Labcorp Holdings Inc (LH) 2017 Q1 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to your Q1 2017 LabCorp Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. It is now my pleasure to hand the conference over to Mr. Scott Frommer, Vice President of Investor Relations. Sir, please proceed.

Good morning, and welcome to LabCorp's first quarter 2017 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 Executive Officer; Glenn Eisenberg, Executive Vice President and Chief Financial Officer; and John Ratliff, 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 2016 Form 10-K. 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, Scott, and good morning. LabCorp delivered another solid quarter to start 2017, with year-over-year revenue growth of 5%, adjusted EPS growth of 8% and excellent free cash flow, and we returned $150 million to shareholders through share repurchases. We made strong progress on our enterprise-wide initiatives and turned in an outstanding performance in the diagnostics business. Customers continue to embrace our integrated solutions, as evidenced by 2 major health system partnerships, a record number of study wins based on combined data and strong growth in companion diagnostics. In diagnostics, which represents 70% of our total revenue, we had excellent top line growth, with significant increases in total and organic volume and in revenue per requisition, leading to a 50-basis-point expansion of our industry-leading margins. Our diagnostics business is the backbone for our strong free cash flow, which we deployed judiciously in the quarter toward investing in the business, returning capital to shareholders and growing through acquisitions.

In drug development, our results were mixed. Although we are disappointed in our first quarter financial performance, we had some bright spots in the quarter, notably, strong net orders and improved book-to-bill and better performance in the clinical business. These are all leading indicators that give us continuing optimism about the long-term growth characteristics of our company in 2018 and beyond. We continue to invest in the future of the drug development business. In the quarter, we, again, strengthened the leadership team and decided to expand LaunchPad to rightsize the business in the near-term and create a more scalable technology-enabled business for the future.

As I mentioned a moment ago, the strong growth in the areas of strategic focus for the combined business demonstrates that customers are embracing our differentiated offer. I would like to update you on major developments during the quarter that highlight the unmatched value proposition of the combination of LabCorp Diagnostics and Covance Drug Development. We stated at the outset of the year that we are focused on the delivery of comprehensive integrated solutions to our customers' needs. Among the customers who need solutions in today's rapidly changing health care environment are health systems, and this quarter brought 2 important successes there. We announced an important transaction with Mount Sinai earlier this year that strengthens our position in the New York Metro market. And we agreed on a significant partnership with PAML, a market-leading reference and outreach laboratory based in the Pacific Northwest. Through PAML, we aligned ourselves with 2 innovative, fast-growing health systems and strengthened our relationships with over 10 community-based health systems across multiple states. Our offering to health systems and large provider groups is unique and extends beyond our multifaceted lab testing, operational, analytical and clinical decision to support expertise. The integration of our drug development solutions is a fundamental component of these relationships, enabling our partners to become research hubs. Patients gain greater assets to high-quality care through clinical trials. Providers will realize increased revenue tied to patient enrollment, and our biopharma customers will benefit from faster site activation and recruitment capabilities. The level of interest in our combined set of solutions from leading health systems has increased significantly, and we continue to be pleased at the very robust set of opportunities.

Another of our unique capabilities is the powerful combination of LabCorp Diagnostics patients data and global Covance physician investigator performance data. Through these proprietary data sets, we continue to provide unique insights that help us win orders. During the quarter, the use of LabCorp data played an important role in securing multiple awards with an aggregate value of more than $150 million, by far our strongest quarter to date. This brings our cumulative quarter from the use of LabCorp data to more than $350 million, and I'll provide 3 concrete examples that highlight how we're using these capabilities to solve problems for our patients and customers.

In the first example, we observed that approximately 18% of type 2 diabetes patients in our database had evidence of moderate kidney disease. We work with our client on the design of the study protocol, showing them that through minor changes in inclusion and exclusion criteria, we could safely increase the study-eligible patient population by over 50%. In the second example, we identified more than 30,000 patients in our database who were diagnosed in the past 5 years with myelofibrosis, a rare disease with few treatment options. 40 of these patients had opted in through the LabCorp Patient Portal to receive information about clinical trials, providing an opportunity for direct outreach to these consenting patients. The client side of this capability is a significant factor in the decision to choose Covance. The fusion of our combined capabilities spawns unique solutions in all stages of drug development, including real-world evidence. For example, we partnered with a large customer interested in certain biomarkers associated with use and nonuse of a commercially available product. Through this collaboration, Covance screens and enrolls subjects, distributes study kits to patients' homes, collects surveys, coordinates business through LabCorp patient service centers for blood draws, runs laboratory tests and makes reminder calls to subjects. These are but 3 of many examples of our customers' increasing desire to deploy our innovative solutions only available through LabCorp to solve their real-world problems.

Finally, we continue to drive strong growth across the enterprise and companion diagnostics through additional customer partnerships, increased PD-L1 testing in LabCorp Diagnostics, collaboration on the development of tests tied to new immuno-oncology drugs and indications as well as the expansion of our CDx offering to neurodegenerative disorders and rare and orphan diseases. As part of our investment in this business, we will open a dedicated companion diagnostics laboratory in North Carolina later this year to address rapidly growing demand.

