Labcorp Holdings - Earnings Call - Q1 2016

Transcript

Operator (participant)

Good day, ladies and gentlemen, and welcome to the Q1 2016 Holdings earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press star then zero on your touchstone telephone. As a reminder, this conference call is being recorded. I will now turn the conference over to Mr. Paul Cerdas, Vice President of Investor Relations. Please go ahead, sir.

Paul Cerdas (VP of Investor Relations)

Good morning, and welcome to Labcorp's first 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 CEO; Glenn Eisenberg, Executive Vice President and Chief Financial Officer; and Deborah Keller, CEO of 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're 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 our 2015 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.

Dave King (Chairman and CEO)

Thank you, Paul, and good morning. We had an impressive quarter in which we continued to demonstrate the power of our transformed company through our operating performance and progress on key strategic priorities. First quarter pro forma revenue growth was nearly 9%, with strong organic growth in both Labcorp Diagnostics and Covance Drug Development. This growth, coupled with re-engineering our business process through Project Launch Pad and capturing additional cost synergies from the Covance acquisition, drove another quarter of margin expansion and double-digit adjusted EPS growth. Our excellent first quarter operational performance and business momentum give us confidence to increase our 2016 revenue and EPS outlook.

Our ongoing success is due to sustained focus on our mission to improve health and improve lives and execution on our three key strategic initiatives: being the world's leading provider of diagnostic solutions, bringing innovative medicines to patients faster, and using information to change the way care is delivered. I will now update you on our progress on these strategic guideposts. First, we are delivering diagnostic solutions through a combination of enhanced offerings, complementary acquisitions, and technological innovation. We continue to lead in offering cutting-edge testing, introducing over 75 new tests to market during the past year. We are increasingly deploying our integrated testing capabilities, industry-leading science, and innovative technology offerings to establish strategic partnerships with providers. Hospitals, health systems, and large physician networks seek us out for our comprehensive capabilities in reference testing, supply chain management, IT and informatics, decision support, and clinical trials.

We are also focused on our relationship with managed care organizations, a backbone of our business. We have the strongest managed care portfolio in the industry and are proud of our deep partnerships with these plans. In addition, we are increasing our focus on partnering with government and quasi-government payers as they take on broader roles in developing new payment structures and care models. Underpinning our core diagnostic strategy is our innovation in data integration and in tools to support enhanced connectivity, reporting, and decision support. We differentiate from our competitors by providing these tools as well as the highest quality, most cost-efficient laboratory services to help a wide array of partners as they move to more extensive management of patient health and broader sharing of risk. We complement our organic growth initiatives with carefully considered acquisitions and partnerships that drive long-term profitable growth.

During the quarter, we invested approximately $100 million in strategic tuck-in deals, predominantly focused on esoteric testing such as anatomic pathology, which provides critical diagnostic information in the determination of the appropriate course of cancer treatment. Looking ahead, our acquisition pipeline remains robust, and we see attractive opportunities to enhance our test menu and expand our geographic footprint. In addition to our revenue growth initiatives, we are committed to increasing efficiency and improving the customer experience. Project Launch Pad is introducing new tools and systems to re-engineer our processes as well as enhance the patient, employee, and customer experience. With identified projects underway, such as improving our billing system and patient service center workflow, Launch Pad will sustainably reduce costs, benefiting the long-term margins of Labcorp Diagnostics. We remain on track to deliver $150 million in net savings through the three-year period ending in 2017.

Although Launch Pad is a finite program aimed at process re-engineering, we will always have opportunities to drive shareholder value through further productivity and efficiency programs. Our culture of continuous improvement began long before Launch Pad and will remain after we achieve our stated Launch Pad goals. In its second year, Launch Pad has transitioned from shorter-duration initiatives to system re-engineering, which entails longer timelines for execution and longer-term savings impact. Our second core objective is bringing innovative medicines to patients faster. We execute that objective by offering unique capabilities and solutions to solve problems for our customers. Inefficiency in the clinical trial recruitment and startup process persists as the most significant pain point for our biopharma customers. We are introducing solutions that no other company can replicate to address this challenge.

We are commercializing the combination of Labcorp's proprietary patient data and Covance's proprietary informatics and investigator database in support of enhanced study planning, as well as improved clinical trial placement and recruitment. During the quarter, the use of Labcorp data played a key role in winning a large phase III oncology study, which increased our cumulative orders from use of Labcorp data to over $190 million. We have begun to convert this backlog into revenue and remain on track to deliver $150 million in incremental revenue through 2018. In addition, the number of patients that provided consent through our patient portal to be contacted about clinical trials steadily increased throughout the quarter. We believe patients will want to be part of a process that improves the speed at which cutting-edge therapeutics are delivered to the market, and we are exploring partnerships to expand our reach with this initiative.

Over time, we believe that this database will further differentiate our study startup and recruitment capabilities in support of better drug development. We continue to develop comprehensive solutions in key therapeutic areas, capitalizing on our unique end-to-end capabilities across all aspects of drug development. The scientific and clinical expertise that Covance Drug Development and Labcorp Diagnostics offer in combination, our combined laboratory expertise, and our ability to deliver all of our services with the highest quality and at scale put us significantly ahead of our competitors. To give you a couple of specifics, our industry-leading central lab, a product of our combined capabilities, reported another outstanding quarter of double-digit organic revenue growth.

We recently introduced automation to our Geneva central lab to improve productivity and expanded it to double capacity, allowing us to better serve the growing demand for our enhanced menu of lab testing in Europe, Africa, and around the globe. Our Companion Diagnostics franchise continues to thrive and is another excellent example of the power of our combined offering. Companion Diagnostics are growing in importance to our customers to help them secure regulatory approval, reimbursement, and market adoption for their medicines in an increasingly demanding healthcare system. Labcorp and Covance uniquely offer Companion Diagnostic capabilities from discovery through commercialization. These capabilities include development, validation, support for in vitro diagnostic kits, ability to responsibly launch laboratory-developed diagnostics, market analysis, reimbursement support, lifecycle management, and timely commercialization of drugs and their Companion Diagnostics to our sizable base of providers and their patients.

