Labcorp Holdings - Earnings Call - Q2 2016
July 27, 2016
Transcript
Operator (participant)
Good day, ladies and gentlemen, and welcome to the Laboratory Corporation of America Second Quarter 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, you may press star then zero on your touch-tone telephone. As a reminder, this conference call is being recorded. I would now like to turn the conference over to Paul Surdez, Vice President of Investor Relations. Please begin.
Paul Surdez (VP of Investor Relations)
Good morning, and welcome to Labcorp's Second Quarter 2016 Conference Call. As detailed in today's press release, there will be a replay of this conference call available via telephone and internet. With me today are Dave King, Chairman and Chief Executive Officer; Glenn Eisenberg, Executive Vice President and Chief Financial Officer; and Deborah Keller, CEO of Covance Drug Development. In addition to our press release, we also filed a Form 8-K this morning that includes additional financial information. Both are available in the Investor Relations section of our website at www.labcorp.com and include a reconciliation of non-GAAP financial measures discussed during today's call to GAAP. Finally, we are making forward-looking statements during today's call. These forward-looking statements include, among others, statements about our expected financial results, the implementation of our business strategy, and the ongoing benefits from acquisitions.
These statements are based upon current expectations and are subject to change based upon various factors that could affect our financial results. Some of these factors are set forth in detail in our 2015 10-K. We have no obligation to provide any updates to these forward-looking statements, even if our expectations change. Now, I'll turn the call over to Dave King.
David King (Chairman and CEO)
Thank you, Paul, and good morning, everyone. It's an exciting day at Labcorp today as we continue to establish ourselves as the world's leading healthcare diagnostics company. Operationally, we reported another strong quarter led by organic growth in Labcorp Diagnostics and Covance Drug Development. We delivered year-over-year revenue growth of 7%, continued margin expansion, and another quarter of double-digit adjusted EPS growth. Our continued business momentum is attributable to our commitment to improve health and improve lives around the globe, driven by our focus on our three strategic priorities: delivering world-class diagnostic solutions, bringing innovative medicines to patients faster, and using information to change the way care is provided. I'll now update you on our key activities during the quarter and our progress on each of these objectives.
First, to be the world's leading provider of diagnostic solutions, we continue to expand our test menu, innovate in science, and complement our internal efforts with strategic acquisitions. This morning is exciting, as I said, because we announced another important acquisition. We will acquire Sequenom, a market leader in non-invasive prenatal testing and reproductive health. Sequenom is the first company to offer a clinically validated non-invasive prenatal test, and the more than 500,000 tests it has performed to date give it the largest clinical evidence base in the industry. This is a highly strategic acquisition. Sequenom's best-in-class offerings and strong R&D pipeline perfectly complement Labcorp's extensive women's health test menu. We will now offer patients and physicians one source for the full range of women's health, reproductive genetics, and NIPT testing.
Furthermore, Sequenom expands our geographic reach, both domestically with New York licensure and internationally through licensing and commercial partnerships with emphasis on the European Union and the Asia-Pacific region. The transaction also meets our financial criteria, making it, as I said, an important and highly strategic transaction. I note that the acquisition of Sequenom is much like our strategic decision to acquire LipoScience and its unique NMR LipoProfile test 18 months ago, which has translated into strong and consistent organic growth. As we expected, our reach and customer relationships, coupled with the test's strong clinical evidence and numerous expert society recommendations, have established us as the leading diagnostic laboratory for comprehensive cardiovascular testing and risk assessment. We also continue to focus on extending our core testing capabilities beyond the traditional healthcare setting.
For example, our Bode Cellmark Forensics business is the leader in high-quality forensic DNA testing solutions, helping law enforcement agencies solve crimes across the globe. Bode Cellmark is one of two labs partnering with law enforcement across the U.S. to process a significant backlog of sexual assault evidence kits, aiding in solving open criminal cases. In addition, we continue to capitalize on our global footprint and our chemistry and microbiology expertise to provide the highest quality testing and rapid turnaround time to a growing number of food safety customers. We will next build on our track record of scientific innovation into food safety through commercialization of new technologies that enable faster pathogen detection and expected drive growth through acquisitions that increase our scale in this growing and fragmented market.
Second, to bring innovative medicines to patients faster, we continue to enhance our data capabilities, develop innovative solutions, and expand our therapeutic expertise in critical areas of drug development. Data are an essential ingredient to improve patient recruitment and study startup. We have access to unique data generated from each of our business segments. Labcorp Diagnostics provides a growing proprietary database of patient-specific information, including demographics, lab values, and diagnosis codes. Covance Drug Development has a growing base of insights into global investigator and site performance obtained through our central laboratory network and clinical trial experience. We are uniquely able to link this data to individual patients and sites, empowering patients to be more directly engaged with their own healthcare, helping enrich our clinical trial proposals and speeding patient recruitment.
In addition, our unique solutions offer clients their choice of our end-to-end services offering, fostering deeper customer relationships and expanded opportunities to grow our business. For example, our companion diagnostics franchise continues to lead the industry, as evidenced by important new tests launched during the quarter. We were the only national laboratory to introduce the Roche cobas EGFR mutation test V2 for non-small cell lung cancer patients, the first blood-based liquid biopsy test cleared by FDA for clinical use. We also extended our leadership in immuno-oncology through the commercial launch of a complementary PD-L1 diagnostic test for bladder cancer, our third PD-L1 launch, and fourth PD-L1 indication in the past year. Our world-class companion diagnostic capabilities offer our customers unmatched end-to-end development and commercialization expertise. Tying together all of our drug development growth initiatives, we focused on key therapeutic areas such as genetics, rare and orphan diseases, oncology, and infectious disease.
