Labcorp Holdings - Earnings Call - Q2 2017

Transcript

Operator (participant)

Good day, ladies and gentlemen, and welcome to the Q2 2017 Labcorp Holdings 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 you require operator assistance during the program, please press star then zero on your touch-tone telephone. I would now like to introduce your host for this conference call, Mr. Scott. From where you may begin, sir.

Scott Hillier (VP of Investor Relations)

Good morning, and welcome to Labcorp's second quarter 2017 conference call. As detailed in today's press release, there will be a replay of this conference call available via telephone and internet. With me today are Dave King, Chairman and Chief Executive Officer; Glenn Eisenberg, Executive Vice President and Chief Financial Officer; Gary Huff, CEO of Labcorp Diagnostics; and John Ratliff, CEO of Covance Drug Development. In addition to our press release, we also filed a Form 8-K this morning that includes additional financial information. Both are available in the investor relation section of our website at www.labcorp.com and include a reconciliation of non-GAAP financial measures discussed during today's call to GAAP. Finally, we are making forward-looking statements during today's call. These forward-looking statements include, among others, statements about our expected financial results, the implementation of our business strategy, and the ongoing benefits from acquisitions.

These statements are based upon current expectations and are subject to change based upon various factors that could affect our financial results. Some of these factors are set forth in detail in our 2016 Form 10-K. We have no obligation to provide any updates to these forward-looking statements, even if our expectations change. Now, I'll turn the call over to Dave King.

Dave King (Chairman and CEO)

Thank you, Scott, and good morning. Labcorp delivered record results in the second quarter, highlighted by excellent performance in the diagnostics business, a substantial increase in net orders and book-to-bill in the drug development business, and continued strong progress on our enterprise initiatives. We reported year-over-year growth in revenue, adjusted operating income, and adjusted EPS against our strongest quarter from last year. In addition, we reported solid free cash flow of $240 million and returned $100 million to shareholders through share repurchases, bringing our year-to-date total repurchases to over $250 million. The distinctive advantages of our integrated solutions are resonating with customers and partners. In the quarter, we announced two significant partnerships and closed several major health system transactions.

We are collaborating with Walgreens, Novant Health, Mount Sinai, Providence Health and Services, and Catholic Health Initiatives, prestigious healthcare organizations that share our focus on innovation to improve health and improve lives. Through these partnerships, we are expanding the impact of our offering, developing innovative solutions for the rapidly changing healthcare environment, and driving long-term profitable growth. In diagnostics, despite the unfavorable impact from the calendar of approximately 150 basis points, we had outstanding top-line growth, with another quarter of significant increases in both total and organic volume, as well as in revenue per requisition. Our broad-based strength in utilization was powered in part by our strategic focus on women's health and reproductive genetics. Our acquisition of Sequoia Genetics, a leader in non-invasive prenatal testing, has re-energized our larger genetic testing portfolio and is performing ahead of expectations.

I'd also like to highlight our long-standing strategic collaboration with 23andMe, which has demonstrated an impressive growth trajectory, represents an important innovative component of our consumer-facing offering, and presents further strategic collaboration opportunities. In drug development, the trends improved as we expected. Although our financial performance was down year-on-year, consistent with our guidance, we completed our third straight quarter of strong net orders and improved our trailing 12-month book-to-bill to 1.23. This trajectory positions the business to resume growth the remainder of the year and accelerate growth in 2018 and beyond. Moreover, as anticipated, we delivered sequential improvement in revenue, adjusted operating income and margin, and generated initial savings from the Covance Launchpad initiative. Now, I will update you on progress during the quarter on key strategic initiatives, beginning with our initiatives focused on the power of our combination of diagnostics and drug development.

From the time of the Covance acquisition, we identified the combination of Labcorp Diagnostics' patient insights and Covance's global physician investigator performance data as an attractive growth opportunity. This data-driven competitive advantage continues to yield strong results. Labcorp patient data has helped Covance secure approximately 25 new awards since the acquisition in multiple therapeutic areas, including oncology, infectious disease, cardiovascular, and gastroenterology. The dollar value of these awards continues to increase, and we are approaching $500 million in orders won. The combined data is part of almost every proposal we submit and is increasingly valued by sponsors. We are pleased with the ongoing revenue contribution from these projects and enthusiastic about the pipeline of future opportunities to leverage our unique data set.

In one recent example, our informatics team illustrated to a key large biopharma client how our proprietary insights can reveal patient availability, anticipate site performance, and inform protocol design and exclusion/inclusion criteria. Access to the data set supported our clinical and medical operations teams and led the client to select Covance as one of two preferred CRO partners to develop its late-stage portfolio consisting of a series of trials in diabetes, neurology, and oncology. We further highlighted at the time of the acquisition the importance of our companion diagnostics offering. Labcorp is uniquely positioned in this important sector of precision medicine with our end-to-end development capabilities through Covance and our commercialization channel from diagnostics. Our industry-leading expertise and experience is evident from Labcorp's role in the development of approximately three-quarters of the companion diagnostics in clinical use today.

During this quarter, we opened a dedicated state-of-the-art companion diagnostics laboratory in North Carolina and delivered a double-digit increase in year-on-year revenue, aided by continued growth in immuno-oncology services. We also won $100 million in companion diagnostic-related awards during the first half of the year, a record result. Our pipeline spans a diverse range of oncology and non-oncology indications with new and established clients and positions us well for growth in the future. Our last key enterprise initiative involves health systems, which continue to seek broad-based solutions from us. In response, we are focused on cultivating deep enterprise-wide relationships, including access to clinical trials and research opportunities through Covance, enhanced technology applications, data analytics, standardized testing platforms, and broad patient care management and access. Our emphasis on strategic, profitable, and mutually beneficial partnerships demands a selective approach to expanding our business in this area.

Mount Sinai, Palomar Health, and Novant Health contributed to our strong top-line results in the quarter, and the announcement of partnerships with these leading health systems continues to invigorate our already robust pipeline of premier health system opportunities. We continue to invest in our team and capabilities to drive this important strategic growth initiative. In addition to progress on enterprise-wide opportunities, our individual businesses also delivered important successes in the quarter. I mentioned the value of strategic partnerships a few moments ago. Last month, we announced our Labcorp at Walgreens collaboration to locate patient service centers in Walgreens stores. By bringing our lab testing services to a high-quality healthcare-centric retail environment, we will enhance patient convenience, increase direct patient engagement, broaden our channel to market, and build brand identification and loyalty.