We see strong revenue growth in Companion Diagnostic services across many therapeutic areas, including oncology, inflammation, and central nervous system disorders. We remain confident that we will deliver $100 million in incremental revenue in this area through 2018 and highlight our differentiated capabilities from our competitors. For our third objective, we are changing the way care is delivered through the use of information and technology-enabled solutions. In Diagnostics, as noted, 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 medical conditions. We also recently marked the one-year anniversary of Beacon LBS's commercial launch, and we are pleased with the technology's clear financial and clinical benefits. In addition, we are seeing increased provider satisfaction with Beacon LBS's test and lab selection functionality, as well as its ease of use.

We intend to add new capabilities to Beacon LBS this year and remain optimistic about its introduction in new markets. In drug development, we are enhancing Covance's Accelerate suite of services to enable faster patient enrollment, more efficient site monitoring, and improved study planning. Accelerate helps reduce the time and cost of trials by providing an easy-to-use, replicable tool to improve insight into trial site performance and trial success. We will also implement new approaches to lower the patient burden and improve the patient journey through clinical trials. We recently launched a suite of mobile capabilities designed to help biopharmaceutical and technology companies navigate the rapidly evolving mobile health landscape. Through this novel offering, we will provide regulatory consulting and validation services to help companies certify the accuracy and consistency of mobile devices and applications for use in clinical trials.

Through all of this activity, we have been and will be excellent stewards of capital. We have made steady progress in our commitment to delever the balance sheet, and we are now at approximately 3.5 times leverage approaching our target. We continue to deploy capital towards strategic acquisitions and expect to be in a position to return capital to shareholders in the second half of the year. By virtue of our investments in innovation, talent, science, quality, operational excellence, and distinctive technology, Labcorp is increasingly well-positioned to profit from global opportunities across our $200 billion addressable market. I am proud of my colleagues who every day reflect our core values of excellence, integrity, teamwork, courage, inspiration, and ownership as they work tirelessly to improve the health and lives of patients around the globe.

Our team's efforts are the reason for our success this quarter, and they will continue to be Labcorp's greatest competitive advantage. I thank them for their great work and the results they continue to deliver. Now, I'll turn the call over to Glenn.

Glenn Eisenberg (EVP and CFO)

Thank you, Dave. I'm going to start my comments with a 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 2016 guidance. Revenue for the quarter was $2.3 billion, an increase of 30% over last year. Covance contributed 24% year-over-year growth due to strong demand, as well as the inclusion of a full quarter of results compared to a partial quarter last year. The remainder of the increase of 6% was driven by Labcorp Diagnostics' strong organic growth and tuck-in acquisitions, partially offset by currency.

Gross profit for the quarter was $777 million, or 33.9% of revenue, compared to $625 million, or 35.3% last year. The increase in gross profit was due primarily to strong demand, productivity, and acquisitions, partially offset by personnel costs. The decline in gross margin was primarily due to the mixed impact from a full quarter of Covance results. On a pro forma basis, gross margin would have increased 50 basis points over last year. SG&A for the quarter was $412 million, or 17.9% of revenue, compared to $442 million, or 25% last year. Special charges in the quarter were $10 million, primarily related to the integration of Covance and executive transition expenses, compared to $119 million a year ago, which were primarily related to the acquisition of Covance. Excluding special charges, SG&A in the quarter was $402 million, or 17.5% of revenue, compared to $322 million, or 18.2%.

The increase in adjusted SG&A was primarily due to acquisitions, personnel costs, and bad debt, while the percentage of our SG&A benefited from a full quarter of Covance's lower rate. On a pro forma basis, adjusted SG&A would have improved 10 basis points over last year. During the quarter, we recorded $19 million of restructuring charges, primarily relating to the closure of redundant facilities and general integration initiatives. Amortization expense for the quarter was $44 million, up from $31 million a year ago due to the impact of acquisitions. Operating income for the quarter was $302 million, or 13.2% of revenue, compared to $132 million, or 7.5% last year. Excluding amortization, restructuring, and special items of $74 million, adjusted operating income was $376 million, or 16.4% of revenue, compared to $302 million, or 17.1% last year.

The decline in margin was primarily due to the mixed impact from a full quarter of Covance results. On a pro forma basis, adjusted operating margin would have improved 60 basis points. Interest expense for the quarter was $55 million, compared to $104 million in the first quarter of 2015. The decrease was due to non-recurring acquisition-related items of $53 million recorded last year, partially offset by higher debt balances following the acquisition of Covance. The tax rate for the quarter was 37.3%. Excluding special charges and amortization, the adjusted tax rate for the quarter was 36.5%, up from 35.4% last year, primarily due to the geographic mix of earnings. For the full year, we continue to expect our adjusted tax rate to be comparable to last year's rate of 35.3%. Net earnings for the quarter were $160 million, or $1.55 per diluted share.

Excluding amortization, restructuring, and other special items, adjusted EPS were $2.02 in the quarter, up 15% from $1.76 last year. These results included a net gain in the quarter of $0.05 per diluted share on the sale of investment securities from our venture fund. During the quarter, operating cash flow was $123 million, compared to negative $87 million in the first quarter of 2015. Last year, cash flow was negatively impacted by $154 million of one-time charges relating to the acquisition of Covance. Excluding these charges, operating cash flow was up $57 million over last year, due primarily to improved earnings. Capital expenditures totaled $71 million, or 3.1% of revenue, up from $34 million, or 1.9% last year. Capital expenditures in the quarter were in line with typical spending levels, while last year's CapEx was low due to the delayed spending related to the acquisition and integration of Covance.

