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EARNINGS CALL TRANSCRIPT
EARNINGS CALL TRANSCRIPT 2017 - Q1
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Executives

Scott Frommer - Laboratory Corp. of America Holdings David P. King - Laboratory Corp. of America Holdings Glenn A. Eisenberg - Laboratory Corp. of America Holdings John D. Ratliff - Laboratory Corp. of America Holdings.

Analysts

Lisa Gill - JPMorgan Chase & Co. Jack Meehan - Barclays Capital, Inc. Nicholas M. Jansen - Raymond James & Associates, Inc. Amanda Louise Murphy - William Blair & Co. LLC Luke Sergott - Evercore ISI Dan Leonard - Deutsche Bank Securities, Inc. Steven J. Valiquette - Bank of America Merrill Lynch Ralph Giacobbe - Citigroup Global Markets, Inc. Alexander D.

Nowak - Piper Jaffray & Co. Gary Lieberman - Wells Fargo Securities LLC Ricky R. Goldwasser - Morgan Stanley & Co. LLC Brian Gil Tanquilut - Jefferies LLC Isaac Ro - Goldman Sachs & Co..

Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to your Q1 2017 LabCorp Earnings Conference Call. At this time, all participants are in a listen-only mode. Following management's prepared remarks, we will host a question-and-answer session and our instructions will follow at that time.

As a reminder, this conference is being recorded for replay purposes. It is now my pleasure to hand the conference over to Mr. Scott Frommer, Vice President of Investor Relations. Sir, please proceed..

Scott Frommer - Laboratory Corp. of America Holdings

Dave King, Chairman and Chief Executive Officer; Glenn Eisenberg, Executive Vice President and Chief Financial Officer; and Jon 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 on the Investor Relations section of our website at www.labcorp.com and include a reconciliation of non-GAAP financial measures discussed during today's call to GAAP.

Finally, we are making forward-looking statements during today's call. These forward-looking statements include, among others, statements about our expected financial results, the implementation of our business strategy, and the ongoing benefits from acquisitions.

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

Now, I'll turn the call over to Dave King..

David P. King - Laboratory Corp. of America Holdings

oncology, CNS disorders, genetics, and rare and orphan diseases. Our combined company's scientific expertise in these areas is significant, and has driven an increase in the portion of our backlog tied to these therapeutic categories.

These developments, combined with our improving orders and book-to-bill ratio, give us continued optimism about Covance's future. Nonetheless, there is more we can do to improve the delivery of services at Covance. We have therefore decided to expand our highly-successful LaunchPad initiative to include Covance.

Through Covance LaunchPad, we will right-size the business, reengineer our Drug Development systems and processes, and deploy technological advancements to improve service while maintaining the highest quality and sustainably reducing our cost base. Glenn will provide financial and other details on this initiative in a few moments.

In closing, we are in the early stages of capitalizing on multiple growth opportunities across our global markets. We are pleased with the success of our solutions-focused selling and our continued progress in repositioning ourselves to meet the needs of a rapidly-changing healthcare system.

Driven by the outstanding work of more than 50,000 colleagues around the world, we continue to create unique solutions to our customers' problems, improve the health and lives of patients worldwide, unlock profitable growth, and increase long-term shareholder value. Now, I'll turn the call over to Glenn..

Glenn A. Eisenberg - Laboratory Corp. of America Holdings

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

Revenue for the quarter was $2.4 billion, an increase of 4.9% over last year, due to solid organic growth in LabCorp Diagnostics and acquisitions, partially offset by unfavorable currency translation of 40 basis points. Organic revenue growth in the quarter on a constant currency basis was 2.7%.

Operating income for the quarter was $333 million, or 13.8% of revenue, compared to $300 million, or 13%, last year. Adjusted operating income, which excludes amortization, restructuring charges, and special items, was $391 million, or 16.2% of revenue, compared to $373 million, or 16.3%, last year.

The increase in adjusted operating income was primarily due to favorable price, mix, and acquisitions, partially offset by higher personnel costs in Covance Drug Development. The tax rate for the quarter was 31.2% compared to 35.2% last year.

The adjusted tax rate excluding special charges and amortization was 31.5%, down from 34.8% last year, primarily due to the expected tax benefit from stock-based compensation.

The increase in the tax benefit from stock-based comp was primarily driven by the increase in the company's stock price when shares vested in the first quarter of this year compared to the price when shares vested last year. This benefit was included in our prior full-year tax rate guidance, which we continue to expect to be approximately 34%.

Net earnings for the quarter were $192 million, or $1.84 per diluted share. Adjusted EPS, which excludes amortization, restructuring charges, and other special items, were $2.22 in the quarter, up 8% over last year. Operating cash flow was $234 million in the quarter, compared to $128 million a year ago.