These strategic focus areas combine the best capabilities of both organizations to improve health and improve lives. All of our drug development businesses performed well during the quarter. We saw strong revenue growth in clinical, early development, and central labs. Customers have consistently awarded us new orders since the acquisition as they appreciate the benefits of our end-to-end offering and expanded capabilities. For our third objective, we are changing the way care is delivered through the use of information and technology-enabled solutions. In diagnostics, we are expanding our menu of decision support tools and integrated content to assist payers, physicians, health systems, and patients in better understanding and managing disease. BeaconLBS is now entering its second year, and we expect it to grow as we add new markets and capabilities to the platform.
In drug development, we are enhancing Covance's Xcellerate suite of services to enable faster patient enrollment, more efficient site monitoring, and improved study planning. Xcellerate monitoring has been successfully implemented as the exclusive central monitoring portfolio for one of our larger partners' worldwide clinical trials portfolio and is being used by over a dozen other clients. In closing, we continue to invest in assets, people, and capabilities that will drive profitable growth, unlock the value of our growing organization, and further our mission to improve health and improve lives around the globe. I want to specifically compliment both the Sequenom and the Labcorp acquisition teams for the extraordinary efforts that have led to today's announcement. The teams worked tirelessly to get us to the finish line in this important and highly strategic deal.
I continue to be enormously proud of the work of all of my 50,000 colleagues, and I thank them for the direct positive impact they have on millions of lives every day. Now, I'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 second quarter results, followed by a discussion of our Labcorp Diagnostics and Covance Drug Development segments, and conclude with an update on our 2016 guidance. Revenue for the quarter was $2.4 billion, an increase of 7.4% over last year, primarily due to strong organic growth in both segments and tuck-in acquisitions, partially offset by currency. Organic revenue growth in the quarter on a constant currency basis was 6.4%. Gross profit for the quarter was $827 million, or 34.7% of revenue, compared to $773 million, or 34.8% last year. The increase in gross profit was due primarily to strong revenue growth, partially offset by personnel costs. The decline in gross margin was due to the mixed impact from faster growth in Covance Drug Development, which has a lower gross margin than the company's average.
Excluding the mixed impact, gross margin would have improved 10 basis points. SG&A for the quarter was $408 million, or 17.1% of revenue, compared to $391 million, or 17.6% last year. Special charges in the quarter were $8 million, primarily related to the integration of Covance and our LaunchPad initiative, compared to $9 million a year ago. Excluding special charges, SG&A in the quarter was $400 million, or 16.8% of revenue, compared to $382 million, or 17.2%. The increase in adjusted SG&A was primarily due to acquisitions and personnel costs. The improvement in the SG&A rate was due to continued expense control and the mixed impact from faster growth in Covance Drug Development, which has a lower SG&A rate than the company's average. Excluding the mixed impact, the SG&A rate would have improved 20 basis points.
During the quarter, we recorded $7 million of restructuring charges, primarily relating to severance and the closure of redundant facilities. Amortization expense for the quarter was $45 million, consistent with last year. Operating income for the quarter was $367 million, or 15.4% of revenue, compared to $323 million, or 14.6% last year. Excluding amortization, restructuring, and special items of $60 million, adjusted operating income was $427 million, or 17.9% of revenue, compared to $391 million, or 17.6% last year. The increase in adjusted operating income and margin was primarily due to stress offset by personnel costs. Interest expense for the quarter was $54 million, compared to $58 million in the second quarter of 2015. The decrease was due to lower debt balances, which included repayment of $339 million of debt during the quarter. The tax rate for the quarter was 36.6%, compared to 36.1% last year.
Excluding special charges and amortization, the adjusted tax rate for the quarter was 35.7%, the same as last year. We continue to expect our 2016 full-year adjusted tax rate to be 35.3%. Net earnings for the quarter were $198 million, or $1.91 per diluted share. Excluding amortization, restructuring, and other special items, adjusted EPS were $2.31 in the quarter, up 11% from $2.09 last year. During the quarter, operating cash flow was $344 million, compared to $397 million last year. The decline was primarily due to the timing of income taxes paid last year. Capital expenditures totaled $67 million, or 2.8% of revenue, down from $69 million, or 3.1% last year. As a result, free cash flow was $277 million in the quarter, compared to $328 million last year. We continue to expect free cash flow to be between $900 and $950 million for the full year.
At quarter end, our cash balance was $640 million, down from $696 million at the end of the first quarter. Total debt was approximately $6.1 billion. During the quarter, we invested $51 million in acquisitions and paid down $339 million of debt, reducing the company's leverage to 3.3 times gross debt to last 12 months pro forma EBITDA. Now, I'll review our segment performance. Segment results exclude amortization, restructuring, special items, and unallocated corporate expenses. Reconciliations of segment results to historically reported results are included in today's press release and the current report filed today on Form 8-K. Now, I'll review the performance of Labcorp Diagnostics. Revenue for the quarter was $1.7 billion, an increase of 5.4% over last year. The increase in revenue was the result of organic volume growth measured by requisitions, price mix and tuck-in acquisitions, partially offset by currency.
