Labcorp Holdings Inc. (LH) Q2 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Laboratory Corporation of America Holdings Reporting For Second Quarter 2015. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this call is being recorded. I would now like to turn the conference over to Mr. Paul Surdez, Vice President of Investor Relations. Sir, you may begin.

Good morning, and welcome to LabCorp's second quarter 2015 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; Jay Boyle, Chief Executive Officer of LabCorp Diagnostics; Joe Herring, Chief Executive Officer of Covance Drug Development, and Deborah Keller, incoming CEO of Covance Drug Development. In addition to our press release we also filed a Form 8-K this morning that includes additional financial information. Both are available in the investor relations section of our website at www.labcorp.com, and include a reconciliation of non-GAAP financial measures discussed during today's call to GAAP. Finally, we are making forward-looking statements during today’s call. These forward-looking statements include, among others, statements about our expected financial results, the implementation of our business strategy and the ongoing benefits from acquisitions. These statements are based upon current expectations and are subject to change based upon various factors that could affect our financial results. Some of these factors are set-forth in detail in our 2014 10-K and our subsequent filings with the SEC. We have no obligation to provide any updates to these forward-looking statements, even if our expectations change. Now I'll turn the call over to Dave King.

Thank you, Paul and good morning. We had an outstanding quarter in which we delivered impressive top line growth as well as record revenue, earnings and cash flow. We began to see the power of the combined businesses, which extends far beyond merely combining central lab capabilities. Our results demonstrate the soundness of our decision to acquire Covance and create the world’s leading healthcare diagnostics company, and strengthen our conviction in our ability to create long-term value for patients, customers and shareholders through integrated lab testing, our global drug development capabilities, and technology enabled solutions. Overall I am very pleased with our execution and our results in the quarter. Each of our businesses performed well. LabCorp Diagnostics reported another exceptional quarter. We continue to drive strong revenue growth led by increased organic volume. During the quarter, we observed solid growth in both esoteric and core testing, and revenue per requisition was positive for the first time in over two years. LabCorp Diagnostics’ strong top line growth converted into attractive profit growth. Adjusted operating income excluding amortization of nearly $350 million, or 22% of net revenue, translated to 130 basis points year-on-year margin improvement. This increase in profitability was driven by strong volume growth and improved productivity founded on Project LaunchPad. Through LaunchPad we continue to progress with multiple initiatives to re-engineer our company to deliver the highest quality services in the most efficient manner. Covance Drug Development reported revenue growth on a constant currency basis of 1.8% over last year’s pro forma revenue. Early development had strong growth and margin expansion as the toxicology market continues to improve. Central labs revenue increased nicely on a sequential basis due to higher kit receipts as we predicted on our first quarter call. Central labs also contributed strong new orders in the quarter. Clinical business net orders were lower than expected, which combined with slower than typical revenue conversion resulted in growth below our expectations. We are focused on restoring growth in this important service line and expect to see results from these efforts in future quarters. Looking ahead, we see multiple drivers of future profitable growth. First the trajectory of our central labs business is encouraging. We had very strong levels of [Indiscernible] kit shipments throughout the quarter and our average kit receipts over the last two months have increased. Second, we are encouraged by positive momentum in the early development business fuelled by continuing strength in biotech funding levels. Third, we will benefit over time from investing in growing the clinical business. Fourth, we continue to capture cost synergies from our acquisition. Now I would like to comment on our progress with the development of new business models that leverage our combined capabilities. The integration of our businesses continues to go well. I am enthusiastic about the coordinated efforts of our sales force and scientific leadership teams. We have dedicated teams focused on driving more than $300 million in incremental annual revenue by 2018 through accelerated clinical trial enrolment, end-to-end capabilities in companion diagnostics and broad use of real world evidence in support of clinical trials. Our clinical team is featuring the utility of our patient database as a competitive differentiator to enhance patient enrolment, and this initiative has generated a consistently positive response from our clients. Furthermore, we are deploying our differentiated offering to win business. Earlier this month, we were awarded a life cycle management Phase 3b study for uncommon chronically ill patients that present a difficult population to recruit. Using diagnosis codes in our patient database we obtained unique insights that allowed us to identify eligible patients and their treating physicians, which gave our client confidence in our ability to timely enroll the study. We will next be contracting treating physicians to recruit patients that meet the selection criteria for this important trial. In addition, our joint analytics team is responding to multiple client requests to use de-identified patient data for commercial purposes, usually in combination with other datasets. Examples include market sizing, comparative effectiveness, deploying a personalized approach to therapy administration, assessing safety signals and identifying opportunities to improve patient [entry]. Through the interest generated from our combination we have expanded conversations with existing clients and initiated dialogue with new potential clients. We also continue to speak with drug sponsors that expressed interest in consolidating R&D outsourcing from multiple vendors across multiple areas of development to a preferred partner to improve efficiency and reduce the cost of bringing a new drug to market. We see a growing awareness that we can deliver unique solutions that will further validate our decision to deploy capital through this highly strategic combination. Finally, we continue to develop and commercialize technology enabled solutions that use data to enhance decision making, provide scalable platforms and applications for our customers and change the way care is delivered. We have long been committed to helping achieve better patient outcomes at lower cost and we have two services in flight towards that end, Beacon LBS and Enlighten Health. Beacon LBS is an innovative technology enabled solution that is modernizing delivery and laboratory services. Beacon LBS connects physicians will evidence-based clinical guidelines during the ordering process, providing physicians with access to rich clinical content within existing workflows. The application promotes use of the appropriate test for the appropriate patient at the appropriate time to enhance the delivery of optimal care. Last quarter the Beacon LBS team achieved its goal of full implementation and this quarter Beacon LBS contributed 1.1% to our organic revenue growth. I congratulate the entire Beacon LBS team on achieving an outcome that was little more than a dream when they began work on this project some five years ago. The Beacon LBS team remains engaged in discussions with existing and prospective clients that are expanding Beacon LBS’ utilization and we look forward to providing updates in the future. Enlighten Health is utilizing the combined company’s informatics and analytics tools to develop customer solutions and partnerships, such as data integration and data visualization applications. This business is implementing our data strategy and allows us to capture the value of our database and technological skills. To close, I am profoundly grateful to our 48,000 employees around the globe for their efforts during this quarter as well as to their leadership. We have asked a great deal of our people on multiple fronts and they have responded with energy and enthusiasm. Most of all, they have delivered impressive results and I’m proud of each of them and proud to have the honor of leading this great team. As the world’s leading healthcare diagnostics company we are well positioned to drive profitable growth and create long-term patient, customer and shareholder value by delivering world-class diagnostics, bringing innovative new drugs to market and using data to change the way care is delivered. Now I will turn the call over to Glenn.