The increase of $106 million was primarily due to higher earnings and improved working capital management. Capital expenditures totaled $72 million, or 3% of revenue, compared to $71 million, or 3.1%, last year. As a result, free cash flow was $162 million in the quarter, up from $56 million last year.

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

Total debt at quarter-end was approximately $5.9 billion. The company's leverage at the end of the quarter was 3.1 times gross debt to last 12 months EBITDA, comparable to our leverage ratio at the end of 2016. Now, I'll review our segment performance beginning with LabCorp Diagnostics.

Revenue for the quarter was $1.7 billion, an increase of 8% over last year. The increase in revenue was driven by acquisitions, price, mix, and organic volume, measured by requisitions. Revenue per requisition increased 3.8%, benefiting from price, mix, and the Sequenom acquisition. In addition, esoteric testing grew at a faster rate than core testing.

Total volume increased 4.3%, of which organic volume was 1.8%. Acquisition volume was 2.5%, which was primarily driven by tuck-in acquisitions that have not yet annualized. LabCorp Diagnostics' adjusted operating income for the quarter was $341 million, or 19.9% of revenue, compared to 308 million, or 19.4%, last year.

The increase in operating income and 50-basis-point margin improvement were primarily due to solid organic revenue growth, acquisitions, and the benefit from our LaunchPad initiative. LabCorp Diagnostics remains on track to achieve its LaunchPad savings of $150 million over the three-year period ending this year.

Now, I'll review the performance of Covance Drug Development. Revenue for the quarter was $690 million, a decline of $13 million, or 1.8%, from last year. Excluding the impact from approximately 150 basis points of negative currency, revenue was roughly flat compared to last year.

During the quarter, revenue increased in the clinical development business.

This increase was offset by the decline in revenue in the early development and central lab businesses, primarily due to slower revenue conversion from the backlog and the previously discussed cancellation by sponsors of two large clinical studies in late-2016 for which we provided central lab services.

Execution of our strategy, which is focused on higher value therapeutic areas such as oncology and CNS disorders, resulted in a higher percentage of our backlog tied to complex studies that continue to convert into revenue at a slower pace.

Covance Drug Development's adjusted operating income was $83 million, or 12.1% of revenue, compared to 103 million, or 14.7%, last year.

The decline in operating income and margin were primarily due to higher personnel costs, including targeted strategic investments in the clinical business to support future growth, partially offset by cost synergies.

We remain on track to achieve our target of $100 million in cost synergies through the three-year period ending this year, as we expect to complete the consolidation of our central lab facilities by the middle of the year. In addition, the company expanded its LaunchPad initiative to now include Covance Drug Development.

This initiative will be a three-year program for Covance that consists of two phases. We recently initiated the first phase to right-size Covance Drug Development's resources, primarily head count and facility footprint.

This phase is expected to generate pre-tax savings of approximately $20 million in 2017, and approximately $45 million on an annualized basis thereafter. The pre-tax cost to achieve these savings is estimated to be approximately $30 million in 2017, of which around $20 million is expected to be cash expenditures.

The second phase will focus on reengineering our systems and processes, and improving productivity, which will contribute to sustained margin improvement over time. Planning for the second phase is underway, and we will provide additional details later this year.

Covance Drug Development's net orders and net book-to-bill for the trailing 12 months were $3.2 billion and 1.15, respectively, a sequential improvement over the 12-month period ending December 31, 2016.

Backlog at the end of the quarter was $5.2 billion, an increase of $300 million over year-end backlog and we expect approximately $2.1 billion of this backlog to convert into revenue over the next 12 months.

Now, I'll update our 2017 guidance, which assumes foreign exchange rates as of March 31 for the remainder of 2017 and includes the impact of the expansion of LaunchPad in Covance Drug Development, as well as anticipated capital allocation.

We expect reported revenue growth of 3.5% to 5% after adjusting for the negative impact from approximately 40 basis points of foreign currency translation.

This is lower than our prior guidance by 100 basis points, due to lower than expected revenue growth in Covance Drug Development, partially offset by higher than expected revenue growth in LabCorp Diagnostics.

We expect LabCorp Diagnostics' reported revenue growth of 5% to 7%, after adjusting for the negative impact from approximately 10 basis points of foreign currency translation. This is an increase from our prior guidance of 4.5% to 6.5%, primarily due to better than expected organic volume growth.

We expect Covance Drug Development reported revenue growth of 0% to 2%, after adjusting for the negative impact from approximately 130 basis points of foreign currency translation, which is lower than our prior guidance by 350 basis points.