The individual business units also had important successes in the quarter. After a comprehensive search, we announced the promotion of Gary Huff to the position of CEO of LabCorp Diagnostics. Gary has more than 25 years of commercial and operational expertise in the clinical laboratory industry. His last 2 roles, before rejoining LabCorp, were as Chief Operating Officer of a health system-affiliated outreach laboratory and as CEO of a JV between a commercial laboratory and an academic medical center. So he brings deep experience with the requirements for success in forming laboratory partnerships with health systems and integrated delivery networks. Gary will join us beginning with our second quarter earnings call.

I mentioned the success of our health system partnership strategy a few moments ago. During the quarter, our diagnostics business formed a laboratory alliance with HCA in Virginia that will provide reference testing to 4 hospitals and more than 100 community physicians, optimize HCA's local lab footprint, maintain rapid results on stat testing and establishing more streamlined lab results interface. In these settings, we are the provider of choice to provide high-quality patient care, integrated high-value IT and analytics tools and reduced health care costs.

We also continue developing our patient-facing capabilities, including improved online appointment scheduling and bill payment capabilities, self-service registration in patient service centers and a completely revamped Patient Portal. These technologies enables direct communication with LabCorp patients, presenting valuable opportunities to grow our database of about 120,000 patients that have consented to be contacted about future clinical trials. Through continued improvement of the Patient Portal user experience and refinement of the opt-in process, the rate of patients opting in has doubled, accelerating the value of this strategic differentiator.

We are also implementing systemwide solutions to help patients make financial decisions related to our services. We can now check eligibility for services when the patient is in our facility, create a personalized estimate of the cost of services before a blood drop and collect any balance due from the patient at the time of service. We also recently launched a web-based cost estimator for our noninvasive prenatal testing that allows consumers to estimate their cost per testing services based on their health insurance. In combination, these initiatives will improve the patient experience with LabCorp, increase our net promoter scores among our customers and build customer and brand loyalty.

As part of our initiatives to bring services closer to patients, we are exploring new business models that provide long-term growth opportunities, including piloting global phlebotomy, evaluating additional services that we can offer through our PSCs and investing in innovative at-home collection devices. As you can see, we are driving innovation throughout our diagnostic offering on many fronts.

Covance Drug Development is the only CRO providing a full spectrum of drug development capabilities, from research to real-world evidence studies, creating a commercial and scientific advantage for our partners. During the quarter, we entered into a contract for a full programmatic award of 9 type 2 diabetes studies with a top-tier pharma partner. In this instance, our broad-based alliance involves the delivery of clinical central lab and early development solutions. We believe that this powerful end-to-end strategy will yield future cross-functional awards and help us accelerate long-term revenue and profit growth.

In addition, we continue to concentrate our sales efforts on higher-value therapeutic areas: oncology, CNS disorders, genetics and rare and orphan diseases. Our combined company's scientific expertise in these areas is significant and has driven an increase in the portion of our backlog tied to these therapeutic categories. These developments combined with our improving orders and book-to-bill ratio give us continued optimism about Covance's future. Nonetheless, there is more we can do to improve the delivery of services in Covance. We have, therefore, decided to expand our highly successful LaunchPad initiative to include Covance. Through Covance LaunchPad, we will rightsize the business, reengineer our drug development systems and processes and deploy technological advancements to improve service while maintaining the highest quality and sustainably reducing our cost base. Glenn will provide financial and other details on this initiative in a few moments.

In closing, we are in the early stages of capitalizing on multiple growth opportunities across our global markets. We are pleased with the success of our solutions-focused selling and our continued progress in repositioning ourselves to meet the needs of a rapidly changing health care system. Driven by the outstanding work of more than 50,000 colleagues around the world, we continue to create unique solutions to our customers' problems, improve the health and lives of patients worldwide, unlock profitable growth and increase long-term shareholder value.

Now I'll turn the call over to Glenn.

Thank you, Dave. I'm going to start my comments with the review of our first quarter results, followed by a discussion of our LabCorp Diagnostics and Covance Drug Development segments and conclude with an update on our 2017 guidance.

Revenue for the quarter was $2.4 billion, an increase of 4.9% over last year, due to solid organic growth in LabCorp Diagnostics and acquisitions, partially offset by unfavorable currency translation of 40 basis points. Organic revenue growth in the quarter on a constant-currency basis was 2.7%. Operating income for the quarter was $333 million or 13.8% of revenue compared to $300 million or 13% last year. Adjusted operating income, which excludes amortization, restructuring charges and special items, was $391 million or 16.2% of revenue compared to $373 million or 16.3% last year. The increase in adjusted operating income was primarily due to favorable price, mix and acquisitions, partially offset by higher personnel costs in Covance Drug Development.