Thank you, Dave. I'm going to start my comments with a review of our consolidated second quarter results followed by a discussion of our LabCorp Diagnostics and Covance Drug Development segments and conclude with an update on our 2015 guidance. Revenue for the quarter was $2.2 billion, an increase of 46% over last year. The acquisition of Covance contributed $621 million during the quarter, driving 41% year-over-year revenue growth with the other 5% primarily due to strong organic volumes across both core and esoteric testing, Beacon LBS and tuck-in acquisitions partially offset by currency. Gross profit for the quarter was $775 million or 34.9% of revenue compared to $569 million or 37.5% last year. The increase in gross profit dollars was due primarily to the acquisition of Covance, as well as organic volume and productivity. The decline in gross margin was due to the mix impact from Covance. Excluding Covance gross margin would have been 38.2%, an increase of 70 basis points over last year. SG&A for the quarter was $392 million or 17.7% of revenue compared to $298 million or 19.6% last year. Excluding special charges of $9 million related to the acquisition of Covance and Project LaunchPad, SG&A in the quarter was $384 million or 17.3% of revenue, a 200 basis point reduction versus last year’s adjusted SG&A. The increase in SG&A was primarily due to Covance and personnel costs, partially offset by Project LaunchPad savings. The favorable reduction in SG&A as a percentage of revenue benefited from Covance and the reduction in our bad debt rate. Excluding Covance and special charges, SG&A as a percentage of revenue would have been 19%, an improvement of 30 basis points over last year. During the quarter, we recorded $23 million of restructuring charges and special items, primarily relating to facility closures, severance, Project LaunchPad, and the acquisition of Covance. Amortization expense for the quarter was $47 million, up from $22 million a year ago due to the impact of acquisitions. Operating income for the quarter was $321 million or 14.5% of revenue compared to $247 million or 16.3% last year. Excluding amortization, restructuring and special items of $70 million adjusted operating income was $391 million or 17.6% of revenue compared to $275 million or 18.2% last year. The increase in adjusted operating income is primarily due to the Covance acquisition, organic volume growth and productivity, partially offset by currency. Excluding the mix impact from Covance, the adjusted operating margin would have been 19.2%, an increase of 100 basis points over last year. Interest expense for the quarter was $58 million compared to $26 million last year. The increase was due to higher debt balances following the acquisition of Covance. The expense lower than last year’s 39.1% rate driven by the mix impact of Covance, the tax rate for the quarter was higher than our expected rate of 35%, as we had a greater percentage of our earnings generated in the US. For the remainder of the year, we expect an effective tax rate of approximately 36%. As a result, net earnings for the quarter were $168 million or $1.64 per diluted share compared to $141 million or $1.64 per diluted share last year. Excluding amortization, restructuring and other special items adjusted EPS were $2.09 in the quarter, up 14% from $1.84 last year. During the quarter operating cash flow was $397 million compared to $207 million last year, with the increase due to the acquisition of Covance, as well as improved earnings and working capital. Capital expenditures totaled $69 million compared to $48 million last year due to Covance. As a result free cash flow was $328 million compared to $159 million last year. At quarter-end our cash balance was $619 million compared to $446 million at the end of the first quarter. Total debt was approximately $6.8 billion. Our liquidity was approximately $1.6 billion consisting of cash and available credit. During the quarter, we invested $62 million in acquisitions and paid down $145 million of debt, reducing the company’s leverage to 3.6 times net debt to last 12 months pro forma EBITDA. Now I will review our segment performance. For comparative purposes, segment results are presented on a pro forma basis for all periods, as of the acquisition of Covance closed on January 1, 2014 and exclude amortization, restructuring, special items and unallocated corporate expenses. Reconciliations of segment results to historically reported results are included in today's press release and the current report filed today on Form 8-K. In addition, during the quarter we substantially completed our fair market value adjustments in accordance with purchase price accounting associated with the acquisition of Covance. This resulted in reduced depreciation expense of approximately $5 million in the quarter. We expect to complete our fair market value adjustments related to the acquisition by the end of the year. Now I'll review the performance of LabCorp Diagnostics. Revenue for the quarter was $1.6 billion, an increase of 5.4% over last year. The increase in revenue was the result of strong organic volume, measured by requisitions, Beacon LBS, and tuck-in acquisitions, partially offset by currency. The increase in revenue of 5.4% includes the benefit from Beacon LBS of 1.1% and an unfavorable foreign currency translation of 0.7%.Total volume measured by requisitions increased by 4.7% of which organic volume was 4.3% and acquisition volume was 0.4%. Revenue per requisition increased by 0.2%. LabCorp Diagnostics’ adjusted operating income for the quarter was $347 million or 22% of revenue compared to $309 million or 20.7% last year. The increase was primarily due to strong volume growth and productivity. Improvement in productivity was driven in part by Project LaunchPad, which delivered approximately $15 million in savings in the quarter. We remain on-track to deliver approximately $50 million of LaunchPad savings in 2015. Now I'll discuss the performance of Covance Drug Development. Revenue for the quarter was $644 million, a decrease of 2.7% from last year. The strengthening US dollar negatively impacted revenue growth by approximately 450 basis points. On a constant currency basis, revenue increased 1.8% over last year due to volume growth, partially offset by unfavorable mix. The business experienced broad-based volume growth led by early development. We saw sequential improvement in the central lab business, but demand was lower than expected in our clinical business. Adjusted operating income was $90 million or 14% of revenue compared to $85 million or 12.8% last year. The increase in profit and margin was primarily due to increased volume, lower depreciation expense, and cost synergies of approximately $10 million, partially offset by currency and mix. We are on track to deliver cost synergies in 2015 of approximately $35 million. Net orders during the quarter were $737 million, representing a net book-to-bill of 1.15, while backlog at quarter-end was $6.6 billion. Now I'll update our 2015 guidance. We expect revenue growth of 40% to 42% inclusive of Covance as of February 19th after the impact of approximately 190 basis points of negative currency. We've assumed that foreign exchange rates stay at June 30, 2015 levels for the remainder of the year. We expect LabCorp Diagnostics to grow 3.5% to 5.5% in 2015, after the impact of approximately 70 basis points of negative currency. This is an increase from our prior guidance of 3% to 5%, primarily due to better-than-expected organic growth as well as the additional revenue from tuck-in acquisitions. We expect a change in Covance Drug Development net revenue to be in a range of minus 1.5% to 5% versus full year 2014 after the impact of approximately 320 basis points of negative currency. This is a decrease from our previous range of 0% to 2%. The lower guidance for Covance reflects lower-than-expected revenue conversion and orders in the clinical business, partially offset by 120 basis point improvement in currency. We expect 2015 adjusted EPS of $7.75 to $8 compared to prior guidance of $7.55 to $7.90. the increase in our guidance reflect strong second quarter performance and outlook for the year, as well as lower depreciation expense of approximately $0.10 per share due to purchase price accounting that was updated during the quarter. We expect operating cash flow in 2015 to be $990 million to $1.015 billion versus our prior guidance of $1.045 to $1.07 billion. Capital expenditures are expected to be $270 million to $295 million versus prior guidance of $325 million to $350 million. As a result, free cash flow remains unchanged from our prior guidance of $695 million to $745 million. Excluding net non-recurring acquisition items of approximately $120 million, we expect free cash flow of $815 million to $865 million unchanged from our prior guidance. Now I will turn the call back over to Dave before we take questions.