The revenue increase includes unfavorable currency translation of 0.3%. Revenue per requisition increased 3.5%, benefiting from price mix and tuck-in acquisitions. In addition, esoteric testing grew at a faster rate than core testing. Total volume increased by 2.1%, of which organic volume was 1.2% and acquisition volume was 0.9%. Labcorp Diagnostics' Adjusted Operating Income for the quarter was $357 million, or 21.5% of revenue, compared to $337 million, or 21.4% last year. The increase in operating income and margin was primarily due to price mix, organic volume, tuck-in acquisitions, and our LaunchPad initiative, which was partially offset by personnel costs. We remain on track to achieve our LaunchPad savings of $150 million over the three-year period ending in 2017. Now, I'll review the performance of Covance Drug Development. Revenue for the quarter was $722 million, an increase of 12.2% over last year.
Excluding the impact from approximately 70 basis points of negative currency and the expiration of the Sanofi site support agreement, revenue increased 16.4% over last year. The strong revenue growth was broad-based across our early development, clinical, and central lab businesses. Adjusted Operating Income was $108 million, or 14.9% of revenue, compared to $90 million, or 14% last year. The increase in operating income and margin was primarily due to strong revenue growth and cost synergies, which was partially offset by the expiration of the Sanofi site support agreement and personnel costs. We remain on track to deliver cost synergies of $100 million for the three-year period ending 2017. Net orders during the quarter were $818 million, up 11% over last year, representing a net book-to-bill for the quarter of 1.13 and a trailing 12-month net book-to-bill of 1.17. Backlog at the end of the quarter was $7.1 billion.
Now, I'll update our 2016 guidance, which assumes June 30th foreign exchange rates for the remainder of the year. In addition, our guidance excludes the impact from the acquisition of Sequenom, which we expect to close by year-end. We expect revenue growth of 9.5%-10.5% after the impact from approximately 50 basis points of negative currency. This is an increase from our prior guidance of 8.5%-10.5%. We expect the Labcorp Diagnostics segment to grow 4.5%-5.5% over 2015 after the impact from approximately 10 basis points of negative currency. This is an increase from our prior guidance of 4%-5.5%. We expect the Covance Drug Development segment to grow 7%-9% over 2015 pro forma revenue after the impact from approximately 110 basis points of negative currency.
This is an increase from our prior guidance of 6%-9% due to strong organic growth, partially offset by a 60 basis point unfavorable change in currency. Excluding the impact from currency and the expiration of the Sanofi site support agreement, we expect net revenue to increase 11%-13%. We expect adjusted EPS of $8.60-$8.95, which implies a growth rate of 9%-13% over 2015 and is an increase from our prior guidance of $8.55-$8.95. As a reminder, our adjusted EPS guidance includes an increase in our share count due to stock compensation and option exercises but does not include any share repurchases. Finally, we continue to expect record free cash flow for the year of $900-$950 million. This concludes our formal remarks, and we will now take questions.
Operator (participant)
Thank you.
Glenn Eisenberg (EVP and CFO)
Operator?
Operator (participant)
Yes, sir. Ladies and gentlemen, if you do have a question at this time, please press the star, then 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. Once again, if you do have a question, please press star, then one. The first question is from Robert Willoughby of Credit Suisse. Your line is open.
Robert Willoughby (Managing Director and Healthcare Technology and Distribution Equity Research Analyst)
Dave and Glenn, it looks like with EPS guidance up, what's the gating factor to raising the cash flow guidance? And then maybe on the Sequenom deal, it hasn't really worked as a public equity. Can you kind of review what some of the challenges have been and what you can do to reverse some operating losses there?
Glenn Eisenberg (EVP and CFO)
Sure. This is Glenn. I'll take the first part, and Dave can do the other. With regard to the cash flows, as we look to the guidance, and to your point, we did increase the midpoint for the revenue and the earnings guidance that we provided. We elected to hold the cash flow guidance where it was, again, at record levels. Given that from a cash standpoint, we generate the majority of our free cash flow in the second half of the year. From our perspective, we decided to wait till the third quarter is completed when there's one quarter left, in which case we would look to modify that cash guidance as well.
Robert Willoughby (Managing Director and Healthcare Technology and Distribution Equity Research Analyst)
Okay.
David King (Chairman and CEO)
Robert, it's Dave. I think the major challenges for Sequenom as a standalone entity have related to breadth of test menu and scale. I think under Dirk van den Boom's leadership in the last nine months, Sequenom has made significant improvements in technology and operations. The reality is there still is a need for the comprehensive women's health portfolio. There still is a need for broader reach into the OB-GYN office. There is a need for reach in terms of convenience of being able to order NIPT testing on one requisition form with the same orders as other women's health-related testing. I think from an operational perspective, we think about several opportunities to make this a success, and we strongly believe it will be a success.
Number one is just improving the laboratory operation and the efficiency of that operation, which, as you know, is something that we excel at. Number two is expanding the reach of their sales force, which we think of very highly, and extending that into the primary care and the OB-GYN market. Number three is the comprehensiveness of the test menu and the opportunity to create one point where physicians can order all of what they need in women's health and reproductive genetics.
Robert Willoughby (Managing Director and Healthcare Technology and Distribution Equity Research Analyst)
Do you expect it to be accretive year one, Dave, or?
David King (Chairman and CEO)
We do expect it to be accretive. It's not going to be materially accretive in year one, but it will be accretive in year one, and we expect longer term that it will be a significant contributor to earnings growth.