On a constant currency basis, we expect revenue growth of 1.3% to 3.3%, which is also lower than our prior guidance, primarily due to our first quarter results, as well as the mix of contracted awards won during the quarter. Critical development orders remain strong and typically take longer to convert into revenue.

In addition, our strategy to focus on high value therapeutic areas such as oncology has resulted in a higher percentage of our backlog tied to complex studies that continue to convert into revenue at a slower pace.

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

Our 2017 adjusted EPS guidance is $9.20 to $9.60, an increase of 4% to 9% over 2016, and lower than our prior guidance of $9.35 to $9.75 due to lower revenue growth expectations.

We expect a decline in our earnings outlook to primarily apply to our results in the second quarter, due to the timing of revenue growth and the benefit from the expansion of our LaunchPad initiative in the second half of 2017.

In addition, our second quarter results will also be negatively impacted by the timing of the Easter holiday, as well as the year-over-year comparison to leap year. We expect free cash flow to be between $925 million and $975 million, unchanged from our prior guidance. This concludes our formal remarks, and we'll now take questions.

Operator?.

Operator

Thank you, sir. In the interest of time, we ask that everyone please limit themselves to one question then rejoin the queue. Our first question will come from the line of Lisa Gill with JPMorgan. Please proceed..

Lisa Gill - JPMorgan Chase & Co.

Thanks very much, and good morning. I just want to go quickly back to Glenn, your comment about favorable growth in margins in the second half.

Is that primarily due to the Covance LaunchPad, or is there something else that's going to be driving that?.

Glenn A. Eisenberg - Laboratory Corp. of America Holdings

Yeah. No. A couple of things, Lisa. First, I think your reference of Covance, we expect to see sequentially improving revenues as we go throughout the year, even though for the second quarter, we expect revenues to be down year-on-year. The second half will be up in the third and the fourth quarter we expect year-over-year.

So that's going to help to drive the improvement. And then, to your point, in addition with the LaunchPad initiative now moving to Covance, the bulk of the savings in 2017 will be recorded in the second half. So, obviously, that will improve their margins in the third and fourth quarter year-over-year as well..

Lisa Gill - JPMorgan Chase & Co.

And I apologize if you already went through this earlier, but I just – I want to better understand what is happening on the Covance side, especially on the organic side.

I think when, Dave, you gave guidance last quarter talking about the organic growth in this business and your expectations around the business, can you maybe just give us a little more color as to what you're seeing in the marketplace.

I know when we had a call a few weeks ago, we talked about the fact of in-sourcing, outsourcing, and you weren't really seeing the impact there.

We already knew about some of the customer delays and cancellations, but what else is happening in the market?.

John D. Ratliff - Laboratory Corp. of America Holdings

Yeah. I'll take that on, Lisa. This is John. And so, inside the first quarter, you obviously saw a mix of contracted awards that were won and/or delayed. Clinical orders were strong, to give you color, and that actually takes, obviously, longer to convert into revenue than our early development and/or even our central labs to a certain extent.

Secondly, we saw within the backlog, we are increasingly raising our penetration within the oncology, CNS, rare and orphan. And this higher percentage of our backlog tied to those complex studies are also converting into revenue at a slightly slower pace.

We did see delays in certain key customers' pipelines through the second quarter, third, and fourth. But pleased overall with the net orders that we saw within the quarter in terms the long-term growth.

And specifically based on the data involved with the LabCorp and the Covance areas, we saw our largest quarter to-date, about $150 million in the quarter, about $350 million of new awards in a cumulative due to the combination of the datasets and how that then drove wins within the quarter in terms of the aggregate book-to-bills..

Lisa Gill - JPMorgan Chase & Co.

Okay. Thanks..

Operator

Thank you. Our next question will come from the line of Jack Meehan with Barclays. Please proceed..

Jack Meehan - Barclays Capital, Inc.

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

John D. Ratliff - Laboratory Corp. of America Holdings

Again, John. In terms of the early development, in aggregate, a strong area, but saw certain delays in terms of specific customer pipelines within lead optimization, et cetera. But at the same time, we saw strength in our backlog and book-to-bill.

We did have a little bit of a mix of awards to clinical versus pure pre-clinical, and that drove a little bit of the delay in revenue conversion, but a strong area looking at the pipeline of orders going forward and the opportunities that we see in terms of for the balance of the year.

In terms of central labs, we did see a real shut down in those two cancellations within the quarter, and central labs were affected by, what I previously just mentioned, the penetration in oncology. So they are seeing a stretch out in terms of the revenue conversion. And those are really the two areas that we saw affected.

I'll proactively address one last question, and that is if you look at our segment, clinical is growing above the actual total Covance revenue growth projected, with the labs and early development below..

Jack Meehan - Barclays Capital, Inc.