We view the Labcorp at Walgreens initiative as additive to our existing PSC footprint, providing attractive opportunities to strategically expand our channel and customer access points with a globally trusted partner. In addition, this collaboration presents significant opportunities to leverage our complementary offerings and expertise to jointly deliver patient care. We also made strong progress in other elements of our consumer strategy, changing the way care is delivered. We now offer a pre-draw estimate to patients with most commercial insurance plans that shows their anticipated out-of-pocket costs. This service is available at all Labcorp patient service centers and a growing number of sites where Labcorp phlebotomists collect specimens in physician offices. We also continue to add content to our web-based cost estimator that allows consumers to calculate their out-of-pocket costs for testing services based on their health insurance information before their encounter.

These solutions will help patients make informed financial decisions related to the transparent cost of our services. In addition, we continue to enhance the patient experience and convenience in our patient service centers through easy self-check-in options, opportunities to learn more about clinical trials, and free Wi-Fi. Our customer focus extends beyond the patient and consumer experience. We continue to invest in technology to expand our offerings for hospitals, health systems, ACOs, large provider groups, and managed care partners. We are focused on enhancing our integrated data capabilities, including self-service report delivery, high-frequency data feeds, and new patient care management and trending insights. These upgrades will continue to support our customers' value-based care and population health management initiatives. In our drug development business, we continue to invest in the future.

Our focus on accelerating growth includes attracting additional strong talent, leveraging the breadth of our drug development offerings, and further differentiating our award-winning Accelerate Informatics platform. These areas of emphasis underpin the important role that Covance plays in bringing innovative medicines to patients faster. During the quarter, we continue to deepen the Covance bench, adding experienced clinical development leadership and strategic partnering, field development, and key therapeutic areas. The strong net orders, increased backlog, and improved book-to-bill in the quarter were driven by the depth of our customer relationships and the execution of our commercial organization. Covance's differentiated offering is rooted in its comprehensive drug development solutions, diverse therapeutic expertise, and its One Covance collaborative approach. For example, a recent phase three win for an oncology drug highlights our integrated development approach focused at the molecule level.

We initiated work on this molecule in 2011 with a first-in-human dosing study and subsequently executed the phase two trial as well. This long-standing engagement on a single product produced a strong level of trust with the customer, created opportunities to win other awards, enhanced efficiency and quality in the drug development process, and reduced its cost. Our deep scientific and therapeutic expertise is another point of differentiation. We continue to be successful in higher-value therapeutic areas and indications such as immuno-oncology, NASH, and diabetic nephropathy, complex disease states in which customers have repeatedly chosen Covance. The biomarker-driven nature of these clinical indications aligns particularly well with the strengths of our combined company. Lastly, we added new capabilities to our Accelerate Informatics suite during the quarter, including the Accelerate Risk and Issue Management module. This application empowers clients with improved workflow management capabilities, replacing current manual tools.

We also implemented further product enhancements, enabling Accelerate users to drive operational efficiency and reduce the number of manual tracking documents. The investments we are making in Koban's extend beyond our focus on revenue growth. As discussed last quarter, the expansion of Launchpad is underway as we are right-sizing the resources supporting each business area. We are also focused on longer-term business process improvement initiatives to re-engineer drug development solutions, utilize new tools and technology, enhance the customer and employee experience, and sustainably increase our margins. We continue to make solid progress advancing this initiative and adhering to the roadmap of our highly successful diagnostics Launchpad initiative. In closing, we continue to deliver strong performance as we make substantial progress on our key strategic initiatives, capitalizing on multiple growth opportunities across our markets.

Fueled by the contribution of more than 50,000 colleagues around the world, Labcorp's ability to improve health and improve lives, differentiated solutions, participate in global healthcare markets, and unlock long-term shareholder value has never been stronger and will create tremendous value in the quarters and years ahead. Now, I'll turn the call over to Glenn. Thank you, Dave. I'm going to start my comments with a review of our second quarter results, followed by a discussion of our Labcorp Diagnostics and Covance drug development segments, and conclude with an update on our 2017 guidance. Revenue for the quarter was $2.5 billion, an increase of 4.9% over last year as organic revenue increased 1.9% and acquisitions added 3.6%. This growth was partially offset by unfavorable currency translation of 60 basis points.

In addition, revenue growth was constrained by approximately 100 basis points due to the unfavorable impact from the year-over-year comparison to leap year and the timing of the Easter holiday. Operating income for the quarter was $336 million, or 13.4% of revenue, compared to $366 million, or 15.3% last year. The decline in operating income was due to restructuring charges and special items in the quarter of $50 million, compared to $15 million a year ago, primarily related to severance in connection with the Launchpad initiative and the termination of a software development project. Adjusted operating income, which excludes amortization, restructuring charges, and special items, was $437 million, or 17.5% of revenue, compared to $425 million, or 17.9% last year. The increase in adjusted operating income was primarily due to favorable price mix acquisitions and Launchpad savings, partially offset by higher personnel costs.

The 40 basis point decline in margin was due to the impact from the year-over-year comparison to leap year and the timing of the Easter holiday. The tax rate for the quarter was 33.7%, down from 34.5% last year, primarily due to the company having a higher percentage of its earnings in lower tax rate foreign jurisdictions in the quarter. The adjusted tax rate, excluding special charges and amortization, was 33.6%, compared to 33.8% last year. We continue to expect the full-year tax rate to be approximately 34%. Net earnings for the quarter were $189 million, or $1.82 per diluted share. Adjusted EPS, which excludes amortization, restructuring charges, and other special items, was $2.47 in the quarter, up 4.7% over last year. Operating cash flow was $311 million in the quarter, compared to $350 million a year ago.