Thank you Glenn. At this time I would like to comment on our announcement this morning that Joe Herring will retire at the end of this month and that Deborah Keller will succeed Joe as Chief Executive Officer of Covance. First I would like to thank Joe for his leadership, which helped make Covance the respected drug development organization that it is today, as well as the critical role he played during the merger and integration. During Joe’s tenure as CEO he successfully steered Covance through periods of strong growth and volatility. He led the expansion of Covance’s drug development offerings and the informatics capabilities and he remained steadfast in his dedication to the core principles of Covance, people, process, clients and science. I have great personal respect for Joe and I thank him for his many contributions to Covance. We all wish Joe well in his planned retirement. I am very pleased that Deb has accepted our offer to succeed Joe. Deb has been with Covance for 25 years, most recently serving as Executive Vice President and Group President of Covance R&D Laboratories, where she led an organization of more than 6000 employees at 18 facilities across the globe that generated nearly two thirds of Covance’s revenue. She’s a terrific leader who is well respected by our employees and clients with a clear commitment to bringing innovative new medicines to patients. Deb is absolutely the right candidate for this important role, and she distinguished herself during our succession process, in which we considered both internal and external candidates. Given the strong working relationship that Deb and I have developed I am confident that the leadership transition will be seamless. This concludes our formal remarks and we are now ready to take your questions.