Robert Willoughby (Managing Director and Healthcare Technology and Distribution Equity Research Analyst)
Thank you.
Operator (participant)
Thank you. The next question is from Bill Bonello of Craig Holland. Your line is open.
Bill Bonello (Analyst)
Good morning. I wanted to follow up also with some questions on Sequenom. The logic of how you can improve their business makes all the sense in the world to me. What I guess I would like to understand is sort of what they bring to you in terms of the advantages of owning this asset versus sort of maintaining a contractual relationship with them and offering the breadth and the other tests sort of on your own.
David King (Chairman and CEO)
Bill. It's Dave. Good morning. It's just more complicated to maintain a send-out relationship when you're talking about the high-end reproductive genetic testing. It's more complicated, obviously, for somebody like Sequenom because they're not offering the full test menu. You're dealing with organizing logistics. You're dealing with routing blood from one place to another, routing samples from one place to another. You're dealing with delays in turnaround time as a result of the logistics. Although a send-out relationship in concept sounds attractive, it actually leads to more complexity. As we think about how to be successful in the business generally and in this aspect of the business in particular, what the physicians and the patients want is more simplicity. They want to be able to order on one rec form. They want to be able to have one courier pick it up.
They want to be able to have it go to one place where the logistics are handled by Labcorp instead of being handled by two different entities. They want to get the results back on one report form, and they want to have one place to go for interpretation if genetic counseling, for example, is required. From my perspective, what we're doing is we're taking the opportunity to integrate a best-in-class NIPT test into a best-in-class women's health portfolio. That, in my mind, leads to enormous opportunity to grow in that market, which is one of the fastest-growing parts of the diagnostics industry in which we think over the long term, as the technology improves and the test menu improves around not only non-invasive prenatal testing but all sorts of non-invasive testing that's now done through more invasive methods, that we'll be extremely well-positioned to succeed.
Bill Bonello (Analyst)
Just as a follow-up on that, just two things on that. One, is it your opinion as part of the reason, the timing on this now, that indeed we're going to see an expansion into the average risk market from the high-risk market, I assume, still given all your comments about OB-GYNs? Then more importantly, are there things that you see in their pipeline or tests that you imagine you can develop based on their technology that are part of what's driving this?
David King (Chairman and CEO)
We are seeing significant progress in payer coverage for non-invasive prenatal testing for average risk patients. The opportunity there obviously grows the market significantly because it provides at least the potential to reach a couple hundred million covered lives as opposed to what we would characterize as merely the high-risk market. You are seeing payer acceptance of it because the technology is sound. The clinical results are well-validated. Again, with Sequenom, you have over 500,000 tests performed, and you have the largest clinical database to support the expansion of the market. In terms of expansion of the testing, obviously, Sequenom has been at the forefront in terms of offering fetal fractionation, microdeletions, now the genome aspect of NIPT to expand upon the original MaterniT 21 test. Yes, we think there will continue to be opportunities there.
I would just also parenthetically, as mentioned in the talking points, Bill, point to the international opportunity that this provides us should not be underestimated because Sequenom has focused on Europe and Asia-Pacific, and those are markets where I think there's still plenty of opportunity for adoption of non-invasive prenatal testing.
Bill Bonello (Analyst)
Excellent. Thank you very much.
David King (Chairman and CEO)
Thank you.
Operator (participant)
Thank you. The next question is from Amanda Murphy of William Blair. Your line is open.
Amanda Murphy (Principal and Life Sciences Tools and Diagnostics Senior Analyst)
Hi. Good morning. I actually had some questions as well on Sequenom. If I recall correctly, you had spent quite a bit of effort in towards NIPT testing yourself. I'm just wondering how this will integrate into the existing business. You mentioned managed care contracts. Are you going to be able to leverage any of Sequenom's contracts, or will they be sucked into your broader contracts?
David King (Chairman and CEO)
Amanda, it's Dave. Obviously, there are—and I think these comments were made on Illumina's call—people have been moving toward performing these tests in-house. We like Sequenom's technology. We like the breadth of the test menu. Obviously, the New York licensure is quite important. This will integrate well into what we've already done in non-invasive prenatal testing. Again, the number of tests that they've performed and the clinical evidence and support will really help in terms of the demonstration that this test makes sense for the average risk population. In terms of the managed care contracts, typically, the managed care relationships fall under our contracts post-acquisition. We've carefully examined to the extent we're able to do so, obviously, as part of the diligence process, our managed care contracts versus their managed care contracts. We don't see material difference there.
That's another positive in terms of how we think about being able to put these businesses together.
Amanda Murphy (Principal and Life Sciences Tools and Diagnostics Senior Analyst)
Got it. I know this may be too early to answer, but do you have a sense yet of how this might affect the patent pool that's shared with Illumina and royalties that are paid in that context?
David King (Chairman and CEO)
I think it probably is too early to answer, but again, we do not expect it to have any material impact.
Amanda Murphy (Principal and Life Sciences Tools and Diagnostics Senior Analyst)
Got it. Okay. Thanks very much.
Operator (participant)
Thank you. The next question is from Lisa Gill of JP Morgan. Your line is open.
Lisa Gill (Managing Director)
Great. Thanks very much. Thanks for all the commentary. Dave, I guess just two questions for me. The first would be CMS came out the other day talking about bundling cardiovascular. Obviously, you have a suite of products on that side. I know over the years we've talked about, as we move in this direction, getting some of these tests into lower-cost settings. Do you think that there'll be an impact to Labcorp as we start to really start to see this shift to fee-for-value in specific categories?