The tax rate for the quarter was 31.2% compared to 35.2% last year. The adjusted tax rate, excluding special charges and amortization, was 31.5%, down from 34.8% last year, primarily due to the expected tax benefit from stock-based compensation. The increase in the tax benefit from stock-based comp was primarily driven by the increase in the company's stock price when shares vested in the first quarter of this year compared to the price when shares vested last year. This benefit was included in our prior full year tax rate guidance, which we continue to expect to be approximately 34%.

Net earnings for the quarter were $192 million or $1.84 per diluted share. Adjusted EPS, which excludes amortization, restructuring charges and other special items, were $2.22 in the quarter, up 8% over last year. Operating cash flow was $234 million in the quarter compared to $128 million a year ago. The increase of $106 million was primarily due to higher earnings and improved working capital management. Capital expenditures totaled $72 million or 3% of revenue compared to $71 million or 3.1% last year. As a result, free cash flow was $162 million in the quarter, up from $56 million last year.

At the end of the quarter, our cash balance was $366 million, down from $434 million at the end of 2016. During the quarter, we invested $152 million in acquisitions and repurchased $150 million of stock. As of March 31, we had $590 million of authorization remaining under our share repurchase program.

Total debt at quarter-end was approximately $5.9 billion. The company's leverage at the end of the quarter was 3.1x gross debt to last 12 months EBITDA comparable to our leverage ratio at the end of 2016.

Now I'll review our segment performance beginning with LabCorp Diagnostics. Revenue for the quarter was $1.7 billion, an increase of 8% over last year. The increase in revenue was driven by acquisitions, price mix and organic volume measured by requisitions. Revenue per requisition increased 3.8%, benefiting from price, mix and the Sequenom acquisition. In addition, esoteric testing grew at a faster rate than core testing. Total volume increased 4.3%, of which organic volume was 1.8%. Acquisition volume was 2.5%, which was primarily driven by tuck-in acquisitions that have not yet annualized. LabCorp Diagnostics' adjusted operating income for the quarter was $341 million or 19.9% of revenue compared to $308 million or 19.4% last year. The increase in operating income and 50-basis-point margin improvement were primarily due to solid organic revenue growth, acquisitions and the benefit from our LaunchPad initiative. LabCorp Diagnostics remains on track to achieve its LaunchPad savings of $150 million over the 3-year period ending this year.

Now I'll review the performance of Covance Drug Development. Revenue for the quarter was $690 million, a decline of $13 million or 1.8% from last year. Excluding the impact from approximately 150 basis points of negative currency, revenue was roughly flat compared to last year. During the quarter, revenue increased in the clinical development business. This increase was offset by the decline in revenue in the early development and central lab businesses, primarily due to slower revenue conversion from the backlog and the previously discussed cancellation by sponsors of 2 large clinical studies in late 2016, for which we provided central lab services. Execution of our strategy, which is focused on higher-value therapeutic areas, such as oncology and CNS disorders, resulted in a higher percentage of our backlog tied to complex studies that continue to convert into revenue at a slower pace.

Covance Drug Development's adjusted operating income was $83 million or 12.1% of revenue compared to $103 million or 14.7% last year. The decline in operating income and margin were primarily due to higher personnel costs, including targeted strategic investments in the clinical business to support future growth, partially offset by cost synergies. We remain on track to achieve our target of $100 million in cost synergies through the 3-year period ending this year, as we expect to complete the consolidation of our central lab facilities by the middle of the year.

In addition, the company expanded its LaunchPad initiative to now include Covance Drug Development. This initiative will be a 3-year program for Covance that consists of 2 phases. We recently initiated the first phase to rightsize Covance Drug Development's resources, primarily headcount and facility footprint. This phase is expected to generate pretax savings of approximately $20 million in 2017 and approximately $45 million on an annualized basis thereafter. The pretax cost to achieve these savings is estimated to be approximately $30 million in 2017, of which around $20 million is expected to be cash expenditures. The second phase will focus on reengineering our systems and processes and improving productivity, which will contribute to sustained margin improvement over time. Planning for the second phase is underway, and we will provide additional details later this year.

Covance Drug Development's net orders and net book-to-bill for the trailing 12 months were $3.2 billion and $1.15 billion, respectively, a sequential improvement over the 12-month period ending December 31, 2016. Backlog at the end of the quarter was $5.2 billion, an increase of $300 million over year-end backlog, and we expect approximately $2.1 billion of this backlog to convert into revenue over the next 12 months.

Now I'll update our 2017 guidance, which assumes foreign exchange rates as of March 31 for the remainder of 2017, and includes the impact of the expansion of LaunchPad in Covance Drug Development as well as the anticipated capital allocation. We expect reported revenue growth of 3.5% to 5.5% after adjusting for the negative impact from approximately 40 basis points of foreign currency translation. This is lower than our prior guidance by 100 basis points due to lower-than-expected revenue growth in Covance Drug Development, partially offset by higher-than-expected revenue growth in LabCorp Diagnostics. We expect LabCorp Diagnostics' reported revenue growth of 5% to 7% after adjusting for the negative impact from approximately 10 basis points of foreign currency translation. This is an increase from our prior guidance of 4.5% to 6.5%, primarily due to better-than-expected organic volume growth. We expect Covance Drug Development reported revenue growth of 0% to 2% after adjusting for the negative impact from approximately 130 basis points of foreign currency translation, which is lower than our prior guidance by 350 basis points.