As a result, free cash flow was $52 million in the first quarter, an increase from $33 million last year, excluding the non-recurring items. At quarter end, our cash balance was $696 million, compared to $716 million at the end of 2015. Total debt was approximately $6.4 billion. During the quarter, we invested $97 million in acquisitions, and our leverage declined to 3.5 times debt to last 12 months' pro forma EBITDA. Now, I'll review our segment performance. For comparative purposes, segment results are presented on a pro forma basis for all periods, as if the acquisition of Covance closed on January 1, 2015, and exclude amortization, restructuring, special items, and unallocated corporate expenses. Reconciliations of segment results to historically reported results are included in today's press release and the current report filed today on Form 8K. Now, I'll review the performance of Labcorp Diagnostics.

Revenue for the quarter was $1.6 billion, an increase of 7.2% over last year. The increase in revenue was the result of organic volume growth measured by requisitions, Beacon LBS, price mix, and tuck-in acquisitions, partially offset by currency. The revenue increase includes a benefit from Beacon LBS of 1% and unfavorable currency translation of 0.6%. Revenue per requisition increased 2.7%, benefiting from price mix and tuck-in acquisitions. In addition, esoteric testing revenue grew at a faster rate than core testing revenue. Total volume increased by 4%, of which organic volume was 3.4% and acquisition volume was 0.6%. Volume benefited from the impact of weather and the additional day that was partially offset by the timing of the Easter holiday. Labcorp Diagnostics' adjusted operating income for the quarter was $310 million, or 19.5% of revenue, compared to $290 million, or 19.5% last year.

The increase in operating income was primarily due to volume, price mix, and productivity, partially offset by personnel costs and bad debt. Although the operating margin was consistent with last year, it was constrained by the mixed impact from Beacon LBS and an increase in the bad debt rate of approximately 25 basis points due to an increase in patient responsibility. For the remainder of the year, we expect our bad debt rate to improve, benefiting from our Launchpad initiatives. We remain on track to deliver our $150 million Launchpad savings goal over the three-year period ending 2017. Now, I'll review the performance of Covance Drug Development. Revenue for the quarter was $703 million, an increase of 12.6% over last year. Excluding the impact from approximately 160 basis points of negative currency and the expiration of the Sanofi site support agreement, revenue increased 17.9% over last year.

The strong revenue growth was broad-based across our early development, clinical, and central lab businesses. Adjusted operating income was $103 million, or 14.7% of revenue, compared to $74 million, or 11.9% last year. The increase in operating income and margin was primarily due to demand, productivity, and cost synergies, partially offset by the expiration of the Sanofi site support agreement and personnel costs. We remain on track to achieve our three-year $100 million cost savings goal through 2017 related to the acquisition of Covance. Net orders during the quarter were $830 million, representing a net book to bill of 1.18, while backlog at the end of the quarter was $6.9 billion. The trailing 12-month net book to bill was also 1.18. Now, I'll update our 2016 guidance, which assumes March 31st foreign exchange rates for the remainder of 2016.

We expect revenue growth of 8.5-10.5% after the impact from approximately 40 basis points of negative currency. This is an increase from our prior guidance of 7.5-9.5% due to strong organic growth and a 60 basis point improvement in currency. We expect the Labcorp Diagnostics segment to grow 4-5.5% over 2015 after the impact from approximately 20 basis points of negative currency. This is an increase from our prior guidance of 3.5-5.5% due to organic growth and a 30 basis point improvement in currency. We expect the Covance Drug Development segment to grow 6-9% over 2015 pro forma revenue after the impact from approximately 50 basis points of negative currency. This is an increase from our prior guidance of 2-5% due to strong organic growth and a 150 basis point improvement in currency.

Excluding the impact from currency and the expiration of the Sanofi site support agreement, we now expect net revenue to increase approximately 9-12%. We expect adjusted EPS of $8.55-$8.95, which implies growth of 8-13% over 2015, and is an increase from our prior guidance of $8.45-$8.85. 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. We expect free cash flow of $900-$950 million, unchanged from our prior guidance. This concludes our formal remarks, and we will now take questions. Operator.

Operator (participant)

Thank you. Ladies and gentlemen, if you would like to ask a question at this time, please press Star and then the number one key on your touch-tone telephone.

If your question has been answered or you wish to remove yourself from the queue, you may press the pound key. Due to time constraints, we ask that you please limit yourself to one question and one follow-up if needed. Our first question comes from Robert Willoughby of Credit Suisse. Your line is now open.

Robert Willoughby (Analyst)

Thank you. Good morning. Dave and Glenn, wondering why maybe not a bit more profit margin leverage on the quarter based on how well the lab volumes as well as revenues for accession trended. Maybe a quick comment on just the deal pipeline. Is it robust for smaller kinds of tuck-ins, or is the focus more on some larger transactions added to some of your newer platforms?

Glenn Eisenberg (EVP and CFO)

Okay. Hey, Robert. Let me go ahead, and this is Glenn. I'll cover the margin question and pass over to Dave.

Dave King (Chairman and CEO)

First of all, obviously, we had good margins overall for the company. At 16.4% margins, we're up around 60 basis points year over year on a pro forma basis. I know your comment was probably more directed to the diagnostic side of the business, where we maintain our 19.5% margins year over year. As I commented in our opening remarks, our first quarter was constrained, so were it not for some of those issues, we would have seen margin expansion. Really, there are three primary reasons. The first is our Beacon LBS business, which we had a full quarter this year with none last year. It annualizes actually now beginning into the second quarter. Given that most of it right now is still passed through, that was a constraint on our margins.

We also did have bad debt rate increase for the first time given the high patient responsibility. As we said, we expect that rate to come down going forward through Launchpad initiatives, so it will not be a constraint, we believe, going forward. Finally, worth noting is that with our merit increase, we did have a good merit increase year over year. That will annualize in July of this year. For the first half, we will see some constraint on the margin from that. Overall, at over 7% top-line growth, maintaining very strong 19.5% margin still means our operating income grew by over 7% despite those constraints. Dave?

Thanks, Glenn. Bob, on the acquisition pipeline, I would say the acquisition pipeline is robust across the broadest, across the whole spectrum.

