong.

Lisa, it's Dave.

Just to add a little color to that. When we talk about slower-than-typical revenue conversion, this has to do with the complexity of studies. The fact that there may be other modalities, such as imaging, included in the study that have to be coordinated and patient visits.

So it's not that the studies aren't starting. It's just that they are taking longer from the placing of the order to the actual beginning of completion of recruitment, beginning of patient visits. And I think that's characteristic across all of the clinical businesses that are comparable that we're seeing in the market.

So based on what we saw in the first and second quarter, Dave or Glenn, can you just talk about the updated guidance around Covance and how conservative you feel that is as we move toward the back half of the year?

Sure, Lisa.

Obviously, while we've taken down the revenue guidance of Covance Drug Development, it's still a growth rate. I think in the midpoint on constant currency, we are still up around 2.7%. As Joe spoke to I believe earlier, we've really seen good growth in early development in the Central Labs; and that remains unchanged.

Where we saw the lower expectation for growth was really in the clinical business. And, again, we talked about it, or Dave just mentioned it -- the slower-than-expected revenue conversion, as well as a little bit softer on the order side.

However, we feel pretty good about the outlook that we have now. In part because that one part of the business that had generated the lower-than-expected revenues, the new orders that we're getting now effectively are going to impact 2016 beyond. So we do expect to end the year or what is embedded in our outlook is growth across all the main business lines of Covance year over year, albeit clearly a little bit lower than what we had originally envisioned.

I guess on the positive side, while we've seen a reduction in the revenue outlook for Covance Drug Development, we've equally seen the increase in the outlook within LabCorp Diagnostic. So that from an enterprise, our top-line revenue outlook continues to be roughly where it was. Actually, it's up slightly because of the tuck-in acquisitions. And as you saw, we have obviously also taken up the leverage as we've moved up the earnings-per-share guidance as well.

That is helpful. Thanks, Glenn.

Jack Meehan of Barclays.

Hello. Thanks and good morning.

I just wanted to start and ask about the genomic and esoteric testing in the quarter and how much of a contributor that was to the better pricing? And then just any areas of growth that you could highlight there.

Jack, this is Jay Boyle. Thank you for the question.

We've seen growth in both the genomic and esoteric business that helped drive our revenue per accession for the quarter that we are really pleased with. We expect that to continue as we move into the back half of the year, and hope that we are going to continue to see that kind of growth.

And did you ask a second question? I'm sorry I missed it.

Yes, just maybe any areas that you could highlight within that or if you thought it was more broad-based across the portfolio there.

Yes. You hit the nail right on the head.

We are very pleased with obviously our volume growth, and it's across both the core and the esoteric businesses. And we expect that that will continue.

And I would be remiss at this point in not mentioning that our team has just done a terrific job. This is the last of several quarters where we have had significant organic volume growth and volume growth across the board. And it is in the esoteric/genomic, and also in the core area, and has helped give us the price that we've experienced this quarter.

Yes I agree. Then just as a last one. On the commentary around M&A, just with tuck-in deals, if there are any different thoughts around the way you think about leverage through year end? And then just whether any of this was being driven by some of the regulatory uncertainty out there. Thanks.

Jack, it's Dave. Good morning.

I'm not sure what's driving the pipeline, so it would be hard to give any kind of reasonable speculation. I will say in terms of our focus and perspective, we continue to be focused on the same basic priorities, as I mentioned, which is the esoteric test menu; the strategic footprint; and other potential strategic opportunities.

In terms of the leverage, we have not changed our perspective, which is we need to delever. We paid down some debt this quarter; but, at the same time, we did a couple of tuck-ins because they were attractive opportunities. And you can expect to see the same from us going forward. As long as we are paying down more debt than we are doing tuck-in acquisitions, we'll continue to delever.

And as Glenn said in his prepared comments, net debt to EBITDA was 3.6 in the quarter. So we have already started delevering from where we were post-close.

(Operator instructions)

Isaac Ro of Goldman Sachs.

Good morning. Thank you.

Dave, wanted to ask another question on Covance, if I may. If we look back 90 days ago when you last offered guidance for the year and updated your views on the business, can you walk us through what your assumptions were then and what changed during the quarter?

Because I take in context your comments around the revenue conversion and the complexity of studies. But based on the latter item, I would assume that a lot of the studies you were working on, you knew that they were going to be flat. So I'm trying to figure out what led to this revised view 90 days later.

Isaac, it's Dave.

Obviously, at the time that we updated the Covance revenue guidance, we felt that we had very good visibility in the second half of the year. And I would say we did have very good visibility in the second half of the year in early development and in Central Labs.