On a constant currency basis, we expect revenue growth of 1.3% to 3.3%, which is also lower than our prior guidance, primarily due to our first quarter results as well as the mix of contracted awards won during the quarter. Clinical development orders remain strong and typically take longer to convert into revenue. In addition, our strategy to focus on high-value therapeutic areas, such as oncology, has resulted in a higher percentage of our backlog tied to complex studies that continue to convert into revenue at a slower pace.

From a timing perspective, we expect Covance Drug Development's revenue and margins to sequentially increase throughout the year. However, we expect revenue and margins in the second quarter to be down year-on-year before showing favorable growth in the second half of 2017 compared to last year.

Our 2017 adjusted EPS guidance is $9.20 to $9.60, an increase of 4% to 9% over 2016, and lower than our prior guidance of $9.35 to $9.75 due to lower revenue growth expectations. We expect the decline in our earnings outlook to primarily apply to our results in the second quarter due to the timing of revenue growth and the benefit from the expansion of our LaunchPad initiative in the second half of 2017. In addition, our second quarter results will also be negatively impacted by the timing of the Easter holiday as well as the year-over-year comparison to leap year.

We expect free cash flow to be between $925 million and $975 million, unchanged from our prior guidance. This concludes our formal remarks, and we'll now take questions. Operator?

(Operator Instructions) Our first question will come from the line of Lisa Gill with JPMorgan.

I just want to go quickly back to Glenn. Your comment about favorable growth in margins in the second half, is that primarily due to the Covance LaunchPad? Or is there something else that's going to be driving that?

Yes. No. A couple of things, Lisa. First, I think your reference of Covance, we expect to see sequentially improving revenues as we go throughout the year, even though for the second quarter, we expect revenues to be down year-on-year. The second half will be up in the third and fourth quarter, we expect year-over-year. So that's going to help drive the improvement. And then to your point, in addition with the LaunchPad initiative now moving to Covance, the bulk of the savings in 2017 will be recorded in the second half. So obviously, that will improve their margins in the third and fourth quarter year-over-year as well.

And I apologize if you already went through this earlier, but I just want to better understand what is happening on the Covance side, especially on the organic side. I think when, Dave, you gave guidance last quarter talking about the organic growth in this business and your expectations around the business, can you maybe just give us a little more color as to what you're seeing in the marketplace? I know when we had a call a few weeks ago, we talked about the factor of insourcing, outsourcing, and you weren't really seeing the impact there. We already knew about some of the customer delays and cancellations, but what else is happening in the market?

Yes. I'll take that on, Lisa. This is John. And so inside the first quarter, you obviously saw a mix of contracted awards that were won and/or delayed. Clinical orders were strong, to give you color. And that actually takes, obviously, a longer convert into revenue than our early development and/or even our central labs to a certain extent. Secondly, we saw, within the backlog, we are increasingly raising our penetration within the oncology, CNS, rare and orphan. And this higher percentage of our backlog tied to those complex studies are also converting into revenue at a slightly slower pace. We did see delays in certain key customers' pipelines to the second quarter, third and fourth, but pleased overall with the net orders that we saw within the quarter in terms of the long-term growth. And specifically, based on the data involved with the LabCorp and the Covance areas, we saw our largest quarter to date, about $150 million in the quarter, about $350 million of new awards in a cumulative due to the combination of the data sets and how that then drove wins within the quarter in terms of the aggregate book to bills.

Our next question will come from the line of Jack Meehan with Barclays.

I wanted to follow up on the change in the view of Covance just over the past month. I'm surprised your early development was cited as a weak area. Can you talk about the trends there? And then maybe just the magnitude of the weakness for central lab would also be helpful.

Again, John. In terms of the early development, in aggregate a strong area, but saw certain delays in terms of specific customer pipelines within lead optimization, et cetera, but at the same time saw strength in our backlog and book-to-bill. Did have a little bit of a mix of awards to clinical versus pure preclinical, and that drove a little bit of the delay in revenue conversion. But strong area, looking at the pipeline of orders going forward and the opportunities that we see in terms of for the balance of the year. In terms of central labs, we did see a real shutdown in those 2 cancellations within the quarter, and central labs were affected by, what I previously just mentioned, the penetration in oncology. So they are seeing a stretch-out in terms of the revenue conversion, and those are really the 2 areas that we saw affected. I'll proactively address one last question, that is if you look at our segment, clinical is growing above the actual total Covance revenue growth projected with the labs and early development below.

That is helpful. And then, Glenn, I wanted to ask about the volume growth in the quarter. As you've looked at the numbers, do you think the calendar was a headwind or a tailwind in the quarter? Or otherwise, what do you attribute to be the step-up in the activity there?

