Labcorp Holdings Inc (LH) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Laboratory Corporation of America second-quarter 2016 Holdings earnings conference call. (Operator Instructions) As reminder, this conference call is being recorded.

I would now like to turn the conference over to Paul Surdez, Vice President of Investor Relations. Please begin.

Good morning. Welcome to LabCorp's second-quarter 2016 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 today are Dave King, Chairman and Chief Operating Officer; Glenn Eisenberg, Executive Vice President and Chief Financial Officer; and Deborah Keller, 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 measures discussed 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 in our 2015 10-K. We have no obligation to provide any updates to these forward-looking statements, even if our expectations change.

Now I will turn the call over to Dave King.

Thank you, Paul, and good morning, everyone. It's an exciting day at LabCorp today as we continue to establish ourselves as the world's leading healthcare diagnostics company.

Operationally, we reported another strong quarter, led by organic growth in LabCorp Diagnostics and Covance Drug Development. We delivered year-over-year revenue growth of 7%, continued margin expansion, and another quarter of double-digit adjusted EPS growth.

Our continued business momentum is attributable to our commitment to improve health and improve lives around the globe, driven by our focus on our three strategic priorities: delivering world-class diagnostic solutions, bringing innovative medicines to patients faster, and using information to change the way care is provided.

I will now update you on our key activities during the quarter and our progress on each of these objectives. First, to be the world's leading provider of diagnostic solutions, we continue to expand our test menu, innovate in science, and complement our internal efforts with strategic acquisitions.

This morning is exciting, as I said, because we announced another important addition. We will acquire Sequenom, a market leader in noninvasive prenatal testing and reproductive health. Sequenom is the first company to offer a clinically validated, noninvasive prenatal test. And the more than 500,000 tests it has performed to date give it the largest clinical evidence base in the industry.

This is a highly strategic acquisition, as Sequenom's best-in-class offerings and strong R&D pipeline perfectly complement LabCorp's extensive women's health test menu. We will now offer patients and physicians one source for the full range of women's health, reproductive genetics, and NIPT testing.

Furthermore, Sequenom expands our geographic reach, both domestically with New York licensure and internationally through licensing and commercial partnerships with emphasis on the European Union and the Asia-Pacific region. The transaction also meets our financial criteria, making it, as I said, an important and highly strategic transaction.

I note that the acquisition of Sequenom is much like our strategic decision to acquire LipoScience and its unique NMR lipoprofile test 18 months ago, which has translated into strong and consistent organic growth. As we expected, our reach and customer relationships, coupled with the test's strong clinical evidence and numerous expert society recommendations, has established us as the leading diagnostic laboratory for comprehensive cardiovascular testing and risk assessment.

We also continue to focus on extending our core testing capabilities beyond the traditional healthcare setting. For example, our Bode Cellmark forensics business is the leader in high-quality forensic DNA testing solutions, helping law enforcement agencies solve crimes across the globe. Bode Cellmark is one of two labs partnering with law enforcement across the US to process a significant backlog of sexual assault evidence kits, aiding in solving open criminal cases.

In addition, we continue to capitalize on our global footprint and our chemistry and microbiology expertise to provide the highest-quality testing and rapid turnaround time to a growing number of food safety customers. We will next build on our track record of scientific innovation into food safety through commercialization of new technologies that enable faster pathogen detection, and expect to drive growth through acquisitions that increase our scale in this growing and fragmented market.

Second, to bring innovative medicines to patients faster, we continue to enhance our data capabilities, develop innovative solutions, and expand our therapeutic expertise in critical areas of drug development. Data are an essential ingredient to improve patient recruitment and study startup. We have access to unique data generated from each of our business segments.

LabCorp Diagnostics provides a growing proprietary database of patient-specific information, including demographics, lab values, and diagnosis codes. Covance Drug Development has a growing base of insights into global investigator and site performance obtained through our central laboratory network and clinical trial experience. We are uniquely able to link this data to individual patients and sites, empowering patients to be more directly engaged with their own healthcare, helping enrich our clinical trial proposals, and speeding patient recruitment.

In addition, our unique solutions offer clients their choice of our end-to-end services offering, fostering deeper customer relationships and expanded opportunities to grow our business. For example, our companion diagnostics franchise continues to lead the industry, as evidenced by important new tests launched during the quarter.

We were the only national laboratory to introduce the Roche cobas EGFR Mutation Test v2 for non-small cell lung cancer patients, the first blood-based liquid biopsy test cleared by FDA for clinical use. We also extended our leadership in immuno-oncology through the commercial launch of a complementary PD-L1 diagnostic test for bladder cancer, our third PD-L1 launch and fourth PD-L1 indication in the past year.