Our focus, as evidenced in the quarter, is on the tuck-in strategic deals that, on the diagnostic side, would enhance our geographic footprint or expand our test menu. On the drug development side, we provide specific areas either of therapeutic expertise or other assets that would complement our current set of offerings.

Robert Willoughby (Analyst)

Thank you.

Thank you. Our next question comes from Bill Vanello of Craig-Hallum. Your line is now open.

Bill Vanello (Equity Analyst)

Hey, guys. Thanks a lot. Particularly good-looking quarter on the Covance side of the business and overall. Just wondering if you would be willing to comment at all at this point with Covance on board for more than a year now. How you're thinking about growth over the longer period of time? Do you think you can be a sustainable 10% plus EPS grower? Do you have any kind of internal objectives?

Anything that you can give of color on that front would be great.

Dave King (Chairman and CEO)

Morning, Bill. It's Dave. Thanks for the comments. I think we have a sense of where we think long-term revenue growth should be, and that's with the diagnostics business kind of low to mid-single digits and with the Covance business mid to higher single digits consistently over time. How that translates to EPS, obviously, is a function of capital deployment and some other things. I think you can expect us this year to set some aspirational targets for EPS growth over time. I think if you look back historically, obviously, before the major reimbursement cuts of 2013 and 2014, we had a very nice, I believe it was a five-year EPS CAGR of 13-plus %.

We had a couple of years of flat to declining EPS simply because of declining pricing and the cuts attended to that. I think it's an excellent question. As I say, I think you can expect us during this year to set out some long-term EPS growth expectations that we expect to achieve over time as these businesses are fully integrated.

Bill Vanello (Equity Analyst)

Okay. Thanks a lot.

Operator (participant)

Thank you. Our next question comes from Lisa Gill of J.P. Morgan. Your line is now open.

Lisa Gill (Analyst)

Thanks very much. Good morning. Dave, can I just follow up on a couple of your comments that you made? Just first, when you think about the acquisition strategy and you think about how well Covance is doing right now, can you maybe just give us a little more color as to how you think about the acquisition strategy there?

You talked about tuck-in more on the diagnostic side, but on the drug development side, is there areas that you feel that you need to really, truly compete in the market? As we think about the better results in the quarter, was there something specific that drove that versus your original expectations?

Dave King (Chairman and CEO)

Morning, Lisa. In terms of the acquisition strategy specifically for the drug development business, what I would say is I divide it into 2 parts. The first part is just continuing to look at, for right now, the tuck-ins and the things that are additive to particular parts of the business that we would like to expand. Therapeutic expertise, market access, the areas where we feel that there is an interesting opportunity to either expand capabilities or enhance capabilities with things that would be additive to the overall end-to-end capabilities of the business.

Over time, as we've said, we feel that we need to be larger in the clinical business. Some of that will come from organic growth and the initiatives that we have underway in therapeutic expertise and integration with Labcorp Diagnostics. It's my expectation that some of that will also come from acquisition. I would say that now our focus is not on another sizable deal. Our focus is on complementary capabilities that are additive to what we have. Although, obviously, we evaluate a lot of things, and we're going to look at anything that looks like the right opportunity for us given price multiples and long-term return on invested capital. That's how I would summarize the acquisition strategy around the Covance business. In terms of the performance, it's hard to single out any particular area because they all did so well.

The business is clicking along extremely well. Deb is doing a great job as CEO. On top of that, the leadership moves that she has made have created terrific stability and a sense of purpose in the organization. I compliment everybody at Covance from early development and preclinical all the way through clinical for a very strong performance in the quarter, just as I compliment everybody on the diagnostic side from phlebotomist to senior executive for a very strong performance there. We just have really executed well on the strategic initiatives, and we perform well operationally in the quarter.

Lisa Gill (Analyst)

I would agree. Congratulations on a nice quarter.

Dave King (Chairman and CEO)

Thank you.

Operator (participant)

Thank you. Our next question comes from Jack Meehan of Barclays. Your line is now open.

Jack Meehan (Analyst)

Hi. Thanks. Good morning, guys. I wanted to start with the strength at Covance.

I caught some of Glenn's commentary around central lab, but I was curious if you stacked up early development and late stage, how they fared relative to that, or if they were really close in terms of the growth rates in the quarter.

Deborah Keller (CEO)

Good morning. This is Deb. I can give you a little more color on that. Early development, as Dave said, had another strong quarter. The market's been recovering over the past 18 to 24 months, and our demand remains strong. Utilization in the market is tightening, which results in slight price increases, and it has in the last 6 quarters. We continue to manage our capacity very efficiently and effectively. As far as central labs, we've had fantastic growth. We've had strong volume and strong demand that's been fueled by the breadth of assays that we have because of the combination of Labcorp and Covance.

We've also seen a nice conversion of the studies that we have in central labs, so that's been driving volume. In clinical trials, as they get more and more complex, the number of esoteric assays are increasing, and that allows us to be a one-stop shop for our customers, which they tend to value that. When you look at clinical, this is the largest market that we serve and one of the largest opportunities that we have for growth, both for Covance as well as for the combined entity. We had strong results this quarter, and we continue to invest in talent and tools. In January, we added a new sales leader who was previously the head of sales for both central labs and early development. As you know, we recently announced that Jonathan Dunk has joined.

He brings a wealth of experience in clinical development as well as a perspective from the voice of the client. These hires, plus our investment in informatics, as Dave had talked about earlier, and the combined data is going to allow us to address our client's biggest pain points, which is decreasing the time for study startups, identifying patients, and sites. We are very pleased with the results this quarter.

Jack Meehan (Analyst)

Great. That is really helpful. Maybe just one more on personnel cost. It was mentioned a few times in the prepared remarks, just an area of modest pressure. I was wondering if that was anything incremental that you are seeing. What is the outlook for the rest of the year? Thank you.