Yes. No, we did benefit, obviously, from the -- call it, the Easter holiday falling in the second quarter. So it obviously was a year-over-year improvement. The calendarization, interestingly enough, with leap year really impacts our second quarter much more than the first. So if you look at the first quarter, a slight tailwind, slight help to the organic volume. It's truly, call it, an improvement in our volume as opposed to just the calendarization. But as we look to the second quarter, you'll see a more substantial headwind for us between Easter falling into the second quarter, between the calendarization of how it matches up for us year-over-year. You're looking at a more substantial impact, probably around 1.5, give or take, on our volume in the second quarter. But for the first quarter, of the 1.8, most -- call it 30 basis points we would consider being called calendarization/Easter.

Our next question will come from the line of Nicholas Jansen with Raymond James.

I just wanted to get an update on the contract negotiations that you're doing with United right now. How do we think about the time line there, and if there's anything of note in terms of relative size as they've grown quite nicely relative to the other managed care organizations over the last 2 to 3 years?

Nick, it's Dave. Obviously, as we've said, we've been engaged with United at the managed care team level for a significant period of time. They've been a terrific partner to us, and I think we've been a terrific partner to them. Over the last 6 months, we've become also significantly engaged at the senior executive level, involving a good deal of my time. And I'm pleased with where we are. Again, I think there's a recognition on both sides of the strength of the partnership and the value of the partnership. We would like to get something done in 2017. I can't give you any further update on this, and I think both sides are committed to a fair resolution of the contract discussion and something that rewards us both for the value of the partnership over the now 10-plus years.

Great. And then just a quick follow-up in terms of the amount of M&A spent in the quarter, I think like a $150 million or so of M&A activity. Can you maybe just walk us through your pipeline and how you're seeing that evolve over the last 6 to 12 months? Is the pending PAMA legislation driving increased interest from both health systems and others that perhaps look to you guys as an exit strategy? Just want to get your thoughts on M&A spent because that was a little bit bigger than we had thought in the quarter.

I think the M&A pipeline continues to be very robust, and I attribute that to the -- not so much to PAMA because I think singling out any one factor is a little misleading. But to the -- just the general change in the health care environment, we're seeing a big push to value-based payment. We're seeing a big push to being able to procure services, the highest quality of services at the most effective cost. And as hospitals install our laboratories, are recognizing that trend, I think a lot of them are really looking at, do we belong in this business? Is it a core competency? Are we bringing value to the patients? So again, I think when you add in the research hub capabilities that Covance brings us, we have a strong differentiated position in doing these really deep, comprehensive hospital partnerships, health system partnerships. And you can expect us to continue to work on those, but we're going to be opportunistic about what's available in the acquisition market and allocate our capital appropriately.

Our next question will come from the line of Amanda Murphy with William Blair.

I just had a question, I guess, for John first, just to start off with. So you had commented about some of the delays that you saw in terms of customer pipeline in both -- I think, you said both preclinical and clinical. I just was wondering if you could give some context there. Is there anything sort of macro that you can point to that might be driving that? Or is that customer-specific?

It's customer-specific and nothing macro. It's purely a pause in their very specific pipeline of activities that hit us in 1 to 2 areas.

Okay, got it. And then, Dave, a question for you on the hospital side. So obviously, you talked about developing deep partnerships. I was curious what your thoughts are around looking at some of the more lab management-type contracts going forward. Is that something that would be of interest to you, just moving into more of the inpatient outpatient side of the business?

Well, Amanda, lab management can be a part of a comprehensive partnership with the health systems. So we're not opposed to lab management contracts, and we have plenty of them in our business. What we're not out looking for is lab management contracts, where essentially the value that we're bringing is [ revanging ] employees and offer them supply chain savings because, in our view, that is not a high-margin business. It's well below our operating margins. It's an extremely high-touch business because of the nature of inpatient hospital services. So pure lab management contracts alone are not particularly attractive to us. Our strategy has always been the lab management contract might be part of a comprehensive overall partnership that includes, obviously, our reference testing capabilities, our population health capabilities, our analytics capabilities, the Covance piece. So those are the types of partnerships we're doing. And I think the announcements that you've seen in the quarter with Mount Sinai and with PAML, which are -- again, you have 3 tremendously innovative market-leading health systems that are deciding that they want to associate themselves with LabCorp, I think that speaks volumes about the success of our hospital strategy.

Our next question will come from the line of Ross Muken with Evercore.

It's Luke in for Ross today. Just to start off on the CRO market, are you seeing any change to the contracts that are the RFPs that are out there, specifically an increase in fee per service versus the strategic relationships?

This is John. I think you're seeing a blend of that, a mix of that. There's certain of the strategics even that have moved to the more functional service provider, more for that fee per services. I think you're referencing, even within their own mix, it's a vital part of our mix within the phase 2 through 4 and we see that playing out with a specific customer set. But in terms of if you look across the portfolio, if you're asking, is there more of a shift to that, I think we've seen that evolution over the last 5 years in terms of the use of that model. And you're seeing that continue, but there hasn't been any radical -- within the last 6 months, I'm going to shift to more of that FSP model than prior. But you clearly have to have that in your repertoire in terms of addressing the different models of clone.