Our world-class companion diagnostic capabilities offer our customers unmatched end-to-end development and commercialization expertise. Tying together all of our drug development growth initiatives, we focus on key therapeutic areas, such as genetics, rare and orphan diseases, oncology, and infectious disease. These strategic focus areas combine the best capabilities of both organizations to improve health and improve lives.

All of our drug development businesses performed well during the quarter. We saw strong revenue growth in clinical, early development, and central labs. Customers have consistently awarded us new orders since the acquisition as they appreciate the benefits of our end-to-end offering and expanded capabilities.

For our third objective, we are changing the way care is delivered through the use of information and technology-enabled solutions. In diagnostics, we are expanding our menu of decision support tools and integrated content to assist payers, physicians, health systems, and patients in better understanding and managing disease. BeaconLBS is now entering its second year, and we expect it to grow as we add new markets and capabilities to the platform.

In drug development, we are enhancing Covance's Xcellerate suite of services to enable faster patient enrollment, more efficient site monitoring, and improved study planning. Xcellerate Monitoring has been successfully implemented as the exclusive central monitoring portfolio for one of our larger partner's worldwide clinical trials portfolio and is being used by over a dozen other clients.

In closing, we continue to invest in assets, people, and capabilities that will drive profitable growth, unlock the value of our growing organization, and further our mission to improve health and improve lives around the globe.

I want to specifically compliment both the Sequenom and the LabCorp acquisition teams for the extraordinary efforts that have led to today's announcement. The teams worked tirelessly to get us to the finish line in this important and highly strategic deal. I continue to be enormously proud of the work of all of my 50,000 colleagues and I thank them for the direct positive impact they have on millions of lives every day.

Now I will turn the call over to Glenn.

Thank you, Dave. I'm going to start my comments with a review of our second-quarter results, followed by a discussion of our LabCorp Diagnostics and Covance Drug Development segments, and conclude with an update on our 2016 guidance.

Revenue for the quarter was $2.4 billion, an increase of 7.4% over last year, primarily due to strong organic growth in both segments and tuck-in acquisitions, partially offset by currency. Organic revenue growth in the quarter on a constant currency basis was 6.4%.

Gross profit for the quarter was $827 million or 34.7% of revenue compared to $773 million or 34.8% last year. The increase in gross profit was due primarily to strong revenue growth, partially offset by personnel costs. The decline in gross margin was due to the mix impact from faster growth in Covance Drug Development, which has a lower gross margin than the Company's average. Excluding the mix impact, gross margin would have improved 10 basis points.

SG&A for the quarter was $408 million or 17.1% of revenue compared to $391 million or 17.6% last year. Special charges in the quarter were $8 million, primarily related to the integration of Covance and our LaunchPad initiative compared to $9 million a year ago. Excluding special charges, SG&A in the quarter was $400 million or 16.8% of revenue compared to $382 million or 17.2%.

The increase in adjusted SG&A was primarily due to acquisitions and personnel costs. The improvement in the SG&A rate was due to continued expense control and the mix impact from faster growth in Covance Drug Development, which has a lower SG&A rate than the Company's average. Excluding the mix impact, the SG&A rate would have improved 20 basis points.

During the quarter, we recorded $7 million of restructuring charges, primarily relating to severance and the closure of redundant facilities. Amortization expense for the quarter was $45 million, consistent with last year.

Operating income for the quarter was $367 million or 15.4% of revenue compared to $323 million or 14.6% last year. Excluding amortization, restructuring, and special items of $60 million, adjusted operating income was $427 million or 17.9% of revenue compared to $391 million or 17.6% last year. The increase in adjusted operating income and margin was primarily due to strong revenue growth, partially offset by personnel costs.

Interest expense for the quarter was $54 million compared to $58 million in the second quarter of 2015. The decrease was due to lower debt balances, which included repayment of $339 million of debt during the quarter.

The tax rate for the quarter was 36.6% compared to 36.1% last year. Excluding special charges and amortization, the adjusted tax rate for the quarter was 35.7%, the same as last year. We continue to expect our 2016 full-year adjusted tax rate to be 35.3%.

Net earnings for the quarter were $198 million or $1.91 per diluted share. Excluding amortization, restructuring, and other special items, adjusted EPS were $2.31 in the quarter, up 11% from $2.09 last year.

During the quarter, operating cash flow was $344 million compared to $397 million last year. The decline was primarily due to the timing of income taxes paid last year. Capital expenditures totaled $67 million or 2.8% of revenue, down from $69 million or 3.1% last year. As a result, free cash flow was $277 million in the quarter compared to $328 million last year. We continue to expect free cash flow to be between $900 million and $950 million for the full year.