In the clinical business, certain parts of the clinical business, the orders burned relatively quickly. And we came up a little short there from what we thought that we were going to accomplish in the quarter, which has an impact for the balance of the year. And that's the reason why we've adjusted the guidance.

And obviously from my perspective and from the Management Team's perspective, we are unhappy about it. But we have made the commitment, as Joe said, from even earlier in the year to invest in the growth of the clinical business and to take the steps necessary to put it back on track.

Great. And if we think about your guidance for this year at this point in second quarter, is it fair to say that your outlook is perhaps more conservative for the year than it would have been 90 days ago? Thank you.

No, I don't think so at all. I think a $0.15 raise in the low end of which, granted, $0.10 is the depreciation, but the rest is due to beat in our projected forecast for the rest of the year signals that we feel that the rest of the year is going to be strong. Obviously, as we have said on many occasions, the guidance encompasses a wide range of outcomes. But I wouldn't describe it as either more conservative or more aggressive than what we've previously had out.

Yes. Keep in mind, Isaac that the Covance business is a little more volatile and less predictable than the historic LabCorp business. But in the second quarter, we delivered sequential revenue growth of $20 million, call it. And sequential operating margin of nearly $20 million. So better than expected. So we fight on from here.

Got it. Thank you.

Gary Lieberman of Wells Fargo.

Good morning. Thanks for taking the question.

Maybe on the Clinical Lab business. Your organic volume growth was substantially stronger than some of your competitors. Do you think you are taking share, or is something else going on?

Gary, this is Jay.

It's hard to determine whether we are actually taking share or not, but certainly our results speak for themselves. As I mentioned earlier, it's across the board. And, as Dave talked about, a coordinated effort earlier.

It's a credit to our sales leadership and leadership in our divisions, where they are just totally focused on growth. And we have a terrific hospital and managed care team that bring deals on board which pave the way. So we are really pleased about the share that we are capturing.

Gary, it's Dave. Just a quick follow-up on that.

Obviously, we've talked about the fact that we've won a couple of contracts last year. Those have started to annualize and will fully annualize in the next quarter. So again, I think the organic volume growth is very strong. You can reach your own conclusions about taking share. But we are continuing to see strong organic volume growth through the beginning of the annualization of the business wins.

Okay. And then maybe just any updated thoughts on the time of study and what you are thinking at this point?

I think the only thing I can do is refer you to the comments that Marc Hartstein made at the CMS Clinical Lab Meeting with respect to the timing. I emphasize again, as I said I think on the last call, this is a very complex task for CMS. There are a lot of data points.

There's a lot of information that they are trying to gather. They are trying to do it in a responsible way that's fair to the industry and also to the payer. So we continue to be optimistic about the outcome and to take, we hope, a positive and supportive approach to what CMS is trying to do.

But have your thoughts changed on the timing? Is it -- do you still expect it? Or do you think it gets pushed off for a year or so?

I think they've said that the timing of the rule is uncertain. So all we can do is go by what they've said, which is the timing of the rule is uncertain. And it will be up to them to determine what that means with respect to implementation.

Okay, great. Thanks a lot.

Ricky Goldwasser of Morgan Stanley.

Hello. Thank you and good morning. So first question is around lab volume.

Dave, last quarter I think you sounded a little bit more cautious in just volume trends in the second half due to these contracts that are annualizing. Today you really kind of like raised second-half revenue expectations for the diagnostic business.

So when you think about what you said today, what has changed? What is adding to your confidence? And what are the buckets that are driving this better outlook for the second half?

Hey Ricky. This is Glenn. Maybe at least I can start just to kind of level set that.

One, obviously we have been consistently generating good volume. As Dave commented, the annualization of the revenue from the new contracts, really, you'll see in the second half of the year. So we've benefited in the first half.

The other thing that will benefit in the second half, obviously, will be the tuck-in acquisitions that we have been doing, as well as the Beacon LBS that will be on for a full half versus the, call it, partial part of the first half of this year. So consistent, still strong good volume growth. But again, tougher comps year over year when you just take it back to the basic organic diagnostics business.

Okay.

And, Dave, do you have any additional comments on that? Or should I move onto my Covance questions?

No, I think Glenn has summarized it well. I mean, volume has been strong. We have Beacon LBS contributing to revenue which, again, is part of the overall guidance perspective. And so I don't think that a whole lot has changed in the outlook, Ricky.

I think as you get further into the year, you have greater visibility into where you are going to come out. And as we get greater visibility into where we are come out, we adjust the expectations accordingly.

Okay. And then on the Covance side, obviously we are hearing that early stage is doing better. Lilly contract is a big part, I think, of that segment. So can you just help us think through that contract?