David King (Chairman and CEO)
Morning, Lisa. Yes. Excuse me. Yes. As you know, CMS started out with the idea of the bundled demonstration or the bundled payment for the joint replacements. Now they've proposed bundled payments for cardiovascular. Obviously, it's going to take some time to see how that really plays out. I would say that particularly when you move away from the inpatient setting—so let's distinguish between the inpatient and the outpatient setting—in the inpatient setting, I continue to believe that these types of bundled structures will encourage hospitals to look at how they can reduce the cost of the components of the bundle. On the laboratory and the diagnostic side, that obviously puts us in a very strong competitive position.
On the outpatient side, as you look at bundled payments for total care, again, physicians who are treating patients who are owned or affiliated with health systems are going to be looking at, "How do I get each component of what I need to treat this patient at the highest quality and the most effective price point?" We are going to be extremely well-positioned. With cardiovascular in particular, as you think about cardiovascular risk because of LipoScience and the NMR LipoProfile and because of our comprehensive suite of cardiovascular services and risk assessment services, I think we are going to be extremely well-positioned to be a valuable ally to the hospitals as they think about how to make the most of any sort of cardiovascular bundling.
Lisa Gill (Managing Director)
Is it too early for you to already have those conversations with the hospital entities? As we think about this, 2018 is not all that far away. I'm just curious at this point, are you starting to have those conversations and starting to think about how the contracting will come about in the next couple of years?
David King (Chairman and CEO)
I think that's a really important point to make, which is we spend a lot of time focused on the hospital relationships, and we think about the importance of our engagement with health systems as broad partnerships. We don't spend a lot of time talking specifically about lab management, for example. We have plenty of lab management deals, but we try to frame them in the context of an overall partnering relationship around pathology, around reference testing, around lab management.
We certainly are having these conversations about—in every hospital executive I talk to, it's about, "How do we continue to provide the highest quality care to our patients and continue to reduce the cost side of the equation?" Those conversations are underway, and we're optimistic about the opportunity to help the health systems in dealing with some of these changes in reimbursement because I agree with you. 2018 is not far off at all when it comes to the type of structural change we're seeing.
Lisa Gill (Managing Director)
Just one follow-up question for Glenn. Glenn, just looking at the leverage at 3.3 times, when we think about the acquisition, will you use cash? I know there is no share repurchase in your guidance, but I think there was some thought that without an acquisition, you would move back towards purchasing some shares in the back half of the year. How should we think about that?
Glenn Eisenberg (EVP and CFO)
Lisa. To your point, we're leveraged at 3.3 now, but again, the bulk of the free cash flow we generate is in the second half. Obviously, our leverage is going to come down. We will use cash to acquire Sequenom by the end of the year, which will take the leverage up, obviously, from where we would have been otherwise, but still, it'll be lower than where we are currently. We continue to not provide our guidance that it would include share repurchases, but we'll continue to consider the possibility of repurchasing shares later this year or clearly, given the cash flows of the business, not too far thereafter. For right now, again, an all-cash transaction with strong balance sheet by the end of the year.
Lisa Gill (Managing Director)
Great. Congratulations on a great quarter. Thanks very much.
David King (Chairman and CEO)
Thank you.
Operator (participant)
Thank you. Ladies and gentlemen, as a reminder, please limit yourself to one question. The next question will come from Jack Meehan of Barclays. Your line is open.
Jack Meehan (Equity Research Analyst)
Hi. Thanks. Good morning, guys. I had two questions on Covance. Dave, could you give us an update on the integrated offering and just traction with incremental bookings in the market? Maybe for Glenn, as you look at the back half of the year, the guide now, at least by my math, implies about five points of organic growth. Obviously, the comps get tougher, but just how would you characterize the guidance at this point?
David King (Chairman and CEO)
Morning, Jack. I'm going to ask Deb to give you an update on kind of the business and the integrated offering, and then Glenn will answer your question on the back half.
Deborah Keller (CEO)
Good morning, Jack. This is Deborah Keller. I think as we look at the business and the integrated offering, I think there's two parts to it. The first is that clients have really been able to see and understand the value proposition of the combined companies. We are differentiated, and they see that. As we look at the orders, since we've made the announcement, we've recorded over $200 million in clinical orders where the Labcorp data actually played a key role in the win. In recent quarter, we actually added a large oncology study where we had an integrated offering as well as what we did in the rare and orphan disease. We had a win in that category as well. I think when we look at the central labs specifically, that business has taken market share for many years and continues to do so.
Now with the acquisition of Labcorp, we have even more offerings that we can provide to clients, whether it's anatomical pathology or genomics around the globe. I would say that we've been very successful with our integration efforts, both commercially and then operationally.
David King (Chairman and CEO)
I would say, Jack—it's Dave—I would just add a couple of follow-ons to that. I mean, my perception is that my conversations and probably Deb's as well are at a different level from prior conversations. We're talking to senior people about broad collaboration across multiple areas of interest for the drug companies as opposed to a procurement fight about, "How much am I going to pay for this?" or, "How much am I going to pay for that?" There is a much greater emphasis in drug development now on quality and speed, and the combination of our capabilities really plays right into that. Also, if you just look at the performance of companion diagnostics, which we highlighted as one of the three key priorities. I mean, our companion diagnostics businesses combined have done tremendously well.