The decline in operating cash flow was primarily due to higher working capital requirements. Capital expenditures totaled $69 million, or 2.8% of revenue, compared to $67 million, or 2.8% last year. As a result, free cash flow was $241 million in the quarter, compared to $283 million last year. Year-to-date, free cash flow was $403 million, an increase of 19% over last year due to higher cash earnings and lower working capital usage. At quarter end, our cash balance was $300 million, down from $366 million at the end of the first quarter. During the quarter, we invested $416 million in acquisitions and repurchased $108 million of stock. As of June 30th, we had $490 million of authorization remaining under our share repurchase program. Total debt at quarter end was $6.1 billion, and the company's leverage was 3.2 times gross debt to last 12 months EBITDA.

Now, I'll review our segment performance, beginning with Labcorp Diagnostics. Revenue for the quarter was $1.8 billion, an increase of 8.4% over last year. The increase in revenue was driven by acquisitions, organic volume measured by requisitions, price and mix, partially offset by unfavorable currency translation of 30 basis points. Revenue per requisition increased 3.6%, benefiting from price mix and the Sequoia acquisition. In addition, esoteric testing grew at a faster rate than core testing. Total volume increased 5%, of which organic volume was 1.9%. We achieved this result despite the negative impact of approximately 1.5% from the year-over-year comparison to leap year and the timing of the Easter holiday. Acquisition volume was 3.1%, which includes our recently completed Palomar Health and Mount Sinai transactions. Labcorp Diagnostics' adjusted operating income for the quarter was $375 million, or 20.8% of revenue, compared to $355 million, or 21.4% last year.

The $20 million increase in adjusted operating income was primarily due to strong organic revenue growth, acquisitions, and Launchpad savings, partially offset by higher personnel costs. Launchpad remains on track to deliver net savings of $150 million through the three-year period ending this year. The 60 basis point decline in margin was due to the impact from the year-over-year comparison to leap year and the timing of the Easter holiday. Now, I'll review the performance of Covance's drug development. Revenue for the quarter was $700 million, a decline of 3.1% from last year. Excluding the impact from approximately 140 basis points of negative currency, revenue was down 1.7% compared to last year, primarily due to the cancellation of two large clinical studies in late 2016. We continue to expect to achieve higher revenue and margins both sequentially and year-over-year in the second half of this year.

Adjusted operating income was $95 million, or 13.6% of revenue, compared to $108 million, or 14.9% last year. The decline in operating income and margin was primarily due to lower revenue and increased personnel costs, including targeted strategic investments in the clinical business to support growth, partially offset by favorable price mix, cost synergies, and initial savings from the Launchpad initiative. We remain on track to achieve our target of $100 million in cost synergies through the three-year period ending this year and have largely completed the remaining consolidation of our central lab facilities in Europe and the U.S. In addition, we continue to expect to generate initial savings from the Launchpad initiative of $20 million this year, which will annualize to $45 million beginning in 2018. We are also actively planning for the expansion of this initiative, and we will update you when our planning is complete.

The strategic investments that we have made to enhance the business's leadership, sales force, and capabilities are beginning to pay off as we posted a strong improvement in net orders and book-to-bill. For the trailing 12 months, net orders were $3.4 billion, an increase of $200 million over last quarter's trailing 12 months, producing an improved net book-to-bill of 1.23. Backlog at the end of the quarter was $5.5 billion, and we expect approximately $2.1 billion of this backlog to convert into revenue over the next 12 months. Now, I'll update our 2017 guidance, which assumes foreign exchange rates as of June 30 for the remainder of 2017 and includes the anticipated capital allocation. We expect reported revenue growth of 5%-6.5% after adjusting for the negative impact of approximately 10 basis points of foreign currency translation. This is an increase over our prior guidance of 3.5%-5.5%.

We expect Labcorp Diagnostics' reported revenue growth of 7%-8%. This is an increase over our prior guidance of 5%-7%, primarily due to continued strong organic growth and acquisitions. We expect Covance's drug development reported revenue growth of 1%-3% after adjusting for the negative impact of approximately 20 basis points of foreign currency translation. This is an increase over our prior guidance of 0%-2%. We expect revenue growth of 1.2%-3.2% on a constant currency basis, which is consistent with our prior guidance. Our 2017 adjusted EPS guidance is $9.30-$9.65, an increase of 5%-9% over 2016, and higher than our prior guidance of $9.20-$9.60, primarily due to the strength of our second quarter results. Finally, we expect free cash flow to be between $925 million and $975 million, unchanged from our prior guidance.

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

Operator (participant)

Ladies and gentlemen, if you have a question or a comment at this time, please press the star then the one key on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Our first question comes from Nicholas Jansen with Raymond James and Associates.

Nicholas Jansen (Analyst)

Hey, guys. Congrats on a strong quarter. Just wanted to get a better understanding of the accelerating organic revenue growth that's built into the Covance guidance for the back half of the year. I know net orders and book-to-bill have been really strong over the last two quarters, but just your level of visibility in terms of backlog conversion. Are we through kind of a lot of the noise that we've seen over the last 12 months on revenue? Thanks. Yeah.

John Ratliff (CEO of Covance Drug Development)

I think that you pegged it. It is based on the backlog that we have and then the last 12 months book-to-bill. The 1.23% is the last 12 months, and that's up from the 1.15% as of last quarter and 1.11% at the beginning of the year. That net order rate will then allow us to have revenue growth in the second half of 2017. We expect revenue growth in all segments, ED, clinical, and central labs. That obviously then allows us to push through the reason for the slower revenue growth in the first half that was primarily due to cancellation by the sponsors, the two large studies in late 2016. That is the rationale for the revenue growth and the backlog conversion.

Although slower based on the complexity of the trials as well as mix as well as startup, we do see the revenue growth for the second half and therefore the implied revenue growth in all segments.

Dave King (Chairman and CEO)

Nick, just a reminder that the cancellations will annualize in four Qs, so that will improve the year-over-year comp as we get toward the end of the year.

Nicholas Jansen (Analyst)

Great. My follow-up question would be on the diagnostic side. Clearly demonstrating strong organic volume growth, actually accelerating sequentially. Just maybe give us an update on your market share positioning right now.

How are these new health system relationships that you developed over the last 12 months kind of helping that figure, and how do we think about the pipeline for M&A as the reimbursement environment continues to be in flux for some of these hospital labs, which will face more greater reimbursement pressure relative to you guys? Thanks.

