Laboratory Corporation of America Holdings
NYSE:LH
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Laboratory Corporation of America Holdings
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Good day, ladies and gentlemen, and welcome to the Q1 2018 LabCorp earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. As a reminder, this conference is being recorded.
I would like to introduce your host for today's conference Scott Frommer, Vice President of Investor Relations. You may begin.
Good morning, and welcome to LabCorp's first quarter 2018 conference call. As detailed in today's press release, there will be a replay of this conference call available via telephone and Internet. With me today are Dave King, Chairman and Chief Executive Officer; Glenn Eisenberg, Executive Vice President and Chief Financial Officer; Gary Huff, CEO of LabCorp Diagnostics; and John Ratliff, CEO of Covance Drug Development.
In addition to our press release, we also furnished 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, but are not limited to statements with respect to 2018 guidance and the related assumptions, the impact of various factors on operating and financial results, and the opportunities for future growth.
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 2017 Form 10-K and subsequent Forms 10-Q and in the company's other 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, Scott, and good morning. We are off to an impressive start in 2018, once again demonstrating the power of our integrated growth platform. The combination of accelerating organic revenue growth and drug development, strong organic growth in diagnostics despite headwinds from PAMA and weather, and acquisition contributions from both businesses yielded year-over-year revenue growth of 18%.
This top line performance along with the benefits from our LaunchPad initiative and tax reform translated into adjusted EPS growth of 31%. We expanded margins significantly in Covance and held them for the enterprise. In addition, we fully deployed our free cash flow through share repurchases and a one-time bonus payment to non-bonus-eligible colleagues as a result of tax reform. We are very pleased with our operating performance during the quarter.
Our results reflect the adoption of the new revenue recognition accounting standard, ASC 606. Although ASC 606 has no impact on our cash flow, we estimate that it will lower our full year 2018 adjusted EPS by approximately $0.20 to $0.30, which Glenn will discuss in more detail.
I want to stress that we are nevertheless maintaining our full year guidance despite this development because our strong first quarter performance, outlook for the balance of the year and progress on key strategic initiatives give us confidence that we will overcome this impact, which is merely due to the accounting change.
As we said early in the year, to achieve our guidance, we are relentlessly focused on execution of three priorities: driving profitable growth, integrating key acquisitions and optimizing enterprise margins. We are driving profitable growth by capitalizing on strong customer demand for our differentiated capabilities and strategically investing in new offerings for future growth.
In Drug Development, our investments in people, solutions, technology, therapeutic expertise and infrastructure are resonating with our customers. The objective evidence is another quarter of strong net orders and book-to-bill. Independent evidence comes from a survey of biopharma customers conducted by the Life Science Strategy Group and William Blair, in which Covance was recognized as far away the most improved CRO over the past year. As John Ratliff memorably told me last year, quite simply, we are winning in the market.
In Diagnostics, our focus on Women's Health and Medical Drug Monitoring as well as our strategic collaboration with 23andMe contributed to market-leading organic growth. The increased volume helped mitigate the impact from lower reimbursement rates related to PAMA. There are multiple growth opportunities in Diagnostics and we will continue to deploy capital judiciously to maximize the return on our growth investments.
Our second priority for 2018 is integrating key acquisitions flawlessly. The integration of Chiltern is largely complete, benefiting customers of both Chiltern and Covance. We have preserved the high-touch customized experience that Chiltern's biotech and emerging pharma customers require while strengthening both Chiltern and Covance's scale, therapeutic expertise and capabilities. In Diagnostics, we continue to demonstrate the value of our be selective and go deep strategy as partnerships with major health systems such as Mount Sinai and PAML expand to new services and initiatives.
Our third priority in 2018 is optimizing our enterprise margins. Besides profitable revenue growth and acquisition integration, our LaunchPad improvement process initiative in both businesses is critical to achieving this goal. LaunchPad centers on fundamentally reengineering service delivery to improve the customer experience while sustainably enhancing margins.
During the quarter, we opened a Covance central delivery center in Bangalore, India, an important milestone toward expanding our global service delivery model. Global service delivery enhances our proficiencies by standardizing processes and procedures, automating workflows and creating a global platform to reduce expenses and support long-term growth. The impact of Covance LaunchPad is clear in significant Covance margin improvement versus last year.
In addition to focusing on these three 2018 priorities, we are also capitalizing on long-term growth opportunities provided by our powerful combination of leading Diagnostics and Drug Development businesses. At our Investor and Analyst Day in February, we identified three strategic initiatives – supporting our customers' transition to value-based care, enhancing the drug development process and creating a leading consumer engagement platform.