The launch of the Roche assay that I mentioned in the talking points, but I also highlight immuno-oncology, one of the fastest-growing therapeutic areas. Everybody's working on immuno-oncology, and we clearly are the market leader in developing and launching these tests with three tests and four applications in the last year or so. I think we're doing an excellent job on the integration, and Covance has done a terrific job on the early development solutions. It's about having an extensive menu that customers can choose what they need from and then delivering the value. With that, I'll turn it over to Glenn for the financial question.
Glenn Eisenberg (EVP and CFO)
Jack. To your point, the implied growth rate in the second half for Covance is lower than the first. We're looking based upon a midpoint, call it around 4% year-over-year growth in the second half. When you look at the impact from currency of a little over 1%, you look at the impact from the Sanofi site support agreement, which is a little over 2%. It kind of gets you to, call it a little bit over 7% growth rate in the second half year-over-year off of a very strong second half of the year that we had last year. Again, consistent with kind of the historical growth rates of Covance, but we believe it's still a very strong performance expectation for the second half of the year.
Jack Meehan (Equity Research Analyst)
Thanks. That's great. I appreciate all the detail. If I can squeeze in one more just on gross margins, Glenn, you overlapped some optical headwinds this quarter. Any color you can provide just on traction from here would be great. Thanks.
Glenn Eisenberg (EVP and CFO)
Again, the company overall is performing well. Obviously, a big focus on our gross margin, which obviously is helped by demand, helped by our LaunchPad initiative. Again, we're pleased to see that gross margin effectively improved year-over-year when you take out just the mix impact, but frankly, as well as our SG&A side where we got good leverage as well taking out mix. Pleased with the performance at the top line and how we're leveraging it.
Operator (participant)
Thank you. Again, we ask that you ask one question and requeue for questions. The next question is from Ross Muken of Evercore ISI. Your line is open.
Ross Muken (Senior Managing Director, Partner and Equity Research Analyst)
Good morning. I just wanted to dig in a little bit more on Covance. It seemed like the net order growth rate continues to be strong. I know you highlighted some of the cross-sell. Can you just give us a little bit of color? I mean, the implied book-to-bill sort of suggests that the early phase business continues to trend well, and maybe some of the others that have shorter turnaround time are kind of elevated. Help us just understand from a mixed basis in the core of revenue how the three key segments are kind of operating and how you expect them to trend over the back half of the year.
Deborah Keller (CEO)
Hi, Ross. This is Deb. Thanks for the question. As you said, the net orders did increase 11% year-on-year, and we had a solid order quarter. The book-to-bill obviously is impacted by our very strong revenue growth, which was double digits in all of the different service lines that we have. As you said, you can remember that we have three business lines in Covance, which is not apples-to-apples to our competitors. Our book-to-bill is an average of all of those areas. We've seen, continue to see strong orders in early development. That's a really good marketplace right now. There's good market demand there, and we're winning. We are very happy and pleased with the performance from that group. Central Labs, as I said earlier, continues to take market share and has had good orders as well.
Clinical, we've had good orders in our early clinical, very strong orders. We have seen more and more emerging clients from that segment come into our business there. We have seen a little bit more in cancellations and delays. In our phase II, IV, we've had some good order quarters. You do see the volatility as you look at some of our competitors, and you look at their Q2 earnings versus or their Q2 book-to-bill versus their Q1. You do see some volatility there. We recently added a sales leader for our phase II, IV business and added some additional salespeople. We are starting to bear fruit from some of those investments.
Ross Muken (Senior Managing Director, Partner and Equity Research Analyst)
Great. And just maybe quickly, Glenn, just as a cleanup, what was the M&A contribution on the rev-per-rec side?
Glenn Eisenberg (EVP and CFO)
We normally don't break that level out. From a volume standpoint, we do comment that it was, I guess, around 90 basis points. We do say, obviously, it's a good component of the rev-per-rec. I think on average, if there is such, you can say it's in the ballpark of around a third of it, which is, I guess, our M&A overall had a nice impact on the quarter. Some of that is annualizing from deals that we would have done in the prior year. Going forward, the impact would be more in line with what our traditional growth rate for M&A is at around 1%.
Ross Muken (Senior Managing Director, Partner and Equity Research Analyst)
Great. Thanks.
Operator (participant)
Thank you. The next question is from Steven Valliquette of Bank of America. Your line is open.
Steven Valiquette (Managing Director and Healthcare Technology and Distribution Analyst)
All right. Thanks. Good morning. You just kind of touched on the question I was going to ask on the rev-per-rec. It'd be just on pricing. Maybe you can just remind us again your latest thoughts on whether or not there may be any material clinical lab fee schedule adjustments by CMS for 2017 in place of the delay of the PAMA-related changes. Just curious to get your latest thoughts on that. Thanks.
David King (Chairman and CEO)
It's Dave. Because PAMA very clearly set out how the clinical lab fee schedule is to be adjusted over time, we don't expect that there will be any 2017 adjustments other than the potential CPI update that's built in. Generally, I would think about the clinical lab fee schedule for 2017 as flat. In terms of overall pricing, I just want to be clear that the revenue-per-requisition increase that you're seeing is driven largely by mix, not by unit price. We think of the pricing environment as stable, and we expect it to be so out through the balance of this year and 2017.
Steven Valiquette (Managing Director and Healthcare Technology and Distribution Analyst)
That's helpful. Thanks.
Operator (participant)
Thank you. The next question is from Ricky Goldwasser of Morgan Stanley. Your line is open.