Dave King (Chairman and CEO)

It's Dave Alstert, and then if Gary has any further comments. Obviously, we're very pleased with the organic growth, and a number of factors are contributing: the women's health focus, the immuno-oncology and companion diagnostics, genetics driven by Sequoia. 23andMe has been a major contributor to organic volume growth as well. The health system partnerships are off to an excellent start.

Obviously, we're in early days with both Mount Sinai and Palomar Health, but they have both exceeded our expectations in terms of performance up to this time and contribute volume as well as additional opportunities for strategic partnership and growth. We are very pleased with the caliber of the institutions that we're forming these deep partnerships with, and we continue to see a robust pipeline of opportunities for hospital partnerships.

Gary Huff (CEO)

Dave, I'd like to add on to that as well. Nicholas, we saw very broad-based growth in organic, which was very encouraging because we have had a strategy of focusing on increasing and enhancing customer value through deeper customer relationships. I think when you go to the health systems piece, once again, our strategy of creating deep, broad-based relationships with anchor health plans or health systems helps us to create additional value through added products and solutions.

Nicholas Jansen (Analyst)

Great.

Thanks, guys.

Operator (participant)

Our next question comes from Jack Meehan with Barclays.

Jack Meehan (Equity Research Analyst)

Thanks. Good morning. Wanted to continue on the lab side. A much bigger organic volume number we were expecting, especially in light of the calendar. Did you see any inflection in the underlying trends at all? Then similar to the hospital commentary, in addition to just doing deals, are you seeing any additional willingness to outsource versus insource with some of the regulatory changes on the horizon?

Dave King (Chairman and CEO)

Jack, this is Dave. Take the second part of the question first. Obviously, we're in a position where there is considerable uncertainty about what particularly the government reimbursement environment's going to look like going forward. I do not think that's changed a lot of perspectives in terms of the hospital labs. I think maybe it's accelerated some decision-making.

We see more a desire to, at least in the customers that we're targeting, to partner broadly at the strategic level around the on-site laboratory, the reference work, the pathology, the patient recruitment, the care management, the analytics. That's our focus, and it's always been our focus in terms of how we think about these health system partnerships. We are optimistic that we're going to continue to have significant deals to announce, but they take time. As we said in the prepared comments, we want to be selective about how we choose to allocate our resources and where we can bring the most value.

Jack Meehan (Equity Research Analyst)

Just on the first part of that question related to any sequential underlying trends in the volume rate?

Dave King (Chairman and CEO)

I don't think there's any particular inflection points. We've seen a nice steady increase across a number of these areas.

I will say, obviously, the non-invasive prenatal testing is growing, and that's pulling along other OB-GYN work, which is really one of the major value propositions that we have with Sequoia. But we're seeing nice broad-based growth across the core, and with Essentera growing a little bit faster than the core business, we're seeing strong positives across the environment.

Jack Meehan (Equity Research Analyst)

Great. If I could just follow up on pamel, how much revenue percentage remains with the JVs that remain outstanding? Did that contribute to any of the margin decline there in the lab business?

Dave King (Chairman and CEO)

I don't have the specific number in terms of the revenue that's outstanding, but in terms of the margin decline, remember the impact of the days explains the margin decline entirely.

That said, we would have had margin improvement, but for the mix down from the acquisitions that have closed because they're not fully integrated into the business yet, and so they haven't reached operating margins.

Gary Huff (CEO)

Yeah. The one thing I'd just add, albeit it's what David said, the acquisitions obviously did have a negative mix impact on our margins as they've become fully integrated. With your specific question on the JVs, until they're consolidated, if you will, they show up below our lines, so really not impacting our operating income at the segment level. Ultimately, when we close those deals, then that income will move up to the segment as well.

Jack Meehan (Equity Research Analyst)

Great. Thanks, guys.

Operator (participant)

Our next question comes from Lisa Gill with JP Morgan.

Lisa Gill (Managing Director)

Thanks very much. Dave, I just wanted to start with PAMA.

Yesterday, Quest had made a comment that the ACLA had met and reiterated the thought that not everyone that's being included today or not all the hospital outreach that should be included are not necessarily being included, and basically thought that perhaps that this could be pushed out from a timeline perspective. I just wanted to get your thoughts around that.

Dave King (Chairman and CEO)

We sent a letter to CMS, met with the CMS administrator, have had multiple legislative and executive branch meetings explaining that the dataset that they are reviewing includes only approximately 5% of the hospital volume that goes through hospital labs. As we know, there's a significant delta between what hospitals get paid by commercial insurance and what independent laboratories get paid.

As we've said from the very beginning, Congress intended to have a market-based approach, and the rule that CMS wrote—and we said this in our initial comments to the rule, and we've been saying it ever since—the rule that CMS wrote looks at a highly selective portion of the market in a way that does not reflect the true market. We've asked for a six-month delay for them to fix the rule to allow for inclusion of the hospital outreach laboratories in the commercial pricing that is not included.

I don't have any insight on whether that will be permitted or not, other than to say that ACLA and all of our colleagues in the industry and other laboratory trade associations as well and the hospital trade associations have been involved in discussions with CMS and with the legislative and executive branch about trying to make this proposal work the way that it was intended to work. I'm hopeful that we'll get a better resolution than what we have seen to date.

Lisa Gill (Managing Director)

When will we hear, though, about the—so you send the letter, you go through this whole process.

Is there a timeline that they need to respond to you in X number of days so we would know before the final ruling comes out in September, or would it be simultaneously that they come out at that point and say, "Look, we're going to delay it because we've now taken a second look and we've decided the following"? I mean, I'm just trying to understand this better from a timing perspective.

Dave King (Chairman and CEO)

Yeah. I wish there were specific requirements, but there are not. So when we were having trouble loading the data in the portal, we made multiple requests for an extension of the deadline, and we didn't hear for quite a while, and then they agreed to extend the deadline pretty close to the initial deadline, which, as I recall, was in March, and they gave us a 60-day extension.

So we're optimistic that they'll respond in a timely fashion. I will say, though, we are obviously preparing for next year on the assumption that there's not going to be any change in the implementation and that we need to take the appropriate actions to manage whatever will come out in September.