[Operator Instructions] Our first question comes from the line of Robert Willoughby of Bank of America. Your line is open. Please go ahead.

Thank you. Dave or Glenn, why the change in how you are thinking about the volume numbers, I see you break out the BeaconLBS, if I were a Florida United member left the sample prior to Beacon versus now is there a different revenue model here that why you call this out separately?

Bob good morning it’s Dave. So the revenue model for BeaconLBS is that there is a payment who are all lab services that are delivered in the market to BeaconLBS some of that lab services will go through LabCorp some of that will go through the other network labs. The reason that we broke out 1.1% contribution is that is the revenue that BeaconLBS received that essentially as pass through to other network participants whereas the revenue the BeaconLBS receives that is take the LabCorp is reported in the diagnostics volume. So as we included essentially the pass through revenue in the -- in our volume numbers it would have given you with distorted perspective on either volume or price wherever we put it and that’s why you see it separately.

I got you, I got you that makes a lot of sense then. Just in [indiscernible] deal pipeline I see you are back to doing talk in so you can comment on the kinds of plans you are working out in the large sector and possibly outside the lab sector?

Yes, so in the lab sector that the pipeline is very robust we are looking at wide variety of potential acquisition opportunities always thinking it’s -- as we’ve said many times about broadening the esoteric testing menu broadening our geographic footprint and anything else would be important from a strategic perspective. On the Covance side we are looking at a variety of potential acquisitions that could either complement some of the existing businesses, support continued data innovation efforts or otherwise round out the capabilities that we have and that we are committed to continuing to invest to grow.

That’s great. Thank you.

Thank you. Our next question comes from the line of Michael Cherny of Evercore your line is open. Please go ahead.

Good morning guys.

Good morning.

So first Glenn for you quick question just and clarify the moving pieces on the guidance, I heard you talk about that performance in the quarter and also the adjustment on the depreciation line, by my math if you leave the looks like your expectations for tax rate as well as [indiscernible] the implied share count, I want to just -- can you please confirm those two numbers?

Yes, the share count should still be the -- roughly called 100 million shares outstanding for the year or so no change there. The tax rate we did have an estimate out before of around 35% we moved it up to around 36% consistent with what we saw in the second quarter and that was just based upon a mix of geographic earnings if you will little higher tax rate in the U.S. So those were the only changes there. And then for the guidance obviously we’ve taken it up we’ve also narrowed it even with the six months left to go so that the midpoint if you will of our guidance is now around $0.15 higher than what we would have shared in our prior guidance due to that performance we have in the quarter our outlook for the year as well as the benefit that we get for lower depreciation expense with -- doing our purchase priced account.

Now appreciate that you are just get to the earnings power and then I guess Dave and maybe Joe, Deborah if you want to pine you obviously I think relative to your expectations you’ve -- are hoping the clinical business perform a little better you talked about focusing on this scenario to reestablish growth, can you maybe talk about some of the specific focuses that you are putting in place to ensure that you can get a better close and some of those wins and get the order rate at the level that you would prefer?

Yes, Michael thanks for the question. First let me say that from an overall order perspective central labs in the first six months of 2015 have all time record orders as you think about the two companies coming together where there is integration and an overlap at central labs and the clients are pouring volume in and kids going out of the door and kids coming back in or even starting to pick up during seasonally saw summer months which is, is how that business generally closed and early development which has been a business that we’ve been trying to restore those two it was actually the fact just going to be part of the portfolio, we have margin expansion and even during the most recent weeks and months which is seasonally saw orders are very strong.

Clinical on the other hand had orders ramping to the end of last year but in the first six months of this year orders were softer and the backlog conversion has not been as fast as we would have hoped. One area where we think we can definitely improve it’s in the small and midsize clients we’ve recognized that early in the year we have added a dozen sales people and in fact in the second quarter proposals in Phase 2, 3 clinical were actually up a little more than 25% sequentially. So the actions we are taking are already making an impact at least some proposals and hopefully that flows through as to orders and eventually as revenue. The other item is that we have been very aggressively [indiscernible] Dave around the globe and introducing him to our clients, CEOs Head of R&D and the person with the longest relationship whether it’s me or Dave or a few other folks have been introducing Dave and he has played very, very well, our clients are not accustomed to see and someone who has a database with 17 million patients technology like the BeaconLBS we talked about to bring both to drug development, investigator site selection, patient identification, as well as new tools on the informatics side that we have been working on that Dave is totally up to speed on. So I guess my final comment there Michael is did the Phase 2, 3 clinical market is very strong I think you will see as our competitors continue to release results, the success that our clients are having in their pipeline as of late it’s a healthy market that we are serving and frankly the combination of Covance and LabCorp bring a tremendous set of tools that will enable us to win and in the recent industry surveys not ours but ones done by so called analyst clients repeatedly say they are actually more willing to work with Covance post merger than before because of similar things that I mentioned. So, we are working on it.