That is helpful. And then, Glenn, I want to ask you about the volume growth in the quarter.

As you've looked at the numbers, do you think the calendar was a headwind or a tailwind in the quarter, or otherwise, what do you attribute to be the step-up in the activity there?.

Glenn A. Eisenberg - Laboratory Corp. of America Holdings

Yeah, no, we did benefit obviously from the, call it, the Easter holiday falling in the second quarter, so it obviously was a year-over-year improvement. The calendarization, interestingly enough, with leap year, really impacts our second quarter much more than the first.

So, if you look at the first quarter, a slight tailwind, slight help to the organic volume. It's truly, call it, an improvement in our volume as opposed to just the calendarization.

But as we look to the second quarter, you'll see a more substantial headwind for us, between Easter falling into the second quarter, between the calendarization of how it matches up for us year-over-year, you're looking at a more substantial impact, probably around a point-and-a-half give or take on our volume in the second quarter.

But for the first quarter, of the 1.8%, call it, 30 basis points, we would consider being, call it, calendarization/Easter..

Jack Meehan - Barclays Capital, Inc.

Very helpful. Thank you..

Operator

Thank you. Our next question will come from the line of Nicholas Jansen with Raymond James. Please proceed..

Nicholas M. Jansen - Raymond James & Associates, Inc.

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

David P. King - Laboratory Corp. of America Holdings

Morning, Nick, it's Dave. Obviously, as we've said, we've been engaged with United at the managed care team level for a significant period of time. They have been a terrific partner to us and I think we've been a terrific partner to them.

Over the last six months, we've become also significantly engaged at the senior executive level involving a good deal of my time. And I'm pleased with where we are. Again, I think there's a recognition on both sides of the strength of the partnership and the value of the partnership. We would like to get something done in 2017.

I can't give you any further update other than I think both sides are committed to a fair resolution of the contract discussion, and something that rewards us both for the value of the partnership over the now 10-plus years..

Nicholas M. Jansen - Raymond James & Associates, Inc.

Great. And then just a quick follow-up in terms of the amount of M&A spend in the quarter, I think it was $150 million or so of M&A activity.

Can you maybe just walk us through your pipeline, how you're seeing that evolve over the last 6 to 12 months? Is the pending PAMA legislation driving increased interest from both health systems and others to perhaps look to you guys as an exit strategy? Just want to get your thought on M&A spend, because that was a little bit bigger than we had thought in the quarter.

Thanks..

David P. King - Laboratory Corp. of America Holdings

I think the M&A pipeline continues to be very robust, and I attribute that to the – not so much to PAMA, because I think singling out any one factor is a little misleading, but to the general change in the healthcare environment. We're seeing a big push to value-based payment.

We're seeing a big push to being able to procure services, the highest quality services at the most effective cost.

And as hospitals and smaller laboratories are recognizing that trend, I think a lot of them are relooking at, do we belong in this business? Is it a core competency? Are we bringing value to the patient? So, again, I think when you add in the research capabilities that Covance brings us, we have a strong, differentiated position in doing these really deep, comprehensive hospital partnerships, health system partnerships, and you can expect us to continue to work on those.

But we're going to be opportunistic about what's available in the acquisition market and allocate our capital appropriately..

Nicholas M. Jansen - Raymond James & Associates, Inc.

Thanks for the color..

Operator

Thank you. Our next question will come from the line of Amanda Murphy with William Blair. Please proceed..

Amanda Louise Murphy - William Blair & Co. LLC

Hi. Good morning. I just had a question, I guess, for John first to start off with. So, you had commented about some of the delays that you saw in terms of customer pipeline in both – I think you said both pre-clinical and clinical. I just was wondering if you could give some context there.

Is there anything sort of macro that you could point to that might be driving that or is that customer specific?.

John D. Ratliff - Laboratory Corp. of America Holdings

Yeah, it's customer specific, and nothing macro. It's purely a pause in their very specific pipeline of activities that hit us in one to two areas..

Amanda Louise Murphy - William Blair & Co. LLC

Okay. Got it. And then, Dave, just a question for you on the hospital size. So, obviously, you talked about developing deep partnerships. I was curious what your thoughts are around looking at some of the more lab management-type contracts going forward.

Is that something that would be of interest to you just moving into more of the in-patient, outpatient side of the business?.

David P. King - Laboratory Corp. of America Holdings

Well, Amanda, lab management can be a part of a comprehensive partnership with a health system. So, we're not opposed to lab management contracts, and we have plenty of them in our business.

What we're not out looking for is lab management contracts where essentially the value that we're bringing is remanaging employees and offering supply chain savings. Because in our view, that is not a high margin business. It's well below our operating margins.