Lisa Gill (Managing Director)

Okay. That's helpful. Thank you.

Operator (participant)

Our next question comes from Steve Villacurti with Bank of America, Merrill Lynch.

Oh, hey. Thanks. Good morning, guys. From the CRO business, we can obviously infer from the improved TTM book-to-bill, bookings were strong in the quarter. I'm not sure if we touched on this before or not, but just how do we think about the bookings trends in early-stage development versus late-stage? Are you seeing perhaps greater strength in one side more than the other, or are things pretty broad-based as far as the improvement in net orders?

John Ratliff (CEO of Covance Drug Development)

This is John, and thanks for the question, Steve. The strength is pretty broad-based. This past quarter, it was actually from the lab side. Over the last three quarters, it's been over the strongest unit would be on the clinical side. Early development, though, had strength even last quarter. The proposals are up in the early development area as well as quarter-to-quarter on clinical and the lab side. Just say that the strength's in all areas. The 1.23% book-to-bill is even with a weak third quarter of 2016 inside of it. We look to continue that strength throughout the second half.

Okay. One other quick follow-up. I know you guys talked previously about perhaps improving your functional service provider or FSP offerings. Where do we stand on that right now, and has that helped in any of the accelerated bookings in the quarter?

It has helped in terms of the first half. We have actually a pretty robust business in terms of the FSP and the monitoring areas with a number of different large clients. At the same time, we'd like to strengthen the FSPs in the biometrics area, etc. Nice strength within the FSP areas. I'd also say in that clinical business, we've actually seen nice diversity of the business wins. We know we've talked to you about oncology, and it'll stay a strength in our backlog, but we've had that even broaden out to the FSP business, to the cardiovascular metabolic areas as well, and somewhat stabilized in that regard and given wider diversity on the strength of our talent that we've added and/or the strength of the talent that we have within the business.

Okay. Great. That's helpful, Keller. Thanks. Perfect. Okay. This is John.

Operator (participant)

Our next question comes from Ross Muken with Evercore ISI.

Ross Muken (Senior Managing Director and Partner)

Just sticking sort of in the same vein as Steve, as we think about all the M&A that's gone on on the CRO side, obviously, you guys are much farther into your process in terms of having integrated the asset, and obviously, others have dealt with also a number of the industry challenges. As you think about sort of the potential for share gains in the market now that you could potentially exploit some of the investments you've made and utilize the technology portion, and hopefully, we're sort of through this period of cancellations, although that's always tough to predict, how are you thinking about the setup of you versus the remainder of the space from that perspective and whether or not, particularly on the clinical side, you guys can start making greater strides?

Obviously, this quarter orders were great, but consistently show maybe some share progression over the maybe next 36 or 24 months.

Dave King (Chairman and CEO)

Ross is Dave. Obviously, we're happy to comment on our own business, and I think John has done an excellent job of that. I think we're extremely well-positioned. We continue to invest in the things we need to be positioned in. We continue to invest in the areas that we need to strengthen, such as the FSP and some of the therapeutic areas. I think we're going to be very well-positioned. Ultimately, how we get selected is a combination of our strengths and capabilities, our technology, our leadership, our relationships, and we're pleased about where we are, and we're pleased about the improvement.

I think that's all we're going to say on the topic of share and share gain because a lot of that has to do with where the competitors are, and it's really not our practice to give commentary on the position of our competitors in the market. I'd just say, Russ, just to on our strength, A, we're proving it in terms of the net orders. Second, we're proving it with approaching the $500 million in terms of the orders based on data. We're proving it on, as Dave said, companion diagnostics, a solution that's evidence of the combination. We're proving it on really the high level of interest from the health systems in becoming preferred clinical partners, and we're proving it even from the opt-ins that are coming from the patient service centers in terms of the 145,000.

This is a people-based business, and we're adding talent. We're adding executive talent and deepening our bench, so we feel good about the future.

Ross Muken (Senior Managing Director and Partner)

Thanks, guys.

Operator (participant)

Our next question comes from Amanda Murphy with William Blair.

Amanda Murphy (Analyst)

Hey, thanks. I just had a couple more questions on the Covance side. I guess, Dave and John, you've been pretty open with the need to scale the clinical business. I just wanted to get your latest thoughts there, how you're thinking about increasing exposure to some of the things you talked about, small, mid-cap pharma, Asia, etc., just especially given the number of CRO assets have traded so far this year.

Dave King (Chairman and CEO)

Amanda, it's Dave.

I think the most important thing for people to take away from what's happened so far this year is we're a disciplined and focused buyer, and when we buy, it's going to be an asset that fits our needs and meets our financial return criteria. We're still interested in doing the things that we've talked about. On the other hand, I should be very clear that we don't have to do anything. We don't have to overpay for an asset. We don't have to acquire something that's not the right fit for us financially, culturally. We're going to continue to evaluate our position, invest internally in building our strengths, as John has made reference to. When we have something further to update you on, we'll absolutely do that.

Amanda Murphy (Analyst)

Got it. Okay.

Then also just a question on the cancellations that are pretty well-discussed, but I was curious if you could help us understand the performance of Covance sort of excluding that in the quarter. Was revenue in line with your expectations? Just thinking about the two cancellations, just how they've progressed over the year, I think that would be helpful just to get a sense. Obviously, you talked about Q4, but just in terms of how that impacted the year so far and then Q3 or the rest of the year, I guess, would be helpful. Thanks.

Dave King (Chairman and CEO)

Yeah. Cancellations this past quarter, first half, first three quarters of last year, all in line. The only abnormal one was where we noted in fourth quarter. From that vantage point, we obviously called that out on the two large studies within the central lab.

Cancellations are right in line with what's transpired on five of the last six quarters.

I think, Amanda, to your specific question on the progression, I think the impact of the cancellations was fairly immediate. It was fourth quarter mostly and then a little bit lapped over into the first. That's why you would see the comp in the fourth quarter being over a lower number.

Gary Huff (CEO)

Yeah. Obviously, in terms of those cancellations that kind of happened in November, it's like Dave said, they annualized in the fourth quarter. Obviously, then 2018 will be a much more normalized year with respect to that.