If I'm not mistaken, it was a 10-year contract. Can you confirm the term of this contract? When should we be thinking about the end date, and what percent of the revenues and what type of trends are you seeing from that business?

Yes Ricky, it's Joe.

I think you are talking about the Lilly agreement, and that goes through 2019. And the agreement continues to perform well and above expectations. And that's clearly an account that we have had Dave in. And it's in really, really good shape.

I think if you just take a step back, the fact that early development continues to see mid- to higher-single-digit revenue growth margin expansion, capacity filling, as well as our competitors doing well, and biotech funding, it's very constructive to the story. And obviously, Central Labs is the largest division of Covance; and it's the most profitable. And to see record orders, and kits out and kits coming in, sort of building up tailwinds for later in the year and certainly for 2016, is very encouraging.

So Deb, who led the recovery of early development, now has the whole enchilada. And of course, the great business that is Central Lab has been her baby. So she can't wait to get her teeth into clinical, as well as her arms around the whole thing, and bring her years and years of experience to the Company fully to bear.

Joe, given the mix that you are seeing in Central Lab, do you feel comfortable with the potential opportunity to even increase margin on that segment? Because I know that in the past, we thought that we've maybe seen very nice margin expansion where we've tapped it. So given what you are seeing now coming through, are you more bullish on the margin opportunity there?

Well, let me say this. In my 18.5 years with the Company, I have proven one thing for sure; and that is that I cannot forecast Central Lab. Over the longer period of time, it grows roughly 10%. I am very, very confident that we are in the early stages of accelerated growth in Central Labs. Our competitive position has improved, I think. I think we've got a couple of competitors that are struggling.

I think our clients like the incremental benefit of having the esoteric volume from LabCorp within the portfolio. And as you pointed out, Ricky, there's good drop-through on additional Central Lab volume. So I think as we look towards the end of the year and in 2016, Central Lab is very constructive. And I guess I would say Covance is stronger than ever in Central Lab.

Ricky, it's Dave. Just one additional comment there, which Joe touched on.

As we add more genomic and esoteric capabilities to the Covance Central Lab business, and particularly as we see great client interest in next-gen sequencing, eXo capabilities hat the LabCorp or Central Lab business is bringing. That will have a natural positive effect on both pricing, mix, and margin in the Central Lab business.

Finally, Ricky, we did add another sole-source Central Lab client in the second quarter as well which, as they ramp up, will be helpful.

Okay. Thank you.

Amanda Murphy of William Blair.

Hello, good morning. So I had a couple more on Covance, if I may.

Joe and Dave, I think another CRO today had talked about seeing strong RFP flow. I'm wondering, now that you've have made some improvements -- I know it's not been all that long since last second quarter -- but have you seen any change there over the past few weeks? And also, did you talk about cancellation rates at all from last quarter?

Well, I guess proposal volume being up 25% sequentially is a very good factoid. It is a little early in the quarter to talk about what will translate into orders. But we're much more out there and have better coverage.

In terms of cancellation rates in clinical, keep in mind, we report net orders. So they're net of cancellations. And we tend to just color cancellations. They were lower than historical run rate in the first quarter and sort of at the historical run rate in the second quarter.

Okay, got it.

And then I guess just a longer-term question. So you've obviously provided some revenue synergy targets at a high level. And then you've also talked about, to your point, the RFP flow, et cetera.

So just thinking about how, I guess, we should be tracking your progress going forward, is there a certain book-to-bill number that you would consider to be a successful number going forward? And over what time frame should we be looking for that, just in context of all the demand commentary that you have laid out so far?

Amanda, it's Dave.

I don't think it would be reasonable to point to one specific number and say that's a target or that's a goal or that represents success. I think what we'll be able to do over time is point to, as we have, specific instances of winning business. Due to the combination of the companion diagnostics, in particular, which we are very enthusiastic about, and tell you how much that's contributed against the $300 million target. I think those would be better indicators to look for than one single number like a book to bill or a revenue growth rate.

I would though, Amanda, remind you that during the really busy time of the acquisition of Covance, we posted two consecutive record order quarters. The fourth quarter was an all-time record; the first quarter was an all-time record. In the second quarter, we had a couple of large clinical studies that we expected to win that pushed out of the second quarter into the third quarter.

So we had a book to bill of 1.15, which is respectable. It is not the record that we had in Q3 and Q4. But also keep in mind that roughly one-third of our revenue is in the preclinical area, where a book to bill of 1.0 to 1 is sort of what you target. So a 1.15 for us, compared to a predominantly clinical company, would translate into something much more like maybe a 1.25 to 1.0.

So good orders. Not as great as they were the last two quarters, but we are out there fighting.

Got it. Thanks very much.

A.J. Rice of UBS.

Thanks. Hello, everybody.