I will now discuss highlights of these areas during the quarter. We entered into a comprehensive laboratory collaboration with Appalachian Regional Healthcare, an 11-hospital health system in Kentucky and West Virginia. We expanded our relationship with Mount Sinai to consolidate all of their reference work and streamline their inpatient labs. We delivered another quarter of strong double-digit growth in companion diagnostics, and Covance's backlog in this area now exceeds $300 million. We continue to offer customers the unique ability to develop companion diagnostics as lab-developed tests or in collaboration with manufacturers as IVDs [In-Vitro Diagnostics].
We are in the process of finalizing an arrangement to offer companion diagnostics globally to meet the requirements of our biopharma customers who wish to sell their medicines outside the United States. We announced a strategic technology agreement with GlaxoSmithKline that covers several Xcellerate modules on a Software-as-a-Service basis including Covance's proprietary risk-based monitoring solution. This software allows sponsors to strategically guide site monitoring resources from trial commencement to completion.
We announced the next step in our LabCorp Walgreens initiative with the opening of 10 patient service centers in Walgreens stores in Florida. Physician and consumer response to the LabCorp Walgreens experience has been outstanding, and we continue to attract new patients to these sites. This quarter, we expect to bring our testing services to consumers' homes through our innovative at-home self-collection testing device. This device will be validated to provide results equivalent to a venous blood draw, assuring LabCorp quality and reliability in another new channel.
LabCorp Express, our differentiated consumer checking kiosk, is now available in more than 600 patient service centers. Feedback on this proprietary tool continues to be extremely positive, and we remain on track to install the capability in all of our patient service centers by year end. We released the LabCorp patient mobile app for download by consumers at various app stores as an additional option to the currently available Patient Portal. These innovations increase consumer engagement, capture more accurate demographic and insurance information, and create efficiencies in patient service center workflow.
In closing, we are off to a terrific start in 2018. Through sharp focus on our key priorities in Diagnostics and Drug Development combined with important strategic accomplishments, we delivered impressive growth and continued to create shareholder value.
We are the world's largest laboratory by revenue and global reach, but we are more than the world's largest laboratory. We are a global leader in life sciences. We offer real solutions beyond lab and beyond CRO, and we provide unique and differentiated value to consumers, physicians, health systems, managed care, and biopharma partners. We could not accomplish these things without the commitment and contributions of nearly 60,000 colleagues around the globe. They dedicate themselves every day to our mission to improve health and improve lives and make all of our current and future successes possible. We are all confident that the future ahead is bright.
Now, I'll turn the call over to Glenn.
Thank you, Dave. My comments today will focus on the company's first quarter results as well as provide an update on our 2018 guidance. However, I'll start off with a discussion of the new revenue recognition accounting standard, ASC 606, given its impact on our numbers.
On January 1, 2018, we adopted ASC 606 using the full retrospective method, meaning that we restated our 2017 financial results to better enable evaluation of our 2018 performance and guidance. In the press release, our prepared remarks, and the Q&A session to follow, all references to our 2017 results are to the restated numbers unless we specifically advise you otherwise. In the back of the press release, we provided tables that include our full-year 2017 results as well as our first quarter 2018 and 2017 results under both ASC 606 and the prior accounting standard, ASC 605. We also provided additional related information on Form 8-K furnished this morning.
As you can see from the tables, the net impact for the enterprise is that the company's full-year 2017 revenues increased by $102 million, or 1%, compared to the prior accounting standard. Our adjusted operating income decreased $56 million or 3% from the prior accounting standard because the inclusion of investigator fees and other pass-through expenses changes the underlying percentage of completion calculation used to recognize revenue. The new accounting standard has the effect of deferring these earnings into future periods. As a result, earnings per share in 2017 decreased $0.35 or 4%. There was no impact on cash flow.
Furthermore, ASC 606 affects our businesses differently. For Diagnostics, the new standard requires us to treat bad debt as a reduction to revenue rather than as an SG&A expense, meaning our revenue is lower but our operating income does not change. Our reported margins therefore are higher. Specifically, as seen in the table in the back of the press release, for the first quarter, revenue under current accounting was lower by $85 million compared to the prior accounting method. There was no change in operating income. And as a result, margins are now 90 basis points higher.
For Drug Development, the new standard requires us to add investigator fees and other pass-through expenses to both revenue and expense. As a result of the increases in both revenue and expense, our reported margins are lower. In addition, these investigator fees and other pass-through expenses, which are tied to our clinical services business, now affect the timing of revenue recognition over the life of the contracts because these expenses tend to be incurred later in the contract life. To be clear, the total earnings of the contracts do not change, only the timing of when they are recognized.