It's an extremely high touch business, because of the nature of in-patient hospital services. So, pure lab management contracts alone are not particularly attractive to us.

Our strategy has always been the lab management contract might be part of a comprehensive overall partnership that includes, obviously, our reference testing capabilities, our population health capabilities, our analytics capabilities, the Covance piece.

So, those are the types of partnerships we're doing, and I think the announcements that you've seen in the quarter with Mount Sinai and with PAML, which are – again, you have three tremendously innovative market-leading health systems that are deciding that they want to associate themselves with LabCorp, I think that speaks volumes about the success of our hospital strategy..

Amanda Louise Murphy - William Blair & Co. LLC

Got it. Thank you very much..

Operator

Thank you. Our next question will come from the line of Ross Muken with Evercore. Please proceed..

Luke Sergott - Evercore ISI

Hey, guys, it's Luke on for Ross today.

I – just to start off on the CRO market, are you seeing any change to the contracts or the RFPs that are out there, specifically, an increase in fee-for-service versus the strategic relationships?.

John D. Ratliff - Laboratory Corp. of America Holdings

This is John. I think you're seeing a blend of that, a mix of that. There's certain of the strategics even that have moved to that more functional service provider, more for that fee-for-service that I think you're referencing even within their own mix.

It's a vital part of our mix within the Phase II through IV, and we see that playing out with a specific customer set. But in terms of, if you look across the portfolio, if you're asking is there more of a shift to that, I think we've seen that evolution over the last five years in terms of the use of that model.

And you're seeing that continue, but there hasn't been any radical, within the last six months, I'm going to shift to more of that FSP model than prior. But you clearly have to have that in your repertoire in terms of addressing the different models of clinical..

Luke Sergott - Evercore ISI

Okay. Great. That's helpful.

And then, I guess, lastly, on the pricing market within the CRO business, is that – are you guys seeing any bad behavior out there when these contracts are up?.

John D. Ratliff - Laboratory Corp. of America Holdings

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

Luke Sergott - Evercore ISI

Okay. Great. Thanks..

Operator

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

Dan Leonard - Deutsche Bank Securities, Inc.

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

David P. King - Laboratory Corp. of America Holdings

Dan, it's Dave. I just want to point out that the reduced outlook is 1% of a $10 billion revenue company. So, this is not a dramatic reduction, either in our perspective on revenue or on earnings, and it's not in any sense an indication that we are displeased with the Covance business. I would cite again what I referred to in my prepared remarks.

You look at the ways in which the combined organizations are generating business as you don't hear anybody else talking about, the depth of the health system partnerships that we're doing, the use of the data and real examples of how the data is helping us to win the companion diagnostics business, these are terrific success stories, and we're two years into this.

It was a major transformational acquisition, and we are very, very enthusiastic about the long-term opportunity here because the growth rate in the CRO industry has historically been higher than the lab industry, because of the opportunity to expand our business on a more global scale.

And so, no, it doesn't in any way diminish our enthusiasm for continuing to grow the CRO business..

Dan Leonard - Deutsche Bank Securities, Inc.

That's helpful color. Thank you. And just a housekeeping question for Glenn.

Glenn, is PAML in the new guidance for 2017, or are you waiting for those parts of the transaction to close before you include them in the guidance?.

Glenn A. Eisenberg - Laboratory Corp. of America Holdings

Yeah, no. As we said earlier, just in general, we have capital allocation included in our guidance, including M&A, and I think it's fair to say that, obviously, we announced two health system transactions that we expect both to close this year. So, it's fair to say that we have assumed those transactions would have an impact this year..

Dan Leonard - Deutsche Bank Securities, Inc.

Got it. Thank you..

Operator

Thank you. Our next question will come from the line of Steven Valiquette with Bank of America. Please proceed..

Steven J. Valiquette - Bank of America Merrill Lynch

Thanks. Hi, good morning, everybody. So, I guess, I'm just thinking about the current CRO results.

Do you think that if you did have a more comprehensive service offering in the market, particularly with greater late-stage development infrastructure, would that help to lift the revenue and EBIT results you're currently generating in the early stage development and the central lab components of your operations? So, is that a big key to success here on the overall CRO odds if you do have more late-stage capabilities? Just curious to get more thoughts on that..

John D. Ratliff - Laboratory Corp. of America Holdings

Again, John. I think we actually have very viable late-stage offerings, but at the same time, we know organically we need to push through in certain therapeutic areas, and internationally expansion, and then even embracing some of the new models flowing through.

So, we see, obviously, areas of the strategy that we're going to embrace, and I also know within that post-marketing Phase IV area, we do have greater penetration. And from our vantage point, having early pre-clinical development as well as then central labs does differentiate us from everyone else.