At quarter end, our cash balance was $640 million, down from $696 million at the end of the first quarter. Total debt was approximately $6.1 billion. During the quarter, we invested $51 million in acquisitions and paid down $339 million of debt, reducing the Company's leverage to 3.3 times gross debt to last 12-months pro forma EBITDA.

Now I will review our segment performance. Segment results 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 8-K.

Now I will review the performance of LabCorp Diagnostics. Revenue for the quarter was $1.7 billion, an increase of 5.4% over last year. The increase in revenue was the result of organic volume growth measured by requisitions, price mix, and tuck-in acquisitions, partially offset by currency.

The revenue increase includes unfavorable currency translation of 0.3%. Revenue per requisition increased 3.5%, benefiting from price mix and tuck-in acquisitions. In addition, esoteric testing grew at a faster rate than core testing. Total volume increased by 2.1%, of which organic volume was 1.2% and acquisition volume was 0.9%.

LabCorp Diagnostics' adjusted operating income for the quarter was $357 million or 21.5% of revenue compared to $337 million or 21.4% last year. The increase in operating income and margin was primarily due to price mix, organic volume, tuck-in acquisitions, and our LaunchPad initiative, which was partially offset by personnel costs. We remain on track to achieve our LaunchPad savings of $150 million over the three-year period ending in 2017.

Now I will review the performance of Covance Drug Development. Revenue for the quarter was $722 million, an increase of 12.2% over last year. Excluding the impact from approximately 70 basis points of negative currency and the expiration of the Sanofi site support agreement, revenue increased 16.4% over last year. The strong revenue growth was broad-based across our early development, clinical, and central lab businesses.

Adjusted operating income was $108 million or 14.9% of revenue compared to $90 million or 14% last year. The increase in operating income and margin was primarily due to strong revenue growth and cost synergies, which was partially offset by the expiration of the Sanofi site support agreement and personnel costs. We remain on track to deliver cost synergies of $100 million for the three-year period ending 2017.

Net orders during the quarter were $818 million, up 11% over last year, representing a net book-to-bill for the quarter of 1.13 and a trailing 12-month debt book-to-bill of 1.17. Backlog at the end of the quarter was $7.1 billion.

Now I will update our 2016 guidance, which assumes June 30 foreign-exchange rates for the remainder of the year. In addition, our guidance excludes the impact from the acquisition of Sequenom, which we expect to close by year end.

We expect revenue growth of 9.5% to 10.5% after the impact from approximately 50 basis points of negative currency. This is an increase from our prior guidance of 8.5% to 10.5%. We expect the LabCorp Diagnostics segment to grow 4.5% to 5.5% over 2015 after the impact from approximately 10 basis points of negative currency. This is an increase from our prior guidance of 4% to 5.5%.

We expect the Covance Drug Development segment to grow 7% to 9% over 2015 pro forma revenue after the impact from approximately 110 basis points of negative currency. This is an increase from our prior guidance of 6% to 9% due to strong organic growth, partially offset by a 60-basis-point unfavorable change in currency. Excluding the impact from currency and the expiration of the Sanofi site support agreement, we expect net revenue to increase 11% to 13%.

We expect adjusted EPS of $8.60 to $8.95, which implies a growth rate of 9% to 13% over 2015 and is an increase from our prior guidance of $8.55 to $8.95. As a reminder, our adjusted EPS guidance includes an increase in our share count due to stock compensation and option exercises, but does not include any share repurchases. Finally, we continue to expect record free cash flow for the year of $900 million to $950 million.

This concludes our formal remarks and we will now take questions.

(Operator Instructions) Robert Willoughby, Credit Suisse.

Dave and Glenn, it looks like with EPS guidance, what is the gating factor to raising the cash flow guidance? And then maybe on the Sequenom deal, it hasn't really worked as a public equity. Can you review what some of the challenges have been and what you can do to reverse some operating losses there?

Sure. This is Glenn; I'll take the first part, and Dave can do the other. With regard to the cash flows, as we look to the guidance -- and to your point, we did increase the midpoint for the revenue and the earnings guidance that we provided -- we elected to hold the cash flow guidance where it was, again at record levels, given that from a cash standpoint, we generate the majority of our free cash flow in the second half of the year.

So from our perspective, we decided to wait till the third quarter is completed, when there is one quarter left, in which case we would look to modify that cash guidance as well.

So I think the major challenges for Sequenom as a stand-alone entity have related to breadth of test menu and scale. I think under Dirk van den Boom's leadership in the last nine months, Sequenom has made significant improvements in technology and operations.

But the reality is there still is a need for the comprehensive women's health portfolio. There still is a need for broader reach into the OB/GYN office. There's a need for reach in terms of convenience of being able to order NIPT testing on one requisition form with the same orders as other women's health-related testing.