I guess prior to the merger from the Covance side, I think it was publicly discussed that Sanofi was planning to restructure its partnership with Covance. I haven't heard a lot of discussion about that since the merger.

Can you just update us? Is that restructuring still likely to happen later this year? And how would that impact the back-half guidance or next year's guidance? Is that reflected in there?

Yes. Thanks for the question.

First of all, all of this is in our S-4 filings and it's in all the forecasts that we've talked about. There are two parts. The larger part of the agreement is unaffected in any way, and that is the services agreement. Sanofi volume with Covance is 5 times prior to what we had before we did the agreement.

The asset agreement were for the two specific sites, and our continued expectation is that agreement will not be renewed. But every day is sort of something new. That's roughly about $70 million a year. But again, all of that is fully disclosed. It's in all of our forecasts and all of the expectations.

Okay. And that's presumably in the guidance that the consolidated Company is offering out as well?

Yes.

Yes, it is.

Okay. Then just on the lab side, maybe just Dave or anyone else want to comment. It's been in the news lately, the idea of consumers being able to drive their own tests. There's been changes in Arizona to allow at least some consumer making the decision to ask for tests directly.

I don't know if I have ever heard you express a view on that. Do you have a position on whether you are supportive of that or not? And what do you think the implications would be?

A,J,, it's Dave.

We agree, in the first instance, that consumer engagement is extremely important in their own responsibility for healthcare; and for years we've pushed. When I came to this Company, in most states it was illegal for consumers to get their own lab results without getting permission from their doctor. We pushed for years, and finally HHS responded with a regulation to allow that. So consumer engagement is extremely important.

We do need to think about the consequences of consumer self-ordering, one of which is the patient doesn't understand the test result. Two is the patient decides to start self-treating now that they've got a lab test result. So we've said, and we have been open about, we will have direct-to-consumer business under the LabCorp brand by the end of the year.

We are not going to do it in a way that disintermediates physicians. We are going to do it in a responsible and a compliant way. And we are very sensitive to the importance of physician interpretation of testing, as well as the need to combine individual test results with other signs and symptoms of disease. So I think we have been clear in that position. And again, we continue to support consumer engagement, but in a responsible and compliant and measured way.

Okay. All right. Thanks a lot.

Dave Francis of RBC Capital Markets.

Good morning.

Most of my questions have been answered. Just real quick though. With Joe leaving the Company, Dave, was wondering if as you get deeper into the integration process for the businesses, if there's any other contemplated changes to the leadership team or otherwise on either side of the business? Thanks.

Obviously, we've had some leadership transition at Covance already, all of which was planned as part of the merger synergies. We feel like we've got a strong leadership team in place.

Deb is going to be a terrific leader. I'm sure over time that she will want to make some tweaks to her team, as every CEO does. But there's nothing planned in terms of major leadership or major structural changes.

Thank you.

Whit Mayo of Robert W. Baird.

Thanks.

I think you called out $15 million of synergies with Covance. Was that all realized in the second quarter? Or is that a year-to-date number?

That was realized in the second quarter, our current run rate.

Okay, great.

Did you realize any in the first quarter, or was it fairly immaterial at that point?

This is on the, I guess, on the Covance side. We did around $5 million in the first quarter, call it $10 million in the second. And again, with the target this year of $35 million. So obviously, we're delivering solidly on our expectations.

But the longer term, over the three years, on a cost saving standpoint was going to be, call it $100 million. And again, we are on track for that.

Got it.

My last question. Dave, I think I heard you say in your prepared remarks that Covance is having a number of conversations with various pharma customers about some preferred partner relationship or something along those lines. Can you just elaborate a little bit more on that? Is that something that's actually new?

Well, the conversations about preferred provider relationships are not new. I think what's new is the range of capabilities that we bring to the table.

Now, Covance has always had the unique position in the drug development business of having the combination of early clinical and Central Lab. But I think the LabCorp capabilities, the incremental lab capabilities, the data, the companion diagnostic expertise that complements what Covance has, and obviously the scale and infrastructure for some of the priorities around real-world evidence, these are very, very interesting to our clients.

And Deb and I have, in fact, done several client visits over the past two weeks. And there is a new level of interest about -- first of all, they what I understand the rationale for the merger. Then they want to understand, how can that lead to broader scientific collaboration? How can that lead to broader capabilities collaboration? How can that lead to execution on some of their priorities?

And so we are enthusiastic about the opportunity to grow some of these existing relationships and add some new ones.

Okay. Thanks a lot.

That does conclude our question-and-answer period. I would like to turn the conference back over to Management for any closing remarks.

Thank you very much. We appreciate your time this morning and wish you a good day.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may all disconnect. Have a great rest of your day.