I believe that, A, our leadership in labs and ED can bring our clinical business forward, as well as strengthening clinical can then bring forward great penetration within that early development as well. So, it works both ways. But we know we've got work to do on the expansion territories in that late-stage area and those what I just addressed..

Steven J. Valiquette - Bank of America Merrill Lynch

Okay. And you mentioned a new model, late stage.

I'm pretty sure I know what you're talking about, but maybe just to avoid any confusion, do you want to clarify what you're thinking about new models in terms of servicing clients on late-stage?.

John D. Ratliff - Laboratory Corp. of America Holdings

Well, I think as you've seen, more and more, we're moving to much more of a risk-based model; moving to more and more of a pricing based on value, based on outcomes, et cetera. And so, that's one point of reference. There's different channels off of the FSP model that we were talking about before being addressed.

These are at their infant state, but at the same time, you need to be prepared for those, and then move those forward within the scope of your total portfolio..

Steven J. Valiquette - Bank of America Merrill Lynch

Okay. Got it. Okay. Thanks..

Operator

Thank you. Our next question will come from the line of Ralph Giacobbe with Citi. Please proceed..

Ralph Giacobbe - Citigroup Global Markets, Inc.

Thanks. Good morning. Just on the Covance side, you mentioned higher personnel costs, and I think you brought that up last quarter as well, in terms of, I guess, increased sales force costs.

Is there anything else maybe driving those pressures? If there is, where is that coming from and sort of how do you combat that? And then, more broadly, if you can give us maybe where you are thinking in terms of long-term margin profile at this point on the CRO side of the business. Thank you..

John D. Ratliff - Laboratory Corp. of America Holdings

From the standpoint of – yes, there were specifically strategic investments that were put through all of last year in terms of whether it's in the sales force, whether it's in certain of the therapeutic areas, whether it was on staffing clinical to the backlog.

At the same time, any time you have those personnel on board and then you have now flat revenues within the first quarter, then obviously, you have to address that.

And so, in terms of your comment on combating that, that's the referenced first phase of a Covance LaunchPad, which there's a $45 million annualized savings, and at the same time, then around $20 million, $25 million in the second half of the year for 2017, and those – the majority being resources.

So, clearly, what you're trying to do is align revenues with the resources. Longer term, I think from the vantage point of longer-term margins, we obviously see the business models of our competitors and know we have room to move on that.

We'll obviously be addressing that in terms of, A, the LaunchPad, longer term initiatives that we'll give more details on to the later part of this year..

Ralph Giacobbe - Citigroup Global Markets, Inc.

Okay. Thanks.

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

David P. King - Laboratory Corp. of America Holdings

Well, at the ACLA annual meeting, there was actually a presentation by CMS about data collection, and then we met with some CMS officials – industry representatives met with CMS officials and talked about we were continuing to have difficulty loading data.

And we requested a delay, and that delay was granted, as you saw, to continue to put the data in. So, that is a positive. I continue to be, and I think our team continues to be frustrated that the data collection process is not designed in a terribly efficient way, and the amount of data that will be generated is going to be enormous.

So, it raises the question of can the data be analyzed in a meaningful way between now and when CMS is supposed to put the proposed rule out? I think more fundamentally, Ralph, the issue continues to be the incorrect definition of applicable laboratories.

The definition that the prior rule came up with is inconsistent with the legislative intent, it's inconsistent with floor colloquy, and we supported, that is we the industry, supported PAMA as a way to bring market-based pricing to our industry.

But the way the rule has been generated, 95% of the hospitals are not going to be included, which means their commercial pricing, which is multiples above ours, is not going to be considered to be part of the "market." There's an irony there, because when we talk about acquisitions, the hospital systems are considered to be part of the market, but when we talk about the PAMA pricing, hospital systems are not considered to be part of the market.

So, we continue to push with CMS to revisit the definition, and we're hopeful that they will do that, and that we'll, as a result, get a rule and an implementation of the legislation that's consistent with what Congress and the industry agreed that we wanted to do..

Ralph Giacobbe - Citigroup Global Markets, Inc.

Okay. Helpful. Thank you..

Operator

Thank you. Our next question will come from the line of Bill Quirk with Piper Jaffray. Please proceed..

Alexander D. Nowak - Piper Jaffray & Co.

Great. Good morning, everyone. This is Alex Nowak on for Bill today. This one's for John. So, I just want to be clear. You issued 2017 guidance at the end of February.

And so, should we read into that, that you saw a number of more complex orders come in, or a number of higher mix contracts come in that just took longer to convert over the timeframe, over the March timeframe, and that's what's forcing to you lower your Covance guidance? I guess what I'm getting at is, basically, what happened today versus two months ago?.