So I think from an operational perspective, we think about several opportunities to make this a success. And we strongly believe it will be a success. Number one is just improving the laboratory operation and the efficiency of that operation, which, as you know, is something that we excel at.

Number two is expanding the reach of their sales force, which we think of very highly, and extending that into the primary care and the OB/GYN market. And number three is the comprehensiveness of the test menu and the opportunity to create one point where physicians can order all of what they need in women's health and reproductive genetics.

Do you expect it to be accretive year one, Dave?

We do expect it to be accretive. It's not going to be materially accretive in year one, but it will be accretive in year one. And we expect longer term that it will be a significant contributor to earnings growth.

Thank you.

Bill Bonello, Craig-Hallum.

I wanted to follow up also with some questions on Sequenom. So the logic of how you can improve their business makes all the sense in the world to me. What I guess I would like to understand is what they bring to you in terms of the advantages of owning this asset versus maintaining a contractual relationship with them and offering the breadth and other tests on your own.

So it's just more complicated to maintain a send-out relationship when you are talking about the high-end reproductive genetic testing. And it's more complicated, obviously, for somebody like Sequenom.

Because they are not offering the full test menu, you are dealing with organizing logistics, you are dealing with routing blood from one place to another, routing samples from one place to another. And you are dealing with delays in turnaround time as a result of the logistics.

So, although a send-out relationship in concept sounds attractive, it actually leads to more complexity. And as we think about how to be successful in the business generally and in this aspect of the business in particular, what the physicians and the patients want is more simplicity.

So they want to be able to quarter on one requisition form, they want to be able to have one courier pick it up, they want to be able to have it go to one place where the logistics are handled by LabCorp instead of being handled by two different entities. They want to get the results back on one report form, and they want to have one place to go for interpretation if genetic counseling, for example, is required.

So from my perspective, what we are doing is we are taking the opportunity to integrate a best-in-class NIPT test into a best-in-class women's health portfolio. And that in my mind leads to enormous opportunity to grow in that market, which is one of the fastest-growing parts of the diagnostics industry in which we think, over the long term, as the technology improves and the test menu improves around not only noninvasive prenatal testing, but all sorts of noninvasive testing that is now done through more invasive methods, that we will be extremely well positioned to succeed.

And just as a follow-up on that, just two things on that. One: is it your opinion -- is part of the reason, the timing of this now, that indeed we are going to see an expansion into the average-risk market from the high-risk market? I assume so, given all your comments about OB/GYNs.

But then more importantly, are there things that you see in their pipeline or tests that you imagine you can develop based on their technology that are part of what's driving this?

Yes. So we are seeing significant progress in payer coverage for noninvasive prenatal testing for average-risk patients. So the opportunity there, obviously, grows the market significantly because it provides at least the potential to reach a couple hundred million covered lives as opposed to what we would characterize as merely the high-risk market.

And you are seeing payer acceptance of it because the technology is sound, the clinical results are well validated. And again, with Sequenom, you have over 500,000 tests performed and you have the largest clinical database to support the expansion of the market.

In terms of expansion of the testing, obviously Sequenom has been at the forefront in terms of offering fetal fractionation, micro deletions, now the genome aspect of NIPT to expand upon the original MaterniT21 test. So yes, we think there will continue to be opportunities there.

And then I would just also parenthetically, as mentioned in the talking points, Bill, point to the international opportunity that this provides us should not be underestimated. Because Sequenom has focused on Europe and Asia-Pacific, and those are markets where we think there's still plenty of opportunity for adoption of noninvasive prenatal testing.

Excellent. Thank you very much.

Amanda Murphy, William Blair.

I actually had some questions as well on Sequenom. If I recall correctly, you had spent quite a bit of effort to in-source NIPT testing yourselves. So I'm just wondering how this will integrate into the existing business.

And you mentioned managed care contracts. Are you going to be able to leverage any of Sequenom's contracts, or will they be sucked into your broader contracts?

Obviously, there are -- and I think these comments were made on Illumina's call that people had been moving toward performing these tests in-house. We like Sequenom's technology. We like the breadth of the test menu. Obviously, the New York licensure is quite important.

So this will integrate well into what we have already done in noninvasive prenatal testing. And again, the number of tests that they have performed and the clinical evidence and support will really help in terms of the demonstration that this test makes sense for the average-risk population.

In terms of the managed care contracts, typically the managed care relationships fall under our contracts post-acquisition. We've carefully examined, to the extent we are able to do so, obviously, as part of the diligence process, our managed care contracts versus their managed care contracts. And we don't see material difference there. So that's another positive in terms of how we think about being able to put these businesses together.

Got it. And I know this may be too early to answer. But do you have a sense yet of how this might affect the patent pool that's shared with Illumina and royalties that are paid in that context?