Great appreciate the color and Joe good luck on your retirement.

Thank you.

Thank you. Our next question comes from the line of Lisa Gill of JP Morgan, your line is open. Please go ahead.

Hi, thanks very much and good morning. Joe just a follow up on that, can you maybe just [indiscernible] industry for a month time to just understand your comment around orders sharpening and inflow conversion isn’t the market more competitive do you just -- did you expect this to come in overtime how should we think about that?

Yes Lisa thank you for your question, I mean – give you what maybe sort of the new answered answer but we have a number of large clients who just happen to have portfolios that are a little bit slower as we go right now. For example, in central labs, we have a number of so source clients who plays every stick of their central labs work with us and every year for the last seven years we’ve had a different largest client and it’s not because we’ve lost work or gain work it’s more competitive it’s just how the pipeline flows and we have a couple of clients who are spending a tremendous amount in the launches and a little less in Phase 2, 3 clinical but they have a strong early clinical pipeline that will bring new volume hopefully in the coming quarters and into next year. So it’s sort of the vague reason of how former pipelines go and just been little bit softer for us but again I think the effort in small to mid clients as well as the differentiating tools that we are bringing position us to do well there and again the market is strong.

And Lisa it’s Dave just add a little color to that when we talk about slower than typical revenue conversion this has to deal with the complexity of studies the fact that there maybe other modality such as imaging included in the study that has to be coordinated and patient visit. So it's not that – it's not that the studies aren't starting, it's just that they are taking longer from the placing of the order to the actual beginning of completion of recruitment, beginning of patient visits and that's – I think that's characteristics across all of the clinical businesses that comparable that we are seeing in the market.

And so based on what we saw on the first and second quarter Dave or Glenn can you just talk about that the updated guidance around Covance and how conservative you feel that is as we move towards the back half of the year?

Sure Lisa. Obviously, while we have taken down the revenue guidance of Covance Drug Development it's still a growth rate I think in the midpoint on constant currency we are still up around 2.7%. As Joe spoke to I believe earlier we have really seen good growth in early development and the central labs and that remains unchanged where we saw the lower expectations for growth was really in the clinical business and again we talked about it or Dave just mentioned that the slower than expected revenue conversion as well as little bit softer on the order side, however, we feel pretty good about the outlook that we have now in part because that one part of the business that generated the lower than expected revenues the new orders that were getting now effectively are going to impact 2016 and beyond. So we do expect and the year what's embedded in our outlook is growth across all the main business lines of Covance year-over-year all be it currently a little bit lower than what we had originally envisioned. I guess on the positive side while we have seen a reduction in the revenue outlook and in the enterprise our top line revenue outlook continues to be roughly where it was actually it's up slightly because of the tuck-in acquisitions and as you saw we have also – obviously also taken up the leverage as we moved up the earnings per share guidance as well.

Okay. That's helpful. Thanks Glenn.

Thank you. Our next question comes from the line of Jack Meehan of Barclays Capital. Your line is open. Please go ahead.

Hi, thanks and good morning. I just want to start and ask about the genomic testing in the quarter and how much of a contributor that was the better pricing and then just any areas of the growth that you could highlight there?

Jack, this is Jay Boyle. Thank you for the question. We have seen growth in both the genomics and esoteric business that has helped drive our revenue per session for the quarter that we are really pleased with. We expect that to continue as we move into the back half of the year. And hope to continue to see that kind of growth and did you ask the second question I am sorry I missed it.

Yes, just maybe any areas that you could highlight within that or if you thought it was more broad based across the portfolio there?

Yes, you hit the narrow and ahead we have had – we are very pleased with obviously our volume growth and across both the core and the esoteric businesses and we expect that outlook continuing. I do really missed this point in that mentioning that our team has done a terrific job, this is the best of several quarters where we have had significant organic volume growth and volume growth across the board and it is in the esoteric genomic and also in the core area and has helped to give us the price that we have experienced this quarter.

Yes, great and then just as a last one on the commentary around M&A just with tuck-in deals there are any different thoughts around the way you think about leverage through your end and then just whether any of this was being driven by some of the regulatory and certainty out there. Thanks.

Jack, it's Dave. Good morning. I am not sure what's driving the pipeline and it would be hard to give any kind of reasonable speculation. I will say in terms of our focus and perspective we continue to be focused on the same basic priorities as I mentioned which is the esoteric test menu and this strategic footprint and other potential strategic opportunities [indiscernible]. In terms of the leverage we have not changed our perspective which is we need to de-lever. We paid debts this quarter but at the same time we did a couple of tuck-ins because they were attractive opportunities and you can expect to see the same from us going forward while for paying more debts and we are doing tuck-in acquisitions. We will continue to de-lever and as Glenn said in his prepared comments that debt to EBITDA was 3.6 in the quarter so we have already started de-levering from where we were post close.