John D. Ratliff - Laboratory Corp. of America Holdings

The answer is we did see a higher level of clinical orders, which obviously take longer to convert. We did see higher percentage of the actual orders going in that were oncology-, CNS-based, which are obviously converting into revenues at a slower pace.

We had delays in the eCustomer pipeline that happened in that last 60 days that were more tactical based. So, those are the reason why the reduced outlooks within the Covance revenue..

David P. King - Laboratory Corp. of America Holdings

And it's Dave. I just want to add quickly, because we want to be clear about this. It's not only the late-stage business that's affected by the mix of oncology, CNS. If we have a central lab study that is doing oncology testing, then enrollment may be slower than it is for, for example, an infectious disease study or a diabetes study.

So, the change in mix affects all of the segments of the business; it doesn't just affect the clinical late-stage business..

Alexander D. Nowak - Piper Jaffray & Co.

Okay. That's helpful. And then just a second question for you, Dave.

Any update on BeaconLBS? And just curious, does your UnitedHealth in-network contract, does that also include the BeaconLBS program?.

David P. King - Laboratory Corp. of America Holdings

In terms of BeaconLBS, we're very focused on improving the features and function sets, as we think about scaling BeaconLBS to new markets. The Texas situation remains the same. That is, BeaconLBS is running there, but the "hard implementation" where denials start is not in effect. I didn't quite understand the second part of the question.

So, maybe you could just repeat that really quickly because it's five of, and there's four people still waiting..

Alexander D. Nowak - Piper Jaffray & Co.

Yeah. Yeah.

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

David P. King - Laboratory Corp. of America Holdings

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

Alexander D. Nowak - Piper Jaffray & Co.

Great. Thank you..

Operator

Thank you. Our next question will come from the line of Gary Lieberman with Wells Fargo. Please proceed..

Gary Lieberman - Wells Fargo Securities LLC

Good morning. Thanks for taking the question. I guess maybe just to go back to the LaunchPad initiative with respect to Covance and how we should think about that longer term, obviously, with the near term shortfall in the business, I can understand the need to reduce costs.

But I guess how should we think about that longer term and how that might impact your ability to thrive in that market?.

David P. King - Laboratory Corp. of America Holdings

Gary, it's Dave. So, I'm just going to point to the successes of LaunchPad in the LabCorp business and how it's improved our competitive position. We've redeployed resources for the customer-facing positions. We've reduced facilities and consolidated facilities in a way that's improved quality and service.

Our customer satisfaction scores among our provider community are at all-time highs, even after two years of LaunchPad, which means it's improving the quality of the service we've delivered; it's not diminishing it in any way.

The technology improvements in terms of patient self-service, the revenue cycle system, the bad debt improvement, all of these things are direct outgrowths of LaunchPad, and obviously Propel has been a major innovation and improvement in quality and service. So, LaunchPad is not a program that just says, we're going to rip costs out of the business.

LaunchPad is a program that says, every dollar that we spend in the business, we're going to get $1.05 of value in some way or another. And so, I don't think you should think about LaunchPad as hurting our competitive positioning.

Covance LaunchPad is going to improve our competitive positioning through right-sizing facilities, through getting the right employees facing the customer in the right place, through improvement of quality and service delivery, through better technology and tools. All of these things are going to be positive for the business in the long term.

And, frankly, we wouldn't invest in doing the LaunchPad project, because it requires a lot of work from the team, if we didn't believe in the business long term..

Gary Lieberman - Wells Fargo Securities LLC

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

David P. King - Laboratory Corp. of America Holdings

I don't agree with the characterization..

Gary Lieberman - Wells Fargo Securities LLC

Okay. All right. Thank you very much..

Operator

Thank you. Our next question will come from the line of Ricky Goldwasser with Morgan Stanley. Please proceed..

Ricky R. Goldwasser - Morgan Stanley & Co. LLC

one of the questions we're getting from investors is whether the pharma companies are starting to do a lot more – or more of in-sourcing, so bringing some of the trial business back in house. So, also we are seeing some anecdotal evidence from the tool companies that are actually seeing demand from pharma.

So, I would like to hear kind of like your thoughts of what you think kind of like the sponsors are doing, and how they're thinking about in-sourcing versus outsourcing trial work..

John D. Ratliff - Laboratory Corp. of America Holdings

I think – and this is John, again. I really haven't seen that, at least on our spectrum of customers. You'll always have – so I went to head of business of one pharma just recently, where that rumble was that they were going to pull and in-source resources ahead of the meeting, and it was the head of the business plus the head of procurement.

Once I got into the meeting, it was not about that at all. They were consolidating the CROs who they work with, and we were one of those that they were consolidating to. And so, I do hear of some rumble about that, it just hasn't – I haven't seen that with our customer set in terms of the in-sourcing "penetration" or backwards moving into pharma.