I think it probably is too early to answer. But again, we don't expect it to have any material impact.

Got it. Okay, thanks very much.

Lisa Gill, JPMorgan.

Great. Thanks very much and thanks for all the commentary. Dave, just two questions from me. The first would be CMS came out the other day talking about bundling cardiovascular. Obviously, you have a suite of products on that side.

I know over the years, we've talked about as we move in this direction getting some of these tests into lower-cost setting. Do you think that there will be an impact to LabCorp as we start to really start to see this shift to fee-for-value in specific categories?

Yes. As you know, CMS started out with the idea of the bundled payment for the joint replacements. Now they've proposed bundled payments for cardiovascular. Obviously, it is going to take some time to see how that really plays out.

But I would say that, particularly when you move away from the inpatient setting -- so let's distinguish between the inpatient and the outpatient setting. In the inpatient setting, I continue to believe that these types of bundled structures will encourage hospitals to look at how they can reduce the cost of the components of the bundle. And on the laboratory and the diagnostic side, that obviously puts us in a very strong competitive position.

On the outpatient side, as you look at bundled payments for total care, again, physicians who are treating patients who are owned or affiliated with health systems are going to be looking at how do I get each component of what I need to treat this patient at the highest quality and the most effective price point. And we are going to be extremely well positioned.

And with cardiovascular in particular, as you think about cardiovascular risk, because of LipoScience and the NMR profile and because of our comprehensive suite of cardiovascular services and risk assessment services, I think we're going to be extremely well positioned to be a valuable ally to the hospitals as they think about how to make the most of any sort of cardiovascular bundling.

And is it too early for you to already have those conversations with the hospital entities? As we think about this, 2018 is not all that far away. So I'm just curious at this point. Are you starting to have those conversations and starting to think about how the contracting will come about in the next couple of years?

Yes. I think that's a really important point to make, which is we spend a lot of time focused on the hospital relationships. And we think about the importance of our engagement with health systems as broad partnerships.

So we don't spend a lot of time talking specifically about lab management, for example. We have plenty of lab management deals, but we try to frame them in the context of an overall partnering relationship around pathology, around reference testing, around lab management.

And we certainly are having these conversations about -- and every hospital executive I talk to, it's about how do we continue to provide the highest quality care to our patients and continue to reduce the cost side of the equation.

And those conversations are underway. And we are optimistic about the opportunity to help the health systems in dealing with some of these changes in reimbursement. Because I agree with you. 2018 is not far off at all when it comes to the type of structural change we are seeing.

And then just one follow-up question for Glenn. Glenn, just looking at the leverage at 3.3 times, when we think about the acquisition, will you use cash? And I know there's no share repurchase in your guidance. But I think there was some thought that without an acquisition, you would move towards purchasing some shares in the back half of the year. How should we think about that?

To your point, we are leveraged at 3.3 now. But again, the bulk of the free cash flow we generate is in the second half. So obviously our leverage is going to come down.

We will use cash to acquire Sequenom by the end of the year, which will take the leverage up, obviously, from where we would have been otherwise. But still, it will be lower than what we are currently. So we continue to not provide our guidance that it would include share repurchases.

But we will continue to consider the possibility of repurchasing shares later this year, or clearly, given the cash flows of the business, not too far thereafter. But for right now, again, an all-cash transaction with strong balance sheet by the end of the year.

Okay, great. Congratulations on a great quarter. Thanks very much.

(Operator Instructions) Jack Meehan, Barclays.

I had two questions on Covance. Dave, could you give us an update on the integrated offering and just traction with incremental bookings in the market?

And then maybe for Glenn, as you look at the back half of the year, the guide now, at least by my math, implies about 5 points of organic growth. Obviously, the comps get tougher. But just how would you characterize the guidance at this point?

Good morning, Jack. I'm going to ask Deb to give you an update on the business and the integrated offering. And then Glenn will answer your question on the back half.

Good morning, Jack. This is Deb Keller. So I think as we look at the business and the integrated offering, I think there's two parts to it. The first is that clients have really been able to see and understand the value proposition of the combined companies. We are differentiated, and they see that.

And as we look at the orders, since we've made the announcement, we have recorded over $200 million in clinical orders where the LabCorp data actually played a key role in the win. In recent quarter, we actually added a large oncology study where we had an integrated offering as well as what we did in the rare and orphan disease. We had a win in that category as well.

I think when we look at the central labs specifically, that business has taken market share for many years and continues to do so. And now with the acquisition by LabCorp, we have even more offerings that we can provide to clients, whether it's anatomic pathology or genomics, around the globe. So I would say that we have been very successful with our integration efforts, both commercially and then operationally.