Okay, great. That's helpful. And then, I guess, lastly, on the pricing market within the CRO business, is that -- are you guys seeing any bad behavior out there when these contracts are up?

No. Have not seen any individual going for share or in terms of low pricing. It's a pretty stable market.

Our next question will now come from the line of Dan Leonard with Deutsche Bank.

First question, does the reduced outlook in Covance and the implementation of some LaunchPad initiatives there, does that impact at all your appetite to grow that business inorganically? Or do you think that's unrelated?

Dan, it's Dave. I just want to point out that the reduced outflow is 1% of a $10 billion revenue company. So this is not a dramatic reduction either in our perspective on revenue or on earnings, and it's not, in any sense, an indication that we are displeased with the Covance business. I would cite again what I referred to in my prepared remarks. You look at the ways in which the combined organizations are generating business that you don't hear anybody else talking about. The depth of the health system partnerships that we're doing, the use of the data and real examples of how the data is helping us to win, the companion diagnostics business, these are terrific success stories. And we're 2 years into this. It was a major transformational acquisition, and we're very, very enthusiastic about the long-term opportunity here because the growth rate in the CRO industry has historically been higher than the lab industry because of the opportunity to expand our business on a more global scale. And so, no, it doesn't in any way diminish our enthusiasm for continuing to grow the CRO business.

That's helpful color. And just a housekeeping question for Glenn. Glenn, is PAML in the new guidance for 2017? Or are you waiting for that -- those parts of the transaction to close before you include them in the guidance?

Yes. No, as we said earlier, just in general, we have capital allocation including in our guidance, including M&A. And I think it's fair to say that, obviously, we announced 2 health system transactions that we expect both to close this year. So it's fair to say that we have assumed those transactions would have an impact this year.

Our next question will come from the line of Steven Valiquette with Bank of America.

So I guess, when just thinking about the current CRO results, do you think that if you did have a more comprehensive service offering in the market, particularly with greater late-stage development infrastructure, would that help to lift the revenue and EBIT results you're currently generating in the early-stage development and central lab components of your operations? So is that be a key to success here on the overall CRO ops if you do add more late-stage capabilities? Just curious if you could give more thoughts on that.

Again, John. I think we actually have very viable late-stage offering, but at the same time, we know, organically, we need to push through in certain therapeutic areas and, internationally, expansion, and then even embracing some of the new models flowing through. So we see, obviously, areas of the strategy that we're going to embrace. And I also know within that post-marketing phase 4 area, we could have greater penetration. And from our vantage point having early preclinical development, as well as in central labs does differentiate us from everyone else. I believe that, a, our leadership in labs and ED can bring our clinical business forward. And to [ effect ], strengthening clinical can then bring forward grid penetration within that early development as well. So it works both ways. But we know we've got work to do on the expansion territory in that late-stage area, and those are what I just addressed.

Okay. I mean, you mentioned a new model. I'm pretty sure I know what you're talking about. Really just to avoid any confusion, do you want to clarify what you're thinking about on new models in terms of servicing clients on late stage?

Look, I think as you've seen, more and more, we're moving to much more of a risk-based model. You're moving to more and more of a pricing based on value, based on outcomes, et cetera. And so that's one point of reference. There's different channels off of the FSP model that we were talking about before being addressed. These are at their infant state. But at the same time, you need to be prepared for those, and then move those forward within the scope of your total portfolio.

Our next question will come from the line of Ralph Giacobbe with Citi.

Just on the Covance side, you had mentioned higher personnel costs. And I think you brought that up last quarter as well in terms of, I guess, increased sales force costs. Is there anything else maybe driving those pressures? If there is, where is that coming from, and sort of how do you combat that? And then more broadly, if you can give us maybe where you are thinking in terms of long-term margin profile at this point on the CRO side of the business.

From the standpoint of, yes, that there were, specifically, strategic investments that were put through all of last year in terms of whether it's in the sales force, whether it's in certain of the therapeutic areas, whether it was on staffing clinical to the backlog. At the same time, any time you have those personnel on board, and then you have now flat revenues within the first quarter, then obviously, you have to address that. And so in terms of your comment on combating that, that's the referenced first phase of a Covance LaunchPad, which is a $45 million annualized savings and, at the same time, then around $20 million, $25 million in the second half of the year for 2017. And those have a majority of being resources. So clearly, what you're trying to do is align revenues with the resources. Longer-term, I think from the vantage point of longer-term margins, we obviously see the business models of our competitors and know we have room to move on that. We'll obviously be addressing that in terms of, a, the LaunchPad longer-term initiatives that we'll give more details on to the later part of this year.

Okay. And then, Dave, any updated thoughts on PAMA at this point, just given recent news there?