I can't talk to customers I'm not at, and so you'll have to ask the others of my brethren in terms of that, but right now, we haven't seen that, still see an ever-increasing penetration, whether it's in the mid-tier, or biotech, or in that large pharma and as an industry, trim..

Ricky R. Goldwasser - Morgan Stanley & Co. LLC

Okay. And then kind of like you're talking about the fact that it's taking longer to convert into revenues, and that is something that you guys have been talking about for over a year-and-a-half now.

Just, if you can just give us some more context, is it taking longer to convert because you as a CRO and your CRO peers just are seeing more difficulty in recruiting patients, or is it taking longer to convert because of the customer side and the drug companies that are just kind of like pacing – slowing their pace?.

John D. Ratliff - Laboratory Corp. of America Holdings

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

So, the orientation of the pipeline to those areas more and more give you a longer revenue conversion.

Ricky R. Goldwasser - Morgan Stanley & Co. LLC

Okay. And then the last question on....

Scott Frommer - Laboratory Corp. of America Holdings

No, no, that's it. That's it. Sorry, Ricky, but we've got two more people waiting, and you had two, and it's after 10:00. So, let's move on, please. We'll take whatever you have offline..

Operator

Thank you. Our next question will come from the line of Brian Tanquilut with Jefferies. Please proceed..

Brian Gil Tanquilut - Jefferies LLC

Hey. Good morning. Thanks for taking the question. Just on the CRO side, we've heard a lot of discussion on certain assets that you guys probably would be interested in to bolster that business.

As you prioritize international expansion and clinical capabilities, Asia being a perfect example, I mean, how would you rank what you're looking for in terms of what you see the need for the business to turn around and strengthen?.

David P. King - Laboratory Corp. of America Holdings

Brian, it's Dave, good morning..

Brian Gil Tanquilut - Jefferies LLC

Hi, Dave..

David P. King - Laboratory Corp. of America Holdings

We've been talking about this quite a bit, so I'm not going to say anything that I haven't said multiple times. The clinical CRO business, we do need to be more sizable in Asia Pac, so that is one important consideration. It's only one. We want to acquire the asset that's going to fit us best from a strategic perspective.

That involves financial returns. That involves cultural fit. That involves long-term opportunity where we see the business growing in therapeutic areas. So, there are multiple factors that we take into consideration, but you're certainly correct that Asia Pac is one..

Brian Gil Tanquilut - Jefferies LLC

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

David P. King - Laboratory Corp. of America Holdings

Well, I think probably the biggest thing about Asia is there are a number of significant markets there that require data from their particular subjects, and if we don't have the clinical presence in those markets, it's tough to win the studies.

So, it's mostly a function of large customers there in Japan and Korea, for example, large market opportunities, and regulatory environment in which they want to see – and, of course, I should mention China as well – and regulatory environment in which they want to see specific data relating to their populations..

Brian Gil Tanquilut - Jefferies LLC

All right. Got it. Thanks, Dave..

Operator

Thank you. Our next question will come from the line of Isaac Ro with Goldman Sachs. Please proceed..

Isaac Ro - Goldman Sachs & Co.

Good morning. Thanks, guys. So, wanted to follow up on PAMA. You guys went through some of the things you are dealing with. I'm interested in your perspective regarding how you think the rest of the market and particularly the small independent labs and the hospital labs, are preparing for the implementation.

Obviously, we don't know for sure, but hopefully next year. Just curious if you think about just how you'd grade the preparedness among your competitors, what that means for you..

David P. King - Laboratory Corp. of America Holdings

I don't really have a good perspective on that, Isaac. It's Dave. I mean, I know what we hear when we go to ACLA, but I think there's a surprising lack of awareness of the potential impact of PAMA, for example, is my perception, in the hospital lab director environment.

I think small labs are for the most part, at least the leaders of them that I talk to, are aware of the potential outcomes. I don't know where they are in terms of preparedness or data submission. That's not something that we talk about with our peers..

Isaac Ro - Goldman Sachs & Co.

Okay.

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

David P. King - Laboratory Corp. of America Holdings

Well, I think we should be clear, and we tried to be clear, that if PAMA is implemented based on the rule that's out there, there will be a reduction in the Medicare and clinical lab fee schedule. So, it's very hard, no matter how much volume you get, to offset a price reduction in a book of business of that size.

So, I would not expect if PAMA gets implemented in January that we will offset the financial impact of the fee schedule reduction with incremental volume..

Isaac Ro - Goldman Sachs & Co.

Got it. Thank you..

Operator

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

Sir?.

David P. King - Laboratory Corp. of America Holdings

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

Operator

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

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