And I would say, Jack -- it's Dave. A couple follow-ons to that. My perception is that my conversations, and probably Deb's as well, are at a different level from prior conversations. We are talking to senior people about broad collaboration across multiple areas of interest for the drug companies as opposed to a procurement fight about how much am I going to pay for this or how much am I going to pay for that. There's a much greater emphasis in drug development now on quality and speed, and the combination of our capabilities really plays right into that.

Also, if you just look at the performance of companion diagnostics, which we highlighted as one of the three key priorities, our companion diagnostics businesses combined have done tremendously well. And the launch of the Roche assay that I mentioned in the talking points, but I also highlighted immuno-oncology, one of the fastest-growing therapeutic areas. Everybody is working on immuno-oncology, and we clearly are the market leader in developing and launching these tests, with three tests and four applications in the last year.

So I think we are doing an excellent job on the integration. And Covance has done a terrific job on the early development solutions. It's about having an extensive menu that customers can choose what they need from and then delivering the value.

And with that, I'll turn it over to Glenn for the financial question.

Yes, Jack. To your point, the implied growth rate in the second half for Covance is lower than the first. We are looking based upon a midpoint, call it, around 4% year-over-year growth in the second half.

When you look at the impact from currency of a little over 1%, you look at the impact from the Sanofi site support agreement, which is a little over 2%, it gets you to, call it, a little bit over 7% growth rate in the second half year over year off of a very strong second half of the year that we had last year.

So again, consistent with the historical growth rates of Covance, but we believe it's still a very strong performance expectation for the second half of the year.

Thanks. That's great. I appreciate all the detail. If I can squeeze in one more just on gross margins, Glenn. You overlapped some headwinds this quarter. Any color you can provide just on traction from here would be great. Thanks.

Yes. Again, the Company overall is performing well. Obviously a big focus on our gross margin, which obviously is helped by demand, helped by our LaunchPad initiative. Again, we are pleased to see that gross margin effectively improved year over year when you take out just the mix impact.

But frankly as well as our SG&A side, where we got good leverage as well, taking out mix. So pleased with the performance at the top line and how we are leveraging it.

(Operator Instructions) Ross Muken, Evercore ISI.

So I just wanted to dig in a little bit more on Covance. It seemed like the net order growth rate continues to be strong. I know you highlighted some of the cross-sell.

Can you just give us a little bit of color? The implied book-to-bill suggests that the early-phase business continues to trend well and maybe some of the others that have shorter turnaround time are kind of elevated. So help us just understand from a mix basis in the core of revenue how the three key segments are operating and how you expect them to trend over the back half of the year.

As you said, the net orders did increase 11% year on year, and we had a solid order quarter. The book-to-bill obviously is impacted by our very strong revenue growth, which was double digits in all of the different service lines that we have. And as you said, you can remember that we have three business lines in Covance, which is not apples to apples to our competitors. And so our book-to-bill is an average of all of those areas.

We've seen -- continue to see strong orders in early development. That's a really good market place right now. There's good market demand there. And we are winning, and so we are very happy and pleased with the performance from that group.

Central labs, as I said earlier, continues to take market share and had good orders as well. Clinical -- we've had good orders in our early clinical, very strong orders. We have seen more and more emerging clients from that segment come into that -- into our business there. So we've seen a little bit more in cancellations and delays.

And then our Phase II-IV, we have had some good order quarters. You do see the volatility as you look at some of our competitors and you look at their Q2 earnings versus -- or their Q2 book-to-bill versus their Q1. So you do see some volatility there.

We recently added a sales leader in our Phase II-IV business, and added some additional salespeople. And so we are starting to bear fruit from some of those investments.

Great. And just maybe quickly, Glenn, just as a cleanup, what was the M&A contribution on the rev-for-req side?

We normally don't break that level out. From a volume standpoint, we do comment that it was, I guess, around 90 basis points. We do say obviously it's a good component of the rev-for-req.

I think average, if there is such, you can say it's in the ballpark of around a third of it, which is -- I guess our M&A overall had a nice impact on the quarter. Some of that is annualizing from deals that we would have done in the prior year. So going forward, the impact will be more in line with what our traditional growth rate for M&A is at around 1%.

All right, thanks.

Steven Valiquette, Bank of America.

So you just kind of touched on the question I was going to ask on the rev-per-req. But also maybe just on pricing, maybe can you just remind us again your latest thoughts on whether or not there may be any material clinical lab fee schedule adjustments by CMS for 2017 in place of the delay of the PAMA-related changes. Just curious to get your latest thoughts on that. Thanks.

Because PAMA very clearly set out how the clinical lab fee schedule is to be adjusted over time, we don't expect that there will be any 2017 adjustments other than the potential CPI update that's built-in. So generally I would think about the clinical lab fee schedule for 2017 as flat.