Dave King (Chairman and CEO)

Just from that cancellation perspective, the impact—I mean, I get the annualization piece of it, but the impact through the year, is it straight line then, or is it—I think you're saying it was a larger effect right away, and then it should diminish even excluding the annualization point?

Glenn Eisenberg (EVP and CFO)

Yeah. Amanda, this is Glenn. Yeah. The impact is pretty straight lined. It was an active program that was scheduled to go through the full year, if you will, for most of the year. Expect each quarter until we get to the fourth quarter to have the same impact.

Amanda Murphy (Analyst)

Got it. Okay. Thank you very much.

Operator (participant)

Our next question comes from Erin Wright with Credit Suisse.

Erin Wright (Analyst)

Great. Thanks.

On the CRO business, can you speak to the overall RFP environment as well as the biotech funding environment and how your integrated offering is resonating across larger pharma versus smaller biotech customers? Thanks.

John Ratliff (CEO of Covance Drug Development)

Sure. This is John again. In terms of the biotech business, it's robust. It is in the 15%-20% area of our business, much more significant in the early development area. We are up in biotech in the first half over 2016. We see that as a significant opportunity to penetrate greater. That is true within our clinical business as well as our lab business. We see large pharma in terms of spend, but more so in the lower single digits in terms of the R&D dollars, the mid-tier in the mid-single digits, and then the biotechs in that higher single-digit territory in terms of the industry.

I think one of the advantages that we are seeing is strong growth in that early clinical area that is helping drive that later-stage business, and that should be prolonged because once you're in a sticky situation with a customer and you execute, then that plays forward.

Erin Wright (Analyst)

Great. In the clinical CRO side more so, how would you characterize the current pricing environment? Are you seeing any sort of shifts or outliers, or is everyone behaving relatively rationally? Thanks.

John Ratliff (CEO of Covance Drug Development)

Behaving rationally. Haven't seen any real outliers.

Erin Wright (Analyst)

Great. Thanks.

Operator (participant)

Our next question comes from Bill Cork with Fiver Jaffer.

Thanks. Good morning, everybody. A couple of questions for me.

I guess first, Dave, thinking about potential M&A on the diagnostic side, if we consider the continuing performance of Sequoia Genetics and I guess I'd say probably the outperformance of Sequoia Genetics, how should we be thinking about, I guess, your deal preference for other specialty lab deals versus your kind of more traditional kind of routine testing tuck-in deals?

Dave King (Chairman and CEO)

Morning, Bill. Every deal that comes to us gets evaluated against our strategic fit, the financial metrics, and then what I would describe as the cultural fit. So leadership and kind of how we think the organization would fit or not fit well with Labcorp. I wouldn't say that we had a particular preference one way or the other. We've done some very interesting esoteric deals.

On the other hand, we've done some significant health system deals which are not focused on particular tests or particular assets, but they're focused on partnerships, and they're focused on expanding our scale and reach and our patient access. I guess in the end, the preference is going to be for the deal that is going to best fit our strategic and financial needs. That may be a test menu, as with Sequoia Genetics, that we feel gives us the opportunity to pull more work through from the OB-GYN and pull more genetics through. It may be geographic where we want to have a broader presence in a particular market, or it may be a strategic partnership where we want to add another important component as part of our anchor health system strategy.

I know that's not particularly specific in response to your question, but it actually is the way that we think about these opportunities. Everyone stands alone in terms of being evaluated by the team for, "Is it the right deal for us to do given those considerations?"

Understood. I appreciate the color, Dave. I guess separately on PAMA, and I obviously recognize that there's a lot of things going on behind the scenes politically, but is it reasonable to assume for all of us kind of watching this from the outside that as we get closer and closer to September, that it's likely that we're going to see the implementation in accordance with the January 1st, 2018 deadline or date, excuse me?

I would say that that is the working assumption as we think about things like our 2018 budget.

I would also say that I think that would be, from my perspective, a serious mistake if CMS does it. I do not think it has been well thought through. I do not think they have thought about the implications. I was just reading an article that came out in CAP today. I am probably not supposed to give them a comment on an earnings call, but about a hospital system in New Mexico that serves 125 nursing homes in highly rural areas. If there are significant cuts to what they get paid by Medicare for those services, we are going to see significant beneficiary access issues, in my view. That statute was called the Protecting Access to Medicare Act, not the Diminishing Access to Medicare Act. We have made that point to CMS, and they told us that Congress did not tell them to take it into consideration in the statute.

This is a very, very important policy decision that CMS is going to make. I hope that they and Health and Human Services in the legislative branch will be able to come to some understanding that they need to do this right as opposed to just do it and get it done with.

Got it. Thank you.

Operator (participant)

Our next question comes from Kevin Ellis with Craig Heilem.

Good morning. Hey, Dave. I have a couple of quick questions for you. I guess first on the guidance raise, if we look at the midpoint of where you guys took guidance, I think versus the midpoint of your old guidance, I think that gets us an incremental $140 million in revenue, give or take. How much of that should flow through to pre-tax? Because I guess I'm wondering why EPS guidance was not taken up more.

Glenn Eisenberg (EVP and CFO)

Hey, Kevin, this is Glenn. Let me start. Obviously, we give a range when we give our guidances. From our perspective, we talked about the increase in the revenue range in part was due to the currency translation, but also based upon diagnostics' strong performance organically as well as acquisitions and primarily the timing of the acquisitions such as PAMMO. When you look at the earnings per share impact from the acquisition side, while they clearly meet our criteria and are accretive in the first year, they start off obviously fairly marginal. As we integrate them and get the synergies, then the margins kick into, call it, our segment number. Just illustratively, with PAMA, you're looking at the revenues that we're having without a corresponding really meaningful impact in earnings.

Assume that the increase that we had obviously in our earnings guidance, which we took up, we narrowed it, but also took up the midpoint, was really driven off of the performance that we had in the second quarter. Obviously, we'll continue to update that as we go forward.

Okay. No, that makes sense, Glenn. Thanks for the color there. Then kind of a dumb question, so sorry for this one, but you guys called out the 1% impact from leap year and the timing of the Easter holiday. I guess can you explain that to me? I just was thinking about the days. It seems like it's the same number of days this quarter. Easter fell into, it was March last year, April this year. Where does that come from?