Glenn Eisenberg (EVP and CFO)

Just on the—Jack, this is Glenn—on the personnel costs, I think we spoke to just, obviously, the growth of the business and the people, obviously, that are needed to support the growth. We also have the additive part of the higher merit that we provided last year, reflective of the performance of the company that will annualize in July, but more just normal growth in the business supporting the higher growth in our personnel costs.

Operator (participant)

Thank you. Our next question comes from Ross Mukin of Evercore ISI. Your line is now open.

Ross Mukin (Analyst)

Good morning, guys. You highlighted the momentum that's been building on the cross-sell opportunity with utilizing sort of the data sets to continue to drive sort of really nice net orders at Covance.

I guess if you think about companies that do things that are sort of outside the norm and are kind of groundbreaking, usually take some time and network effect amongst the customers to gain momentum. How do you feel like that's sort of translated in the conversations that are going on amongst your different customer base and sort of understanding the value prop and how you're differentiated and how that can lead to sort of improved sort of either enrollment times or patient quality or what have you in terms of them really starting to understand and see some references to where you're having maybe a different effect and a point of differentiation versus your competitors?

Dave King (Chairman and CEO)

Ross, this is Dave. I'll start and then ask Deb if she has any further comments.

I can tell you from my direct interactions with senior executives at the biopharma companies, I mean, they instinctively understand the value of the data and of the Labcorp data and the patient data and the patient engagement and intimacy that we bring. As we said, the number one pain point in terms of getting trials started is finding sites, finding good investigators, and particularly finding patients. You look at the statistics, most trials are under-enrolled. A large majority of trial sites never enroll a patient. Oncology trials, in particular, suffer from a lack of patient enrollment, which makes it hard to get the drugs approved and brought to market. My experience has been this is readily understood.

It's something that our customers are very enthusiastic about, and we have a lot of demand not only for help us find patients for traditional trials, but also help us find patients for observational studies, help us create a database of patients for registry studies. I think this is just a terrific and unique tool.

Deborah Keller (CEO)

Yeah. The only other thing that I would add, Ross, is I think this combination has allowed us to change the conversation with clients. I spend quite a bit of time on the road meeting with clients, and they're very interested about the different capabilities and solutions that are unique to Covance and Labcorp. I think the clients have—I think if you look at some of the research that's been out there, they feel that we're making the right investments to meet not only their needs today, but their needs as clinical trials transform.

Jack Meehan (Analyst)

Great. Thanks, guys.

Operator (participant)

Thank you. Our next question comes from Amanda Murphy of William Blair. Your line is now open.

Amanda Murphy (Analyst)

Hi. Good morning. I actually just had a follow-up to Ross's question. It seems like in terms of the consent database, that that's quite a valuable asset and probably quite difficult to replicate without having the diagnostic piece. It also seems like that's a U.S.-focused asset. Can you just talk through how the combined Labcorp is working to leverage the incremental patient data that you have outside of the U.S. to deliver value to pharma?

Dave King (Chairman and CEO)

Yes, Amanda. Good morning. It's Dave. Obviously, part of the challenge there, particularly in Europe, is the privacy regulations are much, much more complicated. We are working with partners to expand capabilities beyond the U.S. database as well as to expand engagement within the U.S. database to other patient sets.

We will continue to explore that as a way to make this an even more global tool.

Deborah Keller (CEO)

Amanda, the only other thing I would add is still a majority of the clinical trials are done in the United States, so it does give us an advantage for our clients.

Amanda Murphy (Analyst)

Got it. And then just on Beacon, also curious about your perspective longer term in terms of expanding to additional payers and then also shifting the pricing model away from pass-through to maybe incorporate in some fashion the value add that you're providing. Just was looking for your thoughts longer term there.

Dave King (Chairman and CEO)

Yeah. I think the first thing to remember about Beacon is this is something that was invented, I mean, literally invented and built by the Beacon team. They've done a fantastic job bringing a vision to market.

I think we should understand and appreciate how hard it is to start something like this up from scratch, build it, build the software tools, get client adoption. We are thrilled with where Beacon is today. I think it is very important as we continue to build additional tools like genetic and molecular capabilities, further decision support tools for physicians, that we expand the scope of Beacon to include more capabilities. I remain very optimistic that there will be additional market opportunities for Beacon, and my hope is that we will have some positive developments on that in the year.

The other thing I would say in terms of the profitability is I do expect Beacon to be profitable in the nearer term as opposed to just pass-through, however, recognizing that it will not be as profitable ever as the core business because it is just a business of a different nature.

Amanda Murphy (Analyst)

Got it. Thanks very much.

Dave King (Chairman and CEO)

Thank you. Our next question comes from Nicholas Jansen of Raymond James. Your line is now open.

Nicholas Jansen (Analyst)

Hey, guys. Nice job in the quarter. Just wanted to get a better sense of the Covance revenue synergies. I think you mentioned over 190 million orders as it pertains to kind of that $150 million bucket that you previously communicated. What does that order translate into revenue dollars so we kind of get a better sense of where we are on that front?

Sitting here 12 months post-transaction, how comfortable are you with the other phases of the revenue synergies? We have not heard too many specific updates on the other piece. Thanks.

Dave King (Chairman and CEO)

Morning, Nick. It is Dave. Obviously, the rate at which the orders translate to revenue depends on the progress with the pharma companies in terms of when they reach finality on what they want the drug to be developed and what the study parameters look like. That is probably a 12-18 month timeframe to actually get those orders translating into revenue. We do not intend to update the dollars that are translating into revenue. We will just keep you advised, not specific order by order, but generally against the $150 million target. On the $100 million that we talked about for companion diagnostics, I mean, I think we have been very clear that we have done extremely well.

I think we, in all likelihood, if I had to handicap it now, I think we will exceed that $100 million over the three-year period just because that business has been thriving with the combined tools. I commented on that, I think, at some length in the prepared remarks. I think on what we had identified as the last $50 million, which was the real-world evidence, that is probably a longer-term impact just because of the number of areas in which real-world evidence is likely to be applicable. Net-net, I feel very confident that what we identified as the $300 million in revenue synergies by 2018 will be accomplished.