Thank you. [Operator Instructions] Our next question comes from the line of Isaac Ro of Goldman Sachs. Your line is open, please go ahead.

Good morning guys. Thank you. Dave I wanted to ask another question on Covance if I may, if we look back 90 days ago when you last offered guidance for the year and updated your views on the business, can you walk us through sort of what your assumptions were then and what changed during the quarter because I think in context to your comments around the revenue conversion and the complexity of studies but some more later items I would assume that there were lot of the studies who were working on you knew that they were going to be flat, so I am trying to figure out what led to sort of this [revised] due of 90 days later.

Isaac, its Dave. Obviously, it's the time that we updated the Covance revenue guidance. We thought that we had very good visibility in the second half of the year. I would say we did have very good visibility in the second half of the year in early development and in central labs. In the clinical business, certain parts of the clinical business, the orders burn relatively quickly and we came up little short there from what we thought that we were going to accomplish in the quarter, which has an impact for the balance of the year and that's the reason why we've adjusted the guidance. Obviously, from my perspective and for the management team perspective, we're happy about it, but we have made the commitment as Joe said for even earlier in the year to invest in the growth of the clinical business and to take the steps necessary to put it back on track.

Great. And if we just sort of think about your guidance for this year at this point in second quarter, is it fair to say that your outlook is perhaps more conservative for the year than it would have been 90 days ago? Thank you.

No. I don’t think so at all. I think it was $0.15 raised in the low-end of which greater than 10 is the depreciation but the rest is due to be in our fourth projected forecast for the rest of the year. Signals there, we feel that the rest of the year is going to be strong. Obviously, as we have said on many occasions, the guidance encompasses a wide range of outcomes but I wouldn’t describe it as either more conservative or more aggressive than what we've previously head out.

Yes. Keep in mind, Isaac, that the Covance business is a little more volatile than and less predictable than the historic lab core businesses. But in the second quarter we delivered sequential revenue growth of 20 million, call it, and sequential operating margin of nearly 20 million. So, better than expected. So, we'll fight on from here.

Got it. Thank you.

Thank you. Our next question comes from the line of Gary Lieberman of Wells Fargo. Your line is open, please go ahead.

Good morning and thanks for taking the question. Maybe on the clinical lab business, your organic volume growth was substantially stronger than some of your competitors. Do you think you're taking share or is something else going on?

Yes, Gary, this is Jay. Hard to determine whether we're actually taking share or not, but certainly our results speaks for themselves. It's as I mentioned earlier, it's across the board and they talked about the coordinated effort earlier. It's a credit to our sales leadership and then leadership in our divisions, where they're just totally focused on growth. We have a terrific hospital and manage care team that bring deals onboard which pave the way. So we're really pleased about the share that we are capturing.

And Gary, this is Dave. Quick follow-up on that. Obviously, we've talked about the fact that we've won a couple of contracts last year. Those are -- had started to annualize and will fully annualize in the next quarter. So again I think the organic volume growth is very strong. You can reach your own conclusions about taking share but we're continuing to see strong organic volume growth through the beginning of the annualization of the business wins.

Okay. And then maybe just any updated thoughts on the PAMA study and what you're thinking at this point?

I think the only thing I can do is refer you to the comments that more cards being made at the CMS clinical lab meeting with respect to the timing. I emphasize again as I said I think on the last call, this is a very complex task for CMS. There are a lot of data points, there is a lot of information that they're trying to gather. They're trying to do it in a responsible way that's fair to the industry and also to the payer. We continue to be optimistic about the outcome and to take a -- we hope a positive and supportive approach to what CMS is trying to do.

But any -- have your thoughts changed on the timing. Do you still expect or do you think it gets pushed off for years on?

Well, I think they've said the timing of the rule is uncertain and so what we can do is go by what they said which is the timing of the rule is uncertain and it will be up to them to determine what that means with respect to implementation.

Okay, great. Thanks a lot.

Thank you. Our next question comes from the line of Ricky Goldwasser of Morgan Stanley. Your line is open, please go ahead.

Yes, hi. Thank you and good morning. First question is around lab volume. Dave, last quarter I think you sounded a little bit more cautious and just volume trend in second half due to these contracts that are annualizing. Today, you guys grace second half revenue expectations for the diagnostic business. So, when you think about what is done today, what has changed, what is adding to your confidence and what are the dockets that are driving this bit of outlook for the second half?

Hi, Ricky. This is Glenn. Maybe, at least I can start just a kind of level set that. One obviously, we have been consistently generating good volume. And as Dave commented the annualization of the revenue from the new contracts, really, you'll see in the second half of the year. So, we've benefitted in the first half. The other thing that will benefit in the second half obviously will be the tuck-in acquisitions that we have been doing as well as the BeaconLBS. That will be on for a full half versus the ACLA partial part of the first half of this year. So, consistent, still strong, good volume growth, but again tougher comps year-over-year when you just take it back to the basic organic diagnostics business.