John Ratliff (CEO of Covance Drug Development)

I knew somebody would ask how February ends up in the second quarter.

It is not a dumb question. The answer is our revenue, it is the strength of revenue days, Kevin, that is what we compare year over year. The strength of the leap day, because of the way the days of the week fall, actually does end up in the second quarter, even though the day is in February. That is why the impact is so pronounced. Obviously, Easter, because of the holiday time, there is a significant shift when it moves from quarter to quarter in volumes. The leap day is based on the strength of days and the strength of revenue of particular days of the week. That is why it lands in the second quarter.

That makes sense.

Just to add that, obviously, we knew that coming into the year.

Glenn Eisenberg (EVP and CFO)

When we provided even the initial guidance last quarter, we talked about the impact that it was going to have in the second quarter impacting our top line and impacting our margins, which obviously it has.

Okay. Thanks so much, guys.

Operator (participant)

Our next question comes from Dan Leonard with Deutsche Bank.

Dan Leonard (Director and Research Analyst)

Thank you. I was hoping you could elaborate more on how you're looking at the consumer genetics testing opportunity. It seems like 23andMe is accelerating further. You're involved in some other ways in that market. It's in the news a lot lately. If you could elaborate, that would be helpful.

Dave King (Chairman and CEO)

Sure. It's Dave. We've had a long-term collaboration with 23andMe around performing their consumer genetic testing. They've done a terrific job in the market. Our focus on consumer testing is more on the core testing.

It's more on the direct engagement with consumer around the core testing. As we said in the prepared comments, see a lot of opportunities for broader collaboration with 23andMe around some of the work that they're doing. Our consumer offering is largely focused on engaging them around what I would characterize as core testing, wellness testing, things that we would think of as more on the routine side.

Dan Leonard (Director and Research Analyst)

Good. Thank you.

Operator (participant)

Our next question comes from Ricky Goldwasser with Morgan Stanley.

Ricky Goldwasser (Managing Director)

Yeah. Hi. Good morning. A couple of follow-up questions. First of all, just on the questions on the guidance for the year, are you implying that there is potential upside from PAMA as the year continues as we see profits starting to match revenue contribution?

Dave King (Chairman and CEO)

Ricky, it's Dave.

The guidance is a range, and we provide a range because obviously there are points within the range that are achievable if things go better. There are points in the range that we achieve if things go worse. Where we've identified the range is the entire possible range of outcomes. Certainly, there's always the opportunity for outperformance. We're always optimistic about outperformance and certainly don't plan for underperformance.

Ricky Goldwasser (Managing Director)

Okay. On the United contract renewal, can you give us some colors where you are in your conversation with United? Also, when we think about the opportunities in the marketplace, I mean, obviously, there are two contracts right now that have national exclusivity, United and Aetna. How should we think about these two opportunities? Are they fairly comparable in size or any other color there?

Dave King (Chairman and CEO)

Obviously, we have been engaged in conversations with United and continue to be. The conversations have been constructive. All I'll say is when we have something specific to tell you, we will absolutely tell you. In terms of Aetna, even over the years that we've been outside of the Aetna contract, we've had a very constructive relationship with them. We continue to have discussions with them about the possibility of reentering that contract when it opens up. I think in terms of membership lives, United is larger than Aetna. That would at least imply that in terms of dollar spend, United would spend more on lab services than Aetna. I can't give you much further than that because obviously, not being in one of the contracts, we do not have a lot of insight to it.

Ricky Goldwasser (Managing Director)

Okay.

Just lastly on the relationship with Walgreen, I know you made some prepared comments, but can you just kind of share with us how you are going to choose or how you chose the initial sites and how the strategy do you think will evolve over time? Do you think this is just going to be about specimen collection, or you can expand it into other patient care as well?

Dave King (Chairman and CEO)

The team chose the sites based on availability of space in stores, based on strengths of both businesses, places where both businesses had strong infrastructures. We're starting with seven sites. We're going to quickly evaluate whether they're successful. We've already had discussions with Walgreens about other opportunities, both to expand the patient service center positioning as well as to provide other types of patient care services within those sites and within their stores.

I am very, very excited about this relationship. I think it's a significant step forward. We've said for a long time we want to be in a healthcare environment, and we're in one of the premier healthcare environments. We look forward to updating you on how we progress.

Ricky Goldwasser (Managing Director)

Thank you.

Dave King (Chairman and CEO)

It's three minutes past the hour, and we still have a number of people in the queue. If we could try to just ask one question, please. If your question's already been asked, really, it's not necessary to ask it again. Thank you.

Operator (participant)

Our next question comes from Donald Hooker with KeyBanc. Hey, just a real quick follow-up.

Donald Hooker (Senior Equity Research Analyst)

You guys alluded to kind of a pull-through from early stage to late stage work in the Covance business. I don't know if it's possible, but I was curious if there's a way to quantify that and give us a sense if that's something that could be growing now over time or because I guess in the past, those two businesses have been somewhat separate.

John Ratliff (CEO of Covance Drug Development)

Sure. This is John. We analyze the pull-through, whether it's from the preclinical tox business into the BioA, into the CMC, from the BioA into the lab businesses, into the clinical businesses from phase one into the two through four. I think it's safe to say slight increases in terms of those. You still have the buyers of early clinical, the buyers of labs, the buyers of clinical, and then timing of that, even within pharma, those hurdles obviously still exist.

You try to put in pieces of the organization. Our early development segment has a business area, the EPDS area, that actually is a sales marketing technical solution that attempts to then bridge those gaps between those organizations. We are attempting to do that more and more, especially with the oncology portfolios. The immuno-oncology portfolio lends to that. At the same time, you do have natural hurdles in terms of the quote-unquote follow-the-molecule. We do have nice strength in all the areas, and we continue to do business within the individual segments as well.

Operator (participant)

Our next question comes from Ralph Giacomo City.

Thanks. Good morning. I hopped on a little late, so apologies if this was asked already. It seems like there has been more activity on the hospital outreach side. Do you think that is kind of related?