Nicholas Jansen (Analyst)

Thanks. Just on the maybe for going on the bad debt side, we have seen your peer also call out bad debt from an acceleration from a year-over-year perspective.

I know you guys are working hard on Launch Pad to kind of offset some of that. Just maybe going to what we're seeing from a patient collectibility front and how we should be thinking about bad debt over the next 12-18 months. Thanks.

Glenn Eisenberg (EVP and CFO)

Yeah. Again, some of it is just seasonal. We always see our higher bad debt rate in the first quarter and then taper off throughout the rest of the year. What was unique for this first quarter was that on a year-over-year basis, instead of seeing the progress that we had been experiencing, we actually saw the rate go up for the first time. Similar to, again, an industry issue where we have higher patient responsibility, higher deductible plans earlier on in the year.

As we look going forward, while it's still expected to be a challenge, we do expect the rate to come down. We think it'll be more comparable with what we experienced year-over-year. We don't expect it to be an overall constraint on the margins, but driven by the success that we're experiencing on our Launchpad initiatives that will only continue to accrue favorably going forward. An issue in the quarter, don't expect it to be one going forward, but where not for the Launchpad could be.

Dave King (Chairman and CEO)

Nick, it's Dave. Just going to add a little color to that. Obviously, we are seeing more and more patients in high deductible plans, whether through exchanges or through commercial and employer plans. More patients in high deductible plans means more dollars out of pocket before there's any insurance payment whatsoever.

What that means is with higher deductibles, higher patient responsibility at the onset of the year. We are also seeing plans with higher co-pays and with a greater incidence of non-covered services. Between those three factors, you are seeing more dollars of exposure flowing to patient. Although our patient collection rate is generally very good, it still has more dollars flowing to patients. It just puts more pressure on collecting that overall component. As Glenn said, some upward movement in the quarter, but we still feel confident that for the year we will be in the same range as we were last year.

Nicholas Jansen (Analyst)

Thanks for the color.

Operator (participant)

Thank you. As a reminder, ladies and gentlemen, we ask that you please limit yourself to one question and one follow-up. Our next question comes from Will Quirk of HyperJafray. Your line is now open. Great. Thanks.

Will Quirk (Analyst)

Good morning, everybody. First question here on Beacon, Dave, as we think about the expansion of the program, do you think that we're going to end up going through trialing periods as this expands beyond Florida, or do you think that you can take all of the experiences learned from the initial rollout and the trialing program there and kind of put a full program in force when you expand it?

Dave King (Chairman and CEO)

Morning, Bill. I think Beacon is readily scalable, and I think there have been some very good lessons learned for us in Florida, as there always is when you do something new. I don't anticipate a lot of difficulty in scaling the program to new markets or to new payers. Remember, it's basically a software tool.

The whole idea of Beacon was build one and use many times, not have to build a bunch of customizable solutions. I think we've done a very nice job achieving that.

Will Quirk (Analyst)

Got it. As a follow-up, just thinking a little bit about a couple of the macro topics, obviously a lot's been said about the FDA regulation of LDTs, but can you talk a little bit about kind of twisting this a little bit? I mean, there might be a potential opportunity here for Covance. Have you guys thought about that? If so, is there any way to size that potential market? Thanks.

Dave King (Chairman and CEO)

I guess I would say as we think about FDA regulation of LDTs, our position has been pretty clear.

There may be some opportunity for Covance there, although again, remember that in companion diagnostics development, we have supported both LDT launches and kits, depending on the preference of the pharmaceutical partner and what they want the outcome to be. I do not think of it as, I think of it as there's a very large incremental market for companion diagnostics, but I do not know that that would translate into LDTs versus, I would not break it down LDTs versus kits. I would just think about it as what does the global companion diagnostics opportunity look like? As we know, that's very, very robust.

Will Quirk (Analyst)

Got it. Thanks, Dave.

Thank you. Our next question comes from Ricky Goldwasser of Morgan Stanley. Your line is now open. Yeah.

Ricky Goldwasser (Analyst)

Hi. Good morning and congrats on a very good quarter. I have two follow-up questions.

One on the volume side and the prepared remarks you talked about 3.4% increase in organic volume with some moving parts around the winter and leap year and obviously the Easter. Can you kind of just quantify for us what were organic volumes excluding those moving parts?

Glenn Eisenberg (EVP and CFO)

Hi, Ricky. This is Glenn. That's right. From an organic volume standpoint, the 3.4% included the net benefits of those three items that we would say would be roughly call it 1.5-2% benefit out of that 3.4%.

Ricky Goldwasser (Analyst)

Okay. Great. We are actually kind of seeing volume continue to be in line with what they were last year on an organic basis, it seems. That's right. Okay. My next just follow-up relates to Covance. It seems that Covance's margin has expanded nicely by about 280 basis points in the quarter on a year-over-year basis.

How does that 14.7% margin for Covance compare to your internal goals? What is kind of your long-term margin target for the segment?

Glenn Eisenberg (EVP and CFO)

Ricky, this is Glenn. I'll start, and Deb may want to provide some color as well. Obviously, first quarter, we would say was up 280. We want to give them full credit for a very strong quarter in margin improvement driven off of a very strong top-line growth for the company. There is seasonality in the rate, so we would always expect kind of the first quarter rate for the segment to be low in the first quarter and then pick up for the year. From our perspective, it's continued growth in margin year-over-year. Given the strong demand, given the productivity, given the synergies that we're still capturing, we do expect another strong margin improvement year.

I would be remiss if Deb did not come back and say her expectation is always to continue to drive those margins going forward. Deb, you may want to add some color.

Deborah Keller (CEO)

Yeah. The only color I would add, Ricky, is that we had strong growth in both central labs and early development demand, and both of those have nice drop-through on an incremental. They were the biggest driver of our OM expansion. That coupled with our cost synergies. Usually, first quarter tends to be a softer quarter, but we did well. We continue to expect the full-year margins to improve.