And in terms of overall pricing, I just want to be clear that the revenue-per-requisition increase that you are seeing is driven largely by mix, not by unit price. So we think of the pricing environment as stable and we expect it to be so out through the balance of this year and 2017.

Okay, that's helpful. Okay, thanks.

Ricky Goldwasser, Morgan Stanley.

Good morning. Couple of questions here. First of all, on organic volumes, they [hit] 1.2%. Trend seems to be stable compared to the first quarter. Dave, do you think that this is the new normal for the industry? And is this like the steady-state on an organic volume that we should think about as we build our model going forward?

Yes, I think that's reasonable. Obviously, when we talk about that organic volume, that's really just the growth in the business that comes from essentially more tests from the same customers. And I think 1.5%, in that range, is very realistic to think about over time.

Again, just given the demographics of the population, the increasing number of insured lives, the potential for incremental Medicaid expansion. So I think -- I do think that that's the right way to think about it. And obviously, it doesn't take into account things like contract wins or acquisitions, which we tend to call out separately.

Okay. And then a question on PAMA and the visibility that you have into 2018. Is it fair to say that given your scale and (technical difficulty) your reimbursement is going to be weighted by size and the fact that you are a low-cost provider provides you with some fairly good visibility into what at least the floor reimbursement could be? And if that's the case, any thoughts about your ability to offset the changes to price with additional cost reductions in 2018?

So I think in terms of visibility, part of the challenge is that although we are pleased with the expansion of the applicable labs, in the rule that CMS issued, we still don't know what that really means in terms of capturing the hospital outreach business. And I just want to say that I think CMS -- I am pleased that CMS has been willing to consider the industry's comments. I think ACLA has done a terrific job and the hospital associations as well in bringing these issues to CMS's attention.

I continue to be disappointed that the data show that 50% of lab revenue is still going through the hospitals, even though the volume is lower -- considerably lower than what goes through the independent labs. That means hospital pricing has to be way higher. And we all know it is.

So to say that we are doing a market survey and essentially take into account only a very limited slice of that market to me does not do what Congress asked CMS to do. Now having said that, our visibility into what that impact or the floor will be is still limited until we go through the process of understanding how many more labs are captured and what the survey looks like.

In terms of offsetting the financial impact, I think it's important that people think of LaunchPad as a long-term initiative for our business, not as specific projects. And so what we've said about LaunchPad is that we are going to get the savings over a three-year period.

But what we've also said is LaunchPad has now transitioned into organizational and structural activities as opposed to things like our supply chain. And a lot of the things that we are doing around LaunchPad, particularly now focusing on that front-end engagement with the patient, are going to help us to offset the impact of whatever the PAMA and clinical lab fee schedule reductions in 2018 turn out to be.

Okay, thank you.

Nick Jansen, Raymond James.

I just wanted to dig a little earlier into BeaconLBS and what you are doing with United in Florida and the potential for that to be broadened at some point in time. I know the United contract has an expiration date end of next year and just wanted to get your thoughts on how that program could be rejiggered, thinking about a more broader rollout at some point in time. Thanks.

Sure. I think one thing to remember is when we think about BeaconLBS is BeaconLBS is something that the BeaconLBS team invented from scratch and built. So it's a pretty significant accomplishment that that team took an idea and a concept and really built it into a business that's now generating a pretty significant amount of revenue.

The results from BeaconLBS, when you look at the things that the team set out to achieve, the out-of-network lab spend in Florida has declined, the test selection based on evidence-based guidelines has improved. The use of the lack network has increased, which leads to lower consumer out-of-pocket costs. So these are all, I think, positives for what BeaconLBS can accomplish.

Are there things that we want to do to make it better? Absolutely. We want to make it more attractive to providers and helping them to select the right tests so that it becomes a positive tool for choosing the right diagnostic testing. We want to expand the scope of it to increase the utility.

Again, you look at the surveys, and physicians say 30% of the time they are not sure what test to order, particularly when it comes to molecular testing. So we have the opportunity to make BeaconLBS something that becomes a positive in the provider office and helps them get the right tests and interpret it correctly.

Those enhancements are in process. And obviously there are also competitive tools in the marketplace, and we want to be better than the competitive tools. As we enhance BeaconLBS, as we extend its capabilities, as it becomes more and more integrated into EMR systems, I think we will move to new markets.

And I think my perception is that United sees it as a valued tool to help them with correct lab test selection and management of their out-of-network spend. And we are both anxious to see it grow and expand into new markets.

I'll keep my questions to one. Thanks, guys. Nice quarter.

Bill Quirk, Piper Jaffray.

First off, going back to Sequenom deal -- makes sense, given your channel presence, particularly in the OB/GYN side of things. But help us think a little bit about some of the implications here for some of their partner relationships. Are you assuming that some of the deals may potentially move to alternative NIPT providers?