Okay. And Dave, do you have any additional comments on that or should I move on to my Covance questions?

No. I think Glenn has summarized it well. Volume has been strong. We have BeaconLBS contributing to revenue, which again is part of the overall volume perspective. I don’t think a whole lot has changed in the outlook, Ricky. I think as you get further end of the year you have greater visibility and where you're going to come out. And as we get greater visibility into where we come out, we adjust the expectations accordingly.

Okay. Then on the Covance side. Obviously, you were hearing that early stage is doing better. Lilly contract is a big part I think of that segment. So, can you just help us think through that contract, if I'm not mistaken it was a 10-year contract. So, can you just confirm the term of this contract, when she will be thinking about the end date and what percent of the revenues and what type of trends are we seeing from that business?

Yes. Ricky, it’s Joe. I think you're talking about the Lilly agreement and that goes through 2019. The agreement continues to perform well and above the expectations and that's clearly in account that we've had Dave in. It's in really good shape. I think if you just take a step back, the fact that early development continues to see mid-to-higher single-digit revenue growth margin expansion capacity filling as well as our competitors doing well. And biotech funding is very constructive to the story. Obviously, central labs is the largest division of Covance and it's the most profitable. To see record orders and kits out and kits coming in sort of building up tail wins for later in the year and certainly for 2016, is very encouraging. So, Dave who led the recovery of early development, now has the whole enchilada and of course the great business that is central lab has been her baby. So, she can't wait to get her teeth into clinical as well as her arms around the whole thing and bring her years and years of experience to the company, fully to bear.

So, Joe, given kind of like the mix that you're seeing in central lab, do you feel comfortable with potential opportunity to even increase margin on that segment because I noticed in the past we thought that maybe we've seen very nice margin expansion where tap it. So, given what you are seeing now coming through, are you more bullish on the margin opportunity there?

Well let me say this, in my 18 and half years with the company, I have proven one thing for sure and that is that I cannot forecast central lab. Over the longer period of the time, it grows roughly 10%. I am very, very confident that we are in the early stages of accelerated growth in central labs. Our competitive position has improved. I think some -- we got a couple of competitors that are struggling. I think our clients like the incremental benefit of having the esoteric volume from lab core within the portfolio. And as you pointed out Ricky, there is good drop through on additional central lab volume. So, I think as we look towards the end of the year and in 2016, central lab is very constructive and I guess I would say Covance is stronger than ever in central lab.

And Ricky, it's Dave. Just one additional comment there what Joe touched on as we add more genomic and esoteric capabilities to the Covance central lab business and particularly as we see great client interest in next gen sequencing exome capabilities that the lab core or central lab business is bringing that will have a natural positive effect on both pricing mix and margin in the central lab business.

Finally, Ricky, we did add another self-source central lab client in the second quarter as well, which, as they ramp-up will be helpful.

Okay. Thank you.

Thank you. Our next question comes from the line of Amanda Murphy of William Blair. Your line is open, please go ahead.

Hi, good morning. I had a couple more on Covance if I may? Joe and Dave I think another at your row today had talked about the strong RFP growth that I am wondering in another you've made an improvement. They know its knocking on that wall since last second quarter but have you seen any change there over the past few weeks and also did you talk about cancellation made at all from last quarter?

Well, I guess proposal volume being up 25% sequentially is a very good factoid. It's early in the quarter to talk about what will translate into orders but we are much more out there and have better coverage. So, in terms of cancellation rates in clinical, keep in mind we were reporting net orders and so they are net of cancellations and we tend to just color cancellations. They were lower than historical run-rate in the first quarter and sort of at the historical run-rate in the second quarter.

Okay, got it. And then I guess it's the longer term question, so you've obviously provided some revenue synergy target at a high level and then you also talked about to your point the RFP, flow, etcetera. So, just thinking about how we should be tracking your progress going forward, is there a certain book-to-bill number that you would consider to be a successful number going forward and to over what timeframe should we be looking for that that is in context of all the demand commentary that you laid out so far?

Amanda, its Dave. I don't think it would be reasonable to point to one specific number and say that's a target or that's a goal or that represents success. I think what we'll be able to do over time is point to as we have specific instances of winning business due to the combination of the companion diagnostics in particular which we are very enthusiastic about and tell you how much that's contributed against the $300 million target. So, I think those will be better indicators to look for than one single number like the book-to-bill or a revenue growth rate.

I would though, Amanda, remind you that during the really busy time of the acquisition of Covance, we posted two consecutive record order quarters; fourth quarter was an all-time record, the first quarter was an all-time record. In the second quarter we had a couple of large clinical studies that we expected to win that pushed out the second quarter into the third quarter. So, we had a book-to-bill of 1.15, which is respectable. It's not the record that we had in Q3 and Q4. But, also keep in mind that roughly a third of our revenue is in the pre-clinical area where a book-to-bill of 1.0 to 1 is sort of which target. So, 1.15 for us compared to a predominately clinical company, we translate into something much more like maybe 1.25 to 1. So, good orders, not as great as they were the last two quarters but we are out there fighting.