Ricky Goldwasser (Analyst)

Is there any pull forward in the quarter, or should we just expect the business for the remainder of the year to continue at kind of at pace?

Dave King (Chairman and CEO)

There is nothing pull forward, Ricky.

The synergy plan is obviously clearly laid out internally, and we did not pull anything forward.

Ricky Goldwasser (Analyst)

Okay. Great. Thank you.

Operator (participant)

Thank you. Our next question comes from Isaac Rowe of Goldman Sachs. Your line is now open.

Isaac Rowe (Analyst)

Good morning, guys. Thank you. Question on free cash flow. You guys raised guidance for revenue and EPS. I was wondering if you could maybe break down some of the key moving parts that would explain why the free cash guidance is not also going up.

Glenn Eisenberg (EVP and CFO)

Hi, Isaac. This is Glenn. First, obviously, the guidance we have maintained at the, call it, $900 million to $950 million. When you look at the improvement in the earnings per share guidance, which we have taken up to $0.10, we commented around $0.05 of that was from the gain on the sale of securities from our venture fund.

While we did pick up plus or minus around $15 million in cash from the sale of those securities, that does not show up in free cash flow. It's below the operating line, so that cash would not be included. So it's really just the operating improvement impacting EPS that would be cash-related. Given where we are in the year and we have a $50 million spread between the $900 million and $950 million, and the fact that the first quarter is seasonally low, we did around $52 million of free cash versus our $900 million plus for the year, we felt it appropriate to maintain the current level of our guidance. Obviously, after the second quarter, with six months remaining, we'll go ahead and revisit it.

Isaac Rowe (Analyst)

Sure. That makes sense. Appreciate that. And then follow-up on the one-time gains.

Could you maybe walk us through the process that you typically go through to determine when you monetize those investments and to what extent might we want to keep in mind the possibility for more of that to come this year?

Dave King (Chairman and CEO)

Thank you. Hi, Isaac. It's Dave. We have a fund that makes venture investments, and those investments are typically in areas that we think are of either long-term opportunity or things we'd like to know more about or things that might be additive to our business or disruptive to our business. Anytime, for example, one of our earlier investments went public. We're not in the business of owning public shares in public companies. At that point, we made the decision to monetize it.

We look at our return, the continued value of our investment over the long term, whether we're being asked to invest more at the time that we choose to monetize. Each one on a case-by-case basis, we make a determination of what makes sense. There is no way to predict when these events will occur. Periodically, we have some losers as well as some winners. It is not something we can really build into any model.

Isaac Rowe (Analyst)

Got it. Understand. Thanks, Dave.

Operator (participant)

Thank you. Our next question comes from Whitmeyer of Robert Baird. Your line is now open.

Robert Witmeyer (Analyst)

Hey, thanks. I have really just got one question. I just wanted to go back to the Covance cost synergies. Just curious kind of where you're finding most of the opportunities.

Is this mostly procurement savings and whether or not you've consolidated anything on the central lab at this point and if that's an opportunity going forward?

Dave King (Chairman and CEO)

We have consolidated the Singapore central labs, and we're in the process, obviously, of evaluating other appropriate facility consolidations. Some of the savings this quarter come from consolidation of data centers, of Covance data centers into Labcorp capabilities. I think it's very broadly based across public company costs, procurement costs, personnel costs, duplicative capabilities that can be streamlined. There isn't any single area to point out other than to say that we continue to evaluate not only the Covance business but the integrated businesses and the corporate infrastructure to identify additional opportunities.

Robert Witmeyer (Analyst)

Great. Thanks a lot.

Operator (participant)

Thank you. Ladies and gentlemen, due to time constraints, we do ask that you please limit yourself to one question at this time.

Our next question comes from Gary Lieberman of Wells Fargo. Your line is now open. T

Ryan Halsted (Analyst)

Thanks. This is Ryan Halsted in for Gary. Just my one question. On the revenue guidance update, excluding the currency impact, Covance revenue guidance is for about increased by 250 basis points. I was wondering if you could call out where you expect to see the majority of that growth. Is it primarily from the central lab, or how should we think about that?

Glenn Eisenberg (EVP and CFO)

Thanks. Hey, Ryan. This is Glenn. I'll at least start with the comment that, and I think it was alluded to in opening remarks as well, that we've been very pleased with the broad-based view of how Covance is performing across all the major business lines.

When you look at kind of the implied guidance for the rest of the year at a, call it, around 6% growth, we believe it is broad-based and consistent with what they've categorized before as normal, call it, historical growth within the segment.

Dave King (Chairman and CEO)

And it's Dave. I mean, we're not going to provide revenue guidance by segment within segment. I agree with Glenn. Think of it as just it's broad-based across the entire business.

Operator (participant)

Thank you. Our next question comes from AJ Rice of UBS. Your line is now open.

AJ Rice (Analyst)

Thanks. Hello, everyone. Just two sort of pricing-related questions. If I've got my calculation right, your revenue for requisition in the quarter stepped up from the fourth quarter rate to about 50 basis points to 2.7% year-to-year. Is that mixed, or is there underlying price trend, and how much you factor that into the updated guidance?

I guess longer-term pricing, any update on the clinical lab fee schedule reset and your discussions with CMS and Congress?

Glenn Eisenberg (EVP and CFO)

Yeah. AJ, I'll start with just the price mix comment. It's primarily mix-related. Obviously, we've benefited from acquisitions that have mixed us up. Plus, we talked about the mix within our test group. Pricing has been relatively stable, which is a positive. We also do have some Launch Pad initiatives that are targeted to the pricing side. Overall, we would say that the increase that you saw within the price mix is primarily mix-related

Dave King (Chairman and CEO)

. AJ, it's Dave. On PAMA, as you probably saw this week, a notice was filed in the Federal Register indicating that the final rule has gone over to OMB for review. There obviously has been a step forward by CMS.