Say again, Bill? I'm sorry; I didn't quite follow. Some of which deals may move to alternative providers --

Yes, I'm just thinking about some of the partners that Sequenom brought into the pool are competitors of yours in the reference lab side of the business. And just trying to get a sense as to kind of -- presumably, you guys took a look at this and feel pretty comfortable. But just want to get some additional color there.

Yes, we do feel comfortable. Obviously, we have limited visibility when we are doing diligence into an acquired company's customer list. So we don't have a perfect idea. But we always assume there's going to be some attrition.

One of the nice things about this test, though, is we really do feel that it's best in class. And so I think the likelihood that there's going to be significant attrition is not the same as it would be in a typical [lab acquisition] (corrected by company after the call).

I think the other reality is as you get into highly specialized testing that's really dependent on capabilities and methodology and the clinical database that there is less appetite for switching than there is if you are just using one reference lab and now it's acquired by another reference lab. So we feel good about the ability to retain the key customers and, again, are counting on and looking forward to working with the Sequenom team to make that the case.

Got it. And then just staying with the topic for a follow-up questions, most of the comments have concerned their NIPT product. They have -- I guess I'd be curious to hear about your plans for the liquid biopsy program. They haven't talked about this, but candidly have downplayed it in recent quarters and talked about partnering that out.

Yes, thank you for mentioning that. The liquid biopsy pipeline at Sequenom is something that has been there for a while. And as you say, candidly, I think from a resource perspective, they have not been able to focus on it as much as they would like.

They really like the liquid biopsy opportunity. And our scientists from their evaluation think there's real potential there. So that's probably a part of the deal that is going to take a little longer to materialize.

But at the same time, we like that as a long-term opportunity. We like it as complementary to our oncology business. And we will have the resources to support that and integrate it with the work that we are doing on liquid biopsy and on oncology test development generally, which I think will be a strong positive for their program and ultimately for the market.

Okay, got it. Appreciate the color. Thanks, guys.

Gary Lieberman, Wells Fargo.

This is Ryan Halsted on for Gary. Just one broad question. So now that PAMA has been finalized and is capturing the hospital outreach labs, how are you weighing the opportunity to allocate your capital to expanding of the diagnostics business going forward compared with Covance?

Well, I think the fact that we announced an acquisition this morning in the diagnostic space should tell you that we are looking to be opportunistic in acquiring the assets that we think are going to bring the highest value for our business and the best return for shareholders. And we will continue to do that and continue to look at the business needs and evaluate where we should deploy capital.

Is there an opportunity for you to buy hospital outreach labs, do you think?

Certainly there may be. I think the history of hospital outreach to acquisitions is mixed because you worry about significant attrition. And you worry about, now that the lab is not owned by the hospital anymore, the ability to retain the work.

Again, we look at the hospital and health system relationships as we want to be broad partners around the in-house laboratory, the outreach business, the reference business, the pathology, the patient management, the population health. So I wouldn't focus so much on how we deploy capital toward hospital outreach as I would on how do we deploy capital to meet our stated criteria, accretive in year one, meet our financial metrics, and provide value to shareholders over time.

All right, great. Thank you very much.

Isaac Ro, Goldman Sachs.

Just a question on capital allocation and really specifically M&A. On the Sequenom side, just hoping you could give us a couple of the key swing factors that we should consider when thinking about how EPS accretion will play out over time.

And secondly, just looking forward, what your criteria are for future deals if we consider the pro forma capital structure you will have after Sequenom. Thank you.

So as I mentioned earlier, from an accretion perspective, it will be accretive in year one, but not materially so. In the outyears, the combination of the top-line revenue growth opportunity and bringing some greater efficiency to their laboratory operation we think will give us the opportunity for the acquisition to be materially accretive.

In terms of what we look for in acquisitions, we have always talked about expanding our capabilities. We have talked about geographic footprint. We've talked about test menu, two very important criteria for this transaction. And we've talked about strategic fit with the business, whether it's the diagnostics business or the drug development business.

And in terms of the financial criteria, we look at many multiples. Obviously, we look at multiples of EBITDA pre and post; we look at DCF. But the fundamental premise is accretive in year one and meets our cost of capital by year three to four. And again, this transaction falls squarely within those metrics. And our aspiration is that every transaction that we do when we deploy capital would fall squarely within those metrics.

Got it. Thanks very much.

Thank you. There are no further questions in the queue. I'll turn the call back over for closing remarks.

Well, as I said, it's an exciting day at LabCorp today. We appreciate everybody's time and participation on the call. We thank you and hope you have a great day.

Thank you. Ladies and gentlemen, this concludes today's conference. You may now disconnect. Good day.