Got it. Thanks very much.

Thank you. Our next question comes from the line of A.J. Rice of UBS. Your line is open, please go ahead.

Thanks. Hello everybody. I guess prior to the merger from the Covance side, I think it was publicly discussed that Sanofi was restructuring it's -- planning to restructure its partnership with Covance. I haven't heard a lot of discussion about that since the merger. Can you just update us, is that restructuring still likely to happen later this year and how would that impact the back half guidance or next year's guidance, is that reflected in there?

Yes, thanks for the question. First of all, all of this is in our [S4 dial] filings and it's in all the forecast that we've talked about. There's two parts. The larger part of the agreement at a -- and that is the services agreement, Sanofi volume with Covance's 5x prior to what we had before we did the agreement. The asset agreement were for the two specific sites and our continued expectations is that agreement will not be renewed but every day is sort of something new. That's about roughly about $70 million a year, but again all of that's fully disclosed. It's in all of our forecast and in all the expectations.

Okay, and that's presumably in the guidance that the consolidated companies are offering out as well.

Yes.

Yes, it is.

Okay. Then just on the lab side, maybe just Dave or anyone else want to comment. It's been on the news lately the idea of consumers being able to drive their own test. There's been changes in Arizona to allow at least some consumer making the decision to ask for test directly I don't know if I've ever heard you guys express a view on that. You guys have a position on whether you're supportive of that or not and what you think the implications would be?

A. J., its Dave. We agree in the first instance that consumer engagement is extremely important in their own responsibility for healthcare and for years we pushed. When I came to this company and most states it was illegal for consumers to get their own lab results without getting permission from their doctor. We push for years and finally AJ just responded with the regulation to allow that. So, consumer engagement is extremely important. We do need to think about the consequences of consumer self-ordering, one of which is the patient doesn't understand the test result. Two, is the patient decides to start self-treating now that they've got the lab test result. So, we've said and we've been open about, we will have a direct consumer business under the lab core brand by the end of the year. We are not going to do it in a way that disintermediates positions, we are going to do it in a responsible and a compliant way. And we are very sensitive to the importance of physician interpretation of [test] as well as the need to combine individual test results with other signs and symptoms of disease. So, I think we've been clear in that position and again we continue to support consumer engagement but in a responsible and compliant and measured way.

Okay. Alright. Thanks a lot.

Thank you. Our next question comes from the line of Dave Francis of RBC Capital Markets. Your line is open, please go ahead.

Hi, good morning. Most of my questions have been answered. Just real quick though with Joe leaving the company, Dave, I was wondering if as you guys get deeper into the integration process for the business is if there is any other contemplated changes to the leadership team or otherwise on either side of the business? Thanks.

Obviously, we've had some leadership transition at Covance, already all of which was planned as part of the merger synergies. We feel like we've got a strong leadership team in place. Deb was going to be a terrific leader. I am sure overtime that she will want to make some tweaks to her team as every CEO does, but there is nothing planned in terms of major leadership or major structural changes.

Thank you.

Thank you. Our next question comes from the line of Whit Mayo of Robert W. Baird. Your line is open, please go ahead.

Hey, thanks. I think you guys called out 15 million of synergies with Covance. Was that all realized in the second quarter or is that a year-to-date number?

That was realized in the second quarter, at current run rate.

Okay, great. Did you realize any in the first quarter or is it fairly immaterial at that point?

This is on the -- I guess, on the Covance side we did around five in the first quarter, call it 10 in the second and again with the target this year of 35. So, obviously, we are delivering solidly on our expectations but the longer term over the three years on a cost savings standpoint, it was going to be call it a 100 million and again we are on track for that.

Yes, got it. And my last question, Dave, I think I have heard you say in your prepared remarks that Covance is having a number of conversations with various former customers about some preferred partner relationship or something along those lines. Can you just elaborate a little bit more on that and is that something that's actually new?

Well, the conversations of that for why the relationships are not new. I think what's new is the range of capabilities that we bring to the table. Now Covance has always had the unique position in the drug development business of having the combination of early clinical and central lab. But I think that the lab core capabilities, the incremental lab capabilities, the data, the companion diagnostics expertise that compliments with Covance has and obviously the scale and infrastructure for some of the priorities around real world evidence, these are very, very interesting to our clients. Glenn and I have in fact done several clients visits over the past two weeks and there is a new level of interest about -- first of all I want to understand the rationale for the merger, then I want to understand how can that lead to a broader scientific collaboration, how can that lead to broader capabilities collaboration, how can that lead to execution of some of their priorities. And so, we're enthusiastic about the opportunity to grow some of these existing relationships and add some new ones.

Okay. Thanks a lot.

Thank you. And that does conclude our question-and-answer period. I would like to turn the conference back over to management for any closing remarks.

Thank you very much. We appreciate your time this morning and wish you a good day.