Ricky Goldwasser (Managing Director and Head of US Healthcare Services and Technology Research Team)
Good morning. A couple of questions here. First of all, on organic volumes at 1.2%, trend seems to be stable compared to the first quarter. Dave, do you think that this is the new normal for the industry? Is this kind of like the steady state on an organic volume that we should think about as we build our models going forward?
David King (Chairman and CEO)
Ricky, I think that's reasonable. Obviously, when we talk about that organic volume, that's really just the growth in the business that comes from essentially more tests from the same customers. I think 1.5% in that range is very realistic to think about over time. Again, just given the demographics of the population, the increasing number of insured lives, the potential for incremental Medicaid expansion. I do think that that's the right way to think about it. Obviously, it doesn't take into account things like contract wins or acquisitions, which we tend to call out separately.
Ricky Goldwasser (Managing Director and Head of US Healthcare Services and Technology Research Team)
And then a question on PAMA and the visibility that you have into 2018. Is it fair to say that given your scale and that the new reimbursement is going to be weighted by size and the fact that you are a low-cost provider provides you with some fairly good visibility into what at least the floor reimbursement could be? If that's the case, any thoughts about your ability to offset the changes to price with additional cost reductions in 2018?
David King (Chairman and CEO)
I think in terms of visibility, part of the challenge is that although we're pleased with the expansion of the applicable labs in the rule that CMS issued, we still don't know what that really means in terms of capturing the hospital outreach business. I just want to say that I think CMS, I'm pleased that CMS has been willing to consider the industry's comments. I think ACLA has done a terrific job and the hospital associations as well in bringing these issues to CMS's attention. I continue to be disappointed that the data show that 50% of lab revenue is still going through the hospitals, even though the volume is lower, considerably lower than what goes through the independent labs. That means hospital pricing has to be way higher, and we all know it is.
To say that we're doing a market survey and essentially take into account only a very limited slice of that market, to me, does not do what Congress asked CMS to do. Now, having said that, our visibility into what the impact or the floor will be is still limited until we go through the process of understanding how many more labs are captured and what the survey looks like. In terms of offsetting the financial impact, I think it's important that people think of LaunchPad as a long-term initiative for our business, not as specific projects. What we've said about LaunchPad is that we're going to get the savings over a three-year period. What we've also said is LaunchPad has now transitioned into organizational and structural activities as opposed to things like our supply chain.
A lot of the things that we're doing around LaunchPad, particularly now focusing on that front-end engagement with the patient, are going to help us to offset the impact of whatever the PAMA and clinical lab fee schedule reductions in 2018 turn out to be.
Ricky Goldwasser (Managing Director and Head of US Healthcare Services and Technology Research Team)
Thank you.
Operator (participant)
Thank you. The next question is from Nick Jansen of Raymond James. Your line is open.
Nick Jansen (SVP)
Hi, guys. I just wanted to dig a little bit deeper into BeaconLBS and what you're doing with United in Florida and the potential for that to be broadened at some point in time. I know the United contract has an expiration date end of next year, and just wanted to get your thoughts on how that program could be rejiggered, thinking about a more broader rollout at some point in time. Thanks.
David King (Chairman and CEO)
I think one thing to remember is when we think about BeaconLBS is, BeaconLBS is something that the BeaconLBS team invented from scratch and built. That is a pretty significant accomplishment that that team took an idea and a concept and really built it into a business that is now generating a pretty significant amount of revenue. The results from BeaconLBS, when you look at the things that the team set out to achieve, the out-of-network lab spend in Florida has declined. The test selection based on evidence-based guidelines has improved. The use of the lab network has increased, which leads to lower consumer out-of-pocket costs. These are all, I think, positives for what BeaconLBS can accomplish. Are there things that we want to do to make it better? Absolutely.
We want to make it more attractive to providers in helping them to select the right tests so that it becomes a positive tool for choosing the right diagnostic testing. We want to expand the scope of it to increase the utility. Again, you look at the surveys, and physicians say 30% of the time they're not sure what test to order, particularly when it comes to molecular testing. So we have the opportunity to make BeaconLBS something that becomes a positive in the provider office and helps them get the right test and interpret it correctly. Those enhancements are in process. Obviously, there are also competitive tools in the marketplace, and we want to be better than the competitive tools.
As we enhance BeaconLBS, as we extend its capabilities, as it becomes more and more integrated into EMR systems, I think we will move to new markets. I think my perception is that United sees it as a valued tool to help them with correct lab test selection and management of their out-of-network spend. We are both anxious to see it grow and expand into new markets.
Nick Jansen (SVP)
I'll keep my questions to one. Thanks, guys. Nice quarter.
David King (Chairman and CEO)
Thank you.
Operator (participant)
Thank you. The next question is from Bill Quirk of Piper Jaffray. Your line is open.
Bill Quirk (Senior Research Analyst)
Great. Thanks. Good morning, everyone. First off, I guess going back to Sequenom, the deal makes sense given your channel presence, particularly in the OB-GYN side of things. Dave, help us think a little bit about some of the implications here for some of their partner relationships. Are you assuming that some of the deals may potentially move to alternative NIPT providers?
David King (Chairman and CEO)
Say again, Bill. I'm sorry. I didn't quite follow. Some of which deals may move to alternative?