Is it the pressures the hospitals may be seeing and sort of a need for capital from them? Maybe comment on the pipeline as maybe it's just a coincidence that these deals seem to be kind of coming up all at the same time. Then remind us, Dave, again, how long do they have to be out of the market for? Is there a specified sort of contract term where they can't do the outreach, or is it in perpetuity? Thanks.

Dave King (Chairman and CEO)

I think we already commented on the pipeline and the hospital kind of the approach of the health systems. I would say I don't think it's as much PAMA-driven as it's just the entire environment is changing. I mean, value-based care, bundled payments, pay-for-outcome.

I don't think it's PAMA's part of it, but it's certainly not the sole or, in my mind, even one of the major drivers behind hospital thinking. As I say, we commented on the pipeline. Every outreach deal and every partnership deal is different. Our approach is to do strategic deals. We're not asking people to exit the market. We're asking them to build and strengthen the market with us. If you're doing an acquisition, there's typically a negotiation around what that means in terms of a non-compete. There's no standard.

Operator (participant)

Our next question comes from AJ Rice with UBS.

AJ Rice (Analyst)

Hello, everybody. Maybe I'll just ask. In your disclosure around margin trends in Covance the last four or so quarters, there's been this discussion. I think a couple of quarters ago, it was talk about investment in Salesforce and Research Associates.

That was there for a few quarters. Now, the last couple of quarters, it has been including targeted strategic investments to support future growth. What I am just curious about is, is that just sort of part of the ongoing business, or are you signaling that there is some elevated level of spending right now that at some point in the future might taper off and thus be margin-enhancing? Can you give us a little flavor for what is behind that?

Gary Huff (CEO)

Yeah. I think from the standpoint of there has been enhanced investment in the business. Whether that is on the therapeutic side or whether that is on the commercial side or the deal-making side, there has been. From the vantage point, still focused on the organic growth, that will continue. Look, we need to increase our margins. We obviously see the peer-level margins that are out there.

We announced the initial phase of Covance's Launchpad. It's a three-year program. We first addressed restructurings and facilities. Now we'll move into really the re-engineering of our systems, processes, utilizing the new technology and tools focused on improving our productivity. There is investment that will continue, but there will be margin expansion. You'll see even the initial part of that in the second half of this year.

Dave King (Chairman and CEO)

AJ, to respond specifically to what you asked, I think John's done a terrific job investing in enhancing the personnel resources that we have. That is near-term elevated level of investment that will normalize over time.

AJ Rice (Analyst)

Okay. All right. Thanks a lot.

Operator (participant)

Our next question comes from Brian Tanquilut with Jefferies.

Brian Tanquilut (Analyst)

Hey, good morning. Dave, just a quick question since you talked about staying disciplined on valuation for acquisitions, especially in the CRO space.

Is this a time that you and the board, you think, should be revisiting dividends or other forms of capital deployment, kind of like increasing the buyback or paying dividend out?

Dave King (Chairman and CEO)

I think it's very clear that we are committed to buyback. And we bought back $100 million worth of shares in the quarter and over $250 million for the year. I don't think there's going to be any question about our commitment, which we made early in the year and have been firm on that we're returning capital to shareholders. No, I don't think it's a time to revisit our approach. I think our approach has been extremely successful. I think when I became CEO of this company, we were about $3 billion in revenue. We're going to be $10 billion in revenue.

We got there by acquiring strategically, by investing in our people, and by growing the business organically. We are going to keep doing the same things.

Brian Tanquilut (Analyst)

I appreciate that. Just a quick follow-up, John, to Kevin Ellis's question. All right.

Dave King (Chairman and CEO)

We have to continue. I'm sorry. It's almost quarter after now.

Brian Tanquilut (Analyst)

Okay. No worries.

Dave King (Chairman and CEO)

We need to go on.

Brian Tanquilut (Analyst)

Thank you.

Operator (participant)

Our next question comes from Isaac Rowe with Goldman Sachs.

Isaac Ro (VP)

Morning. Thanks for fitting me in. Quick one on PAMA. Dave, I'd be interested in your views if we assume that the current legislation is enacted as expected, if you had a view as to how quickly you think the hospital side of the market will start to take action in light of those reimbursement cuts. The reason I ask is I think there is a perception that hospital systems are slow to react.

They do not have great visibility or metrics around their lab profitability. I am interested in whether or not you think you could see that constituency move relatively quickly once we have some clarity on PAMA, the phase-in. Thank you.

Dave King (Chairman and CEO)

I think there is a growing sense of awareness in hospital administration that PAMA is going to be impactful in 2018. You see that in comments that are being made by hospital executives. I do think, to your question, Isaac, it is hard for hospitals—it is hard for any big organization. I should not limit it to hospitals. It is hard for any big organization to react quickly to change. I do not know how fast you would see movement in the market or even what that movement would look like.

If you look at just health systems generally, there has been a tremendous amount of health system consolidation in the last several years, and that seems to be continuing. Health systems continue selectively to acquire physicians. The market will move, but I do not know that it will move fast.

Isaac Ro (VP)

Fair enough. Thanks.

Operator (participant)

Our next question comes from Mark Massaro with Massaro.

Mark Massaro (Analyst)

Thanks, guys. We are a couple of days in, but recently, there was a startup, direct-to-consumer genomics company that is launching exome sequencing applications. I wanted to see, Dave, how you handicap maybe the platform opportunity over the next three to five years, whether or not you think this is an area that you may want to participate in given some of the success you are having with 23andMe.

Dave King (Chairman and CEO)

I would say that direct-to-consumer genetics is a very complex area from a regulatory, a legal, and an ethical perspective.

I think what you can safely assume is that there'll be a lot of people out there trying it, and it will not be a high priority for us. Again, the collaboration with 23andMe provides that direct-to-consumer genetic testing in a highly reputable, well-proven environment where they've gone to FDA and gotten permission to make the claims and offer the interpretations that they do. We're proud of that relationship. I think, as I say, it's an area that's fraught with challenges. We don't see any need to plunge in.

Mark Massaro (Analyst)

Great. Thank you.

Operator (participant)

There are no further questions in the queue.

Dave King (Chairman and CEO)

Thank you very much for joining us on our second quarter conference call this morning. Hope you have a great day, and we look forward to speaking with you as we have updates in the future. Good day.

Operator (participant)

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.