Well, at the ACLA annual meeting, there was actually a presentation by CMS about data collection. And then we met with some CMS officials. Industry representatives met with CMS officials to talk about we were continuing to have difficulty loading data. And we requested a delay. And that delay was granted, as you saw, to continue to put the data in. So that is a positive. I continue to be -- and I think our team continues to be frustrated that the data collection process is not designed in a terribly efficient way, and the amount of data that will be generated is going to be enormous. So it raises the question of can the data be analyzed in a meaningful way between now and when CMS is supposed to put the proposed rule-out. I think more fundamentally, Ralph, the issue continues to be the incorrect definition of applicable laboratories. The definition that the prior rule came up with is inconsistent with the legislative intent. It's inconsistent with the [ floor ]. We -- and we supported, that is we, the industry, supported PAMA as a way to bring market-based pricing to our industry. But the way the rule has been generated, 95% of the hospitals are not going to be included, which means their commercial pricing, which is multiples above ours, is not going to be considered to be part of the "market." There's an irony there because when we talk about acquisitions, the hospital systems are considered to be part of the market. But when we talk about the PAMA pricing, hospital systems are not considered to be part of the markets. So we continue to push with CMS to revisit the definition, and we're hopeful that they will do that. And that we'll, as a result, get a rule and an implementation of the legislation that's consistent with what Congress and the industry agreed that we wanted to do.

Our next question will come from the line of Bill Quirk with Piper Jaffray.

This is Alex Nowak on for Bill today. This one's for John. So I just want to be clear. You issued 2017 guidance at the end of February. And so should we read into that, that you saw a number of more complex orders come in or a number of higher-mix contracts come in that just takes longer to convert over the time frame, over the March time frame, and that's what's forcing you to lower your Covance guidance? I guess, what I'm getting at is, basically, what happened today versus 2 months ago?

The answer is we did see a higher level of clinical orders, which obviously take longer to convert. We did see higher percentage of our -- the actual orders going in that were oncology, CNS-based, which are obviously converting into revenue at a slower pace. We had delays in the key customer pipeline that happened in that last 60 days that were more tactical-based. So those are the reason why the reduced outlook within the Covance revenue.

This is Dave. I just want to add quickly, because we want to be clear about this, it's not only the late stage business that's affected by the mix of oncology, CNS. If we have the central lab study that is due in oncology testing, then enrollment may be slower than it is, for example, in an infectious disease study or a diabetes study. So the change in mix affects all of the segments of the business, it doesn't just affect the clinical late stage business.

Okay, that's helpful. And then just a second question for you, Dave. Any update on the BeaconLBS? And just curious, does your UnitedHealth and network contract, does that also include the BeaconLBS program?

In terms of BeaconLBS, we're very focused on improving the features and function sets as we think about scaling BeaconLBS to new markets. The Texas situation remains the same, that is BeaconLBS is running there, but the "hard implementation", where denials start, is not in effect. I didn't quite understand the second part of the question, so maybe you could just review that really quickly because it's 5 [ up ], and there's 4 people still waiting.

Yes, yes. Just curious, does the in-network contract that you have with UnitedHealthcare, does that also include BeaconLBS? I guess, what I'm trying to read is, is if you do -- if you don't re-sign with UnitedHealthcare for in network, does that also inhibit you to run the BeaconLBS program?

No. BeaconLBS is a separate company. And so it's not tied to the United contract. Obviously, United has been very supportive of BeaconLBS, and has been very much engaged in this development, and is our partner in its implementation, but it's not a part of the United contract.

Our next question will come from the line of Gary Lieberman with Wells Fargo.

I guess, maybe just to go back to the LaunchPad initiative with respect to Covance and how we should think about that longer-term, obviously, with the near-term shortfall in the business, I can understand the need to reduce cost. But I guess, how should we think about that longer-term and how that might impact your ability to thrive in that market?

Gary, it's Dave. So I'm just going to point to the successes of LaunchPad in the LabCorp business and how it's improved our competitive position. We've redeployed resources toward customer-facing positions. We've reduced facilities and consolidated facilities in a way that's improved quality and service. Our customer satisfaction scores among our provider community are at all-time highs even after 2 years of LaunchPad, which means it's improving the quality of the service we delivered. It's not diminishing it in any way. The technology improvements in terms of patient self-service, the revenue cycle system, the bad debt improvement, all of these things are direct [ outgrows of LaunchPad. And obviously, Propel has been a major innovation and improvement in quality and service. So LaunchPad is not a program that just says, "We're going to rip cost out of the business." LaunchPad's parameter says, "Every dollar that we spend in the business, we're going to get a dollar and 5 of value in some way or another." And so I don't think you should think about LaunchPad as hurting our competitive positioning. Covance LaunchPad is going to improve our competitive positioning through rightsizing facilities, through getting the right employees facing the customer and the right place through improvement of quality and service delivery through better technology and tools. All of these things are going to be positive for the business in the long-term. And frankly, we wouldn't invest in doing the LaunchPad project because it requires a lot of work from the team if we didn't believe in the business long-term.

I guess, it just seems like it's a little bit more reactive here, whereas it was a little bit more proactive in the diagnostics business.

I don't agree with the characterization.

Our next question will come from the line of Ricky Goldwasser with Morgan Stanley.