We do not have insight into what is in the final rule, but hopefully, it has addressed a couple of the major issues with the definition of applicable labs and some of the other things that we highlighted. We continue to work with CMS and obviously with all of the constituencies in Congress on both the definitional and the timeline for implementation. Again, highlight the letter from Senator Hatch and Senator Wyden, as well as the letter from 26, I believe, members of the House and other members of the Senate indicating that a January 2017 implementation date is not practical. We fully agree with that. We hope and expect that CMS will be taking a practical and reasonable approach.

AJ Rice (Analyst)

Okay. Thanks.

Operator (participant)

Thank you. Our next question comes from Brian Tranquil of Jefferies. Your line is now open.

Brian Tranquil (Analyst)

Hey, good morning, guys. Thanks for taking the question.

Glenn, just really quick on G&A. It ticked up quite a bit sequentially. How should we think about that over the course of the year?

Glenn Eisenberg (EVP and CFO)

Just to your point, it's obviously going to fluctuate quarter to quarter. As you think about it for the full year, we do expect to see leverage from G&A. We've benefited on a pro forma basis year over year, even in the first quarter, but fairly nominally so. We did see a tick up in unallocated corporate expenses, which was one of the constraints, if you will. As we target, call it, the roughly 1.5% of our revenues for that category, we were high for the quarter, but for the full year, we expect to be at that, call it, plus or minus 1.5% level.

Brian Tranquil (Analyst)

Got it. Thanks.

Operator (participant)

Thank you. Our next question comes from Donald Hooker of KeyBank.

Your line is now open.

Donald Hooker (Analyst)

Great. Maybe just one kind of general question while we have Deb here. When you look at when you talk about mobile devices and clinical trials and regulatory issues around that, where exactly are we in using, kind of broadly speaking, using mobile devices in different ways in clinical trials? Maybe one or 2 areas where you think would be the biggest source of upside using these internet-enabled mobile devices?

Deborah Keller (CEO)

That is a very broad question, so I'll give you a couple specific answers. One, they're used in clinical trials mainly around patient centricity, making it easier for a patient to participate and adhere to the protocol and to do some monitoring.

Right now, what we're working with clients is to develop that because the data has to come in from these different devices and then be put into a system, which then could potentially go into a filing. That's what we're working on validating for our clients. There are a lot of opportunities, but I would say the first priority is probably around patient centricity.

Dave King (Chairman and CEO)

It's Dave. I fully agree with Deb. I think also, as we think about the mobile suite that we launched, one of the critical components is to make sure that the devices that are being used are validated and accurate because there's nothing worse than patients using mobile devices and providing information, obviously, that's either not validated or that varies from device to device.

That's going to be an important component of use of mobile devices in clinical trials as we go forward. We're pleased that we have launched the tools to be able to help our clients with that.

Deborah Keller (CEO)

It's a nice adjacency to our core competency of clinical trials. We do so many validations. We have the regulatory expertise as well as the validation experience. It's been a nice offering for us.

Donald Hooker (Analyst)

Thank you.

Deborah Keller (CEO)

Thank you. Our next question comes from Mark Massaro of Canaccord. Your line is now open.

Mark Massaro (Analyst)

Hey, guys. Thanks for the question. Question for Dave. How do you prioritize M&A between diagnostics and drug development? More specifically, as you think about your core diagnostics business, recently you had a deal in the women's health space. Again, how do you prioritize women's health over oncology or NGS?

Maybe a final comment on multiples would be great. Thanks.

Dave King (Chairman and CEO)

We have a rigorous process for looking at acquisitions, and it does not center on whether it is a diagnostics or a drug development acquisition. It centers on, first of all, does it fit one of our three strategic priorities, which, as we have talked about, is being the world's leading provider of diagnostic solutions, number one. Number two, bringing novel medicines to patients faster. Number three, using technology and tools to transform the way the care is delivered. Anything we do has to fit within those three basic parameters. The next thing we look at is, does it enhance our capabilities in a meaningful way, whether those are existing capabilities, whether they are add-on capabilities that we need to be better at the business? Then is it geographic capabilities? It could be footprint.

It could be test menu. It could be incremental capabilities that support one or the other of the businesses. Then we look at price, multiples, return on invested capital, IRR, discounted cash flows. I mean, all the basic acquisition metrics. The question, what are we prioritizing? The nice thing about our position now is that there are many, many opportunities to deploy capital towards acquisitions, and yet our businesses are performing extremely well. There is no sort of major gap that we need to fill. I do not think I can answer the question, what is the highest priority? The highest priority is high-value, high-return deals that are going to fit our strategic framework.

Mark Massaro (Analyst)

Thank you.

Thank you. That concludes our question and answer session for today. I would like to turn the conference back over to Mr. King for closing remarks. Thank you all.

Dave King (Chairman and CEO)

As you're aware, Jay Boyle recently retired as Executive Vice President and CEO of Labcorp Diagnostics. I would like to say a few words in appreciation of Jay's many contributions to Labcorp's successes over the past decade. I've known and worked with Jay for more than 15 years. He's been an exceptional lawyer and colleague, but also a trusted advisor. Jay served with great distinction in all of his roles at Labcorp, including legal, managed care, Chief Operating Officer, and most recently, CEO of Labcorp Diagnostics. Among Jay's many achievements was his instrumental role in negotiating our industry-changing contract with UnitedHealthCare, which was a critical step for us in becoming the largest laboratory company in the world. Under Jay's steady leadership, Labcorp executed brilliantly on our strategic priorities of growing the business, establishing deeper partnerships with managed care, and improving customer service.

As outstanding an executive as he has been, Jay is at the same time an exceptional person. There are legions of Labcorp employees, including me, who have benefited from Jay's wise counsel, his extraordinary generosity, and his big heart. On behalf of all of our 50,000 employees around the globe, I would like to thank Jay for his contributions to Labcorp and wish him well in his retirement. We thank you for joining our call this morning and wish you a great day.

Operator (participant)

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