Bill Quirk (Senior Research Analyst)
Yeah. I'm just thinking about some of the partners that Sequenom brought into the pool are competitors of yours in the reference lab side of the business. Just trying to get a sense as to kind of presumably, you guys took a look at this and feel pretty comfortable, but just want to get some additional color there.
David King (Chairman and CEO)
We do feel comfortable. Obviously, we have limited visibility when we're doing diligence into an acquired company's customer list, so we don't have a perfect idea. But we always assume there's going to be some attrition. One of the nice things about this test, though, is we really do feel that it's best in class. And so I think the likelihood that there's going to be significant attrition is not the same as it would be in a typical, "We're acquiring another laboratory." I think the other reality is, as you get into highly specialized testing that's really dependent on capabilities and methodology and the clinical database, that there is less appetite for switching than there is if you're just using one reference lab and now it's acquired by another reference lab. So we feel good about the ability to retain the key customers.
We are counting on and looking forward to working with the Sequenom team to make that the case.
Bill Quirk (Senior Research Analyst)
Got it. Just staying on this topic for a follow-up question, most of the comments have concerned their NIPT product. I'm curious to hear about your plans for the liquid biopsy program. They have talked about this, but candidly have kind of downplayed it in recent quarters and talked about partnering that out.
David King (Chairman and CEO)
Thank you for mentioning that. The liquid biopsy pipeline at Sequenom is something that has been there for a while. And as you say, candidly, I think from a resource perspective, they've not been able to focus on it as much as they would like. They really like the liquid biopsy opportunity, and our scientists, from their evaluation, think there's real potential there. So that's probably a part of the deal that is going to take a little longer to materialize. At the same time, we like that as a long-term opportunity. We like it as complementary to our oncology business. We'll have the resources to support that and integrate it with the work that we're doing on liquid biopsy and on oncology test development generally, which I think will be a strong positive for their program and ultimately for the market.
Bill Quirk (Senior Research Analyst)
Got it. Appreciate the color. Thanks, guys.
Operator (participant)
Thank you. The next question is from Gary Lieberman of Wells Fargo. Your line is open.
Ryan Halsted (VP and Lead Analyst on Post Acute Services Sector)
Thanks. Good morning. This is Ryan Halsted on for Gary. Just one broad question. Now that PAMA has been finalized and is capturing the hospital outreach labs, how are you weighing the opportunity to allocate your capital to expanding the diagnostics business going forward compared with Covance?
David King (Chairman and CEO)
It's Dave. I think the fact that we announced an acquisition this morning in the diagnostics space should tell you that we're looking to be opportunistic in acquiring the assets that we think are going to bring the highest value for our business and the best return for shareholders. We'll continue to do that and continue to look at the business needs and evaluate where we should deploy capital.
Ryan Halsted (VP and Lead Analyst on Post Acute Services Sector)
I mean, is there an opportunity for you to buy hospital outreach labs, do you think?
David King (Chairman and CEO)
Certainly, there may be. I think the history of hospital outreach acquisitions is mixed because you worry about significant attrition, and you worry about now that the lab is not owned by the hospital anymore, the ability to retain the work. Again, we look at the hospital and health system relationships as we want to be broad partners around the in-house laboratory, the outreach business, the reference business, the pathology, the patient management, the population health. I would not focus so much on how we deploy capital toward hospital outreach as I would on how do we deploy capital to meet our stated criteria, accretive in year one, meet our financial metrics, and provide value to shareholders over time.
Ryan Halsted (VP and Lead Analyst on Post Acute Services Sector)
All right. Great. Thank you very much.
Robert Willoughby (Managing Director and Healthcare Technology and Distribution Equity Research Analyst)
Thank you. The final question is from Isaac Ro of Goldman Sachs. Your line is open.
Isaac Ro (VP and Life Science and Diagnostic Tools Senior Analyst)
Good morning. Thanks for fitting me in. Just a question on capital allocation and really specifically M&A. On the Sequenom side, just hoping you can give us a couple of the key swing factors that we should consider when thinking about how EPS accretion will play out over time. Secondly, just looking forward, what your criteria are for future deals if we consider the pro forma capital structure you'll have after Sequenom. Thank you.
David King (Chairman and CEO)
Isaac, it's Dave. As I mentioned earlier, from an accretion perspective, it will be accretive in year one, but not materially so. In the out years, the combination of the top-line revenue growth opportunity and bringing some greater efficiency to their laboratory operation, we think will give us the opportunity for the acquisition to be materially accretive. In terms of what we look for in acquisitions, we've always talked about expanding our capabilities. We've talked about geographic footprint. We've talked about test menu, two very important criteria for this transaction. We've talked about strategic fit with the business, whether it's the diagnostics business or the drug development business. In terms of the financial criteria, I mean, we look at many multiples. Obviously, we look at multiples of EBITDA, pre and post. We look at DCF.
The fundamental premise is accretive in year one and meets our cost of capital sort of by year three to four. This transaction falls squarely within those metrics. Our aspiration is that every transaction that we do and we deploy capital would fall squarely within those metrics.
Isaac Ro (VP and Life Science and Diagnostic Tools Senior Analyst)
Got it. Thanks very much.
Operator (participant)
Thank you. There are no further questions in the queue. I'll turn the call back over for closing remarks.
David King (Chairman and CEO)
As I said, it's an exciting day at Labcorp today. We appreciate everybody's time and participation on the call. We thank you and hope you have a great day.
Operator (participant)
Thank you. Ladies and gentlemen, this concludes today's conference. You may now disconnect. Good day.