So the first question just on the clinical side. One of the questions we're getting from investors is whether the pharma companies are starting to do a lot more -- or more of insourcing, so bringing some of the trial business back in-house. Though we're also kind of in fact seeing some anecdotal evidence from the 2 companies that are actually seeing demand from pharma. So I would love to hear kind of like your thoughts of what you're seeing kind of like the sponsors are doing and how they're thinking about insourcing versus outsourcing trial work.

I think -- and this is John again. I really haven't seen that. At least on our spectrum of customers, you'll always have -- so I went to a head of business of one pharma just recently, where that rumble was, that they were going to pool in insourced resources, a head of the meeting and was the head of the business, plus the head of procurement. Once I got into the meeting, it was not about that at all. They were consolidating the CROs, who they work with and we were one of those that they were consolidating, too. And so I do hear some rumble about that. It just hasn't -- I haven't seen that with our customer set in terms of the insourcing "penetration" or backwards moving into pharma. I can't talk to customers I'm not at. And so you'll have to ask the others of my brethren in terms of that. But right now, we haven't seen that, and still see an ever-increasing penetration, whether it's in the mid-tier or biotech or in that large pharma and as an industry trend.

Okay. And then kind of like you're talking about this afternoon taking longer to convert into revenues, and that is something that you guys have been talking about for over 1.5 years now. If you can just give us some more context. Is it taking longer to convert because you as a CRO, and your CRO peers just are seeing more difficulty in recruiting patients? Or is it taking longer to convert because of the customer side and then drug companies that are just kind of like pacing -- slowing their pace?

No, I would say neither. It's more complex trials at the heart of it. So more complex protocols within the oncology area, within the rare and orphan disease area. It also takes longer in terms of a Phase III recruitment, yes, as opposed to infectious disease when you're looking in an oncology trial, et cetera. So the orientation of the pipeline to those areas more and more give you a longer revenue conversion.

Okay. And then the last question on...

No, no. That's it. That's it. Sorry, Ricky, but we have 2 more people waiting. And you had 2, and it's after 10. So let's move on, please. We'll take whatever you have offline.

Our next question will come from the line of Brian Tanquilut with Jefferies.

Just on the CRO side, we've heard a lot of discussion on certain assets that you guys probably would be interested in to bolster that business. As you prioritize international expansion in clinical capabilities, Asia being a perfect example, I mean, how would you rank what you're looking for in terms of what you see the need for the business to turn around and strengthen?

Brian, this is Dave. We've been talking about this quite a bit, so I'm not going to say anything I haven't said multiple times. The clinical CRO business, we do need to be more sizable in Asia Pac. So that is one important consideration. It's only one. We want to acquire the asset that's going to fit us best from a strategic perspective. That involves financial returns. That involves cultural fit. That involves long-term opportunity, where we see the business growing in therapeutic areas. So there are multiple factors that we take into consideration, but you're certainly correct that Asia Pac is one.

So Dave, what exactly about Asia stands out as driving that view?

Well, I think, probably, the biggest thing about Asia is there are a number of significant markets there that require data from their particular subjects. And if we don't have the clinical presence in those markets, it's tough to win the study. So it's mostly a function of large customers there in Japan and Korea, for example, large market opportunities and regulatory environment in which they want to see. And of course, I should mention China as well and regulatory environment, in which they want to see specific data relating to their populations.

Our next question will come from the line of Isaac Ro with Goldman Sachs.

So I wanted to follow on PAMA. You guys went through some of the things you're dealing with. I'm interested in your perspective regarding how you think the rest of the market, and particularly the small independent labs and hospital labs, are preparing for implementation. You obviously -- we don't know for sure, but hopefully next year. I was just curious if you think about just how you grade the preparedness among your competitors, what that means for you.

I don't really have a good perspective on that, Isaac. It's Dave. I mean, I know what we hear when we go to ACLA, but I think there's a surprising lack of awareness of the potential impact of PAMA, for example, is my perception in the hospital lab director environment. I think small labs are, for the most part at least, the leaders of them that I talked to are aware of the potential outcomes. I don't know where they are in terms of preparedness or data submission. That's not something that we talk about with our peers.

Okay. And maybe just as a follow-up on the impact. We know the perspective walk on future reimbursement. But if we just think about maybe the first 12 months, if all goes according to your best expectations, do you think the net effect of incremental volume will be neutral or positive to your ASPs? Or is it too hard to say?

Well, I think we should be clear, and we've tried to be clear that if PAMA is implemented based on the rule that's out there, there will be a reduction in the Medicare clinical lab fee schedule. So it's very hard, no matter how much volume you get, to offset a price reduction in a book of business of that size. So I would not expect, if PAMA gets implemented in January, that we will offset the financial impact of the fee schedule reduction with incremental volume.

Thank you. Ladies and gentlemen, this concludes our question-and-answer session for today. It is now my pleasure to hand the conference over back to Dave King for closing comments and remarks. Sir?

Thank you very much for joining us this morning. We appreciate your time, and look forward to speaking to you on our second quarter earnings call.

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude the program, and you may all disconnect. Everybody, have a wonderful day.