We have reviewed all of the Drug Development business's contracts, more than 800 that are affected by this new standard. For the first quarter, Drug Development revenues under current accounting increased by $196 million compared to the prior accounting method. Operating income decreased by $7 million, resulting in a 300 basis point decline in margin.
Putting it all together, our consolidated revenue in the first quarter increased by $110 million or 4% compared to the prior accounting standard, while our operating income declined by $7 million or 1%, resulting in lower adjusted EPS of $0.05 or 2%.
To wrap up on the accounting discussion, a couple of key points worth noting. First, although the numbers look a bit different, the company's strong operating performance and its improving trends year over year are clear under both accounting methodologies. Second, ASC 606 has no impact on cash flow.
With that, I'll review our first quarter results. Revenue for the quarter was $2.8 billion, an increase of 18% over last year, as acquisitions added 13.4%, organic revenue increased 3.2%, and we benefited from foreign currency translation of 150 basis points. Operating income for the quarter was $305 million or 10.7% of revenue compared to $318 million or 13.2% last year. During the quarter, we had $68 million of restructuring charges and special items primarily related to acquisition integration and the one-time bonus to non-bonus-eligible employees due to the benefit from tax reform.
Adjusted operating income, which excludes amortization, restructuring charges, and special items, was $436 million or 15.3% of revenue compared to $377 million or 15.6% last year. The $59 million increase in adjusted operating income was primarily due to acquisitions, organic revenue growth, and savings from our LaunchPad business process improvement initiative, partially offset by lower Medicare reimbursement as a result of the implementation of PAMA [Protecting Access to Medicare Act]. The 30 basis point decline in operating margin was due to the mix impact from acquisitions.
The tax rate for the quarter was 28.6% compared to 30.9% last year. The adjusted tax rate excluding special charges and amortization was 22.9%, down from 31.3% last year. This lower rate was due to the implementation of tax reform in the U.S. We continue to expect the full year 2018 adjusted tax rate to be approximately 25%, as the first quarter rate of 22.9% came in as expected due to the benefit of stock vesting.
Strong operational performance and the benefit of tax reform translated into net earnings for the quarter of $173 million or $1.67 per diluted share. Adjusted EPS, which excludes amortization, restructuring charges and other special items, were $2.78 in the quarter, up 31% over last year.
Operating cash flow was $155 million in the quarter compared to $226 million a year ago. The reduction was primarily driven by the one-time bonus payment related to tax reform and higher working capital to support growth, partially offset by higher cash earnings. Capital expenditures totaled $73 million or 2.5% of revenue compared to $72 million or 3% last year. As a result, free cash flow was $82 million in the quarter compared to $154 million last year.
During the quarter, we repurchased $75 million of stock. As of March 31, we had $326 million of authorization remaining under our previously approved share repurchase program. On April 24, the board authorized an increase in the company's share repurchase program to a total of $1 billion demonstrating our continued commitment to returning capital to shareholders.
Our cash balance as of March 31 was $362 million, up from $317 million at the end of 2017. And total debt was $6.8 billion, unchanged from last quarter. The company's leverage at the end of the quarter remained at 3.3 times gross debt to restated last 12 months' pro forma EBITDA.
Now, I'll review our segment performance beginning with LabCorp Diagnostics. Revenue for the quarter was $1.8 billion, an increase of 8% over the last year. The increase in revenue was primarily driven by acquisitions, organic volume measured by requisitions and the benefit from currency translation of approximately 30 basis points, partially offset by the negative impact from PAMA.
Revenue per requisition increased 0.7% due to acquisitions, partially offset by the impact from PAMA. Total volume increased 6.9%, of which organic volume was 3% and acquisition volume was 3.9%. In addition, volume growth was negatively impacted by approximately 1% due to adverse weather.
LabCorp Diagnostics' adjusted operating income for the quarter was $364 million or 20.6% of revenue compared to $342 million or 20.8% last year. The $22 million increase in adjusted operating income was primarily due to acquisitions and strong organic revenue growth. In addition, the negative impact from adverse weather was mostly offset by a favorable legal settlement in the quarter. The decline in operating margin was due to the negative impact from PAMA, partially offset by strong revenue growth.
Now, I'll review the performance of Covance Drug Development. Revenue for the quarter was $1.1 billion, an increase of 39% over last year due to acquisitions, accelerated organic growth and the benefit from 390 basis points of foreign currency translation. Adjusted operating income for the segment was $108 million or 10% of revenue compared to $68 million or 8.8% last year. The $40 million increase in operating income was due to organic demand, LaunchPad savings and acquisitions. The 120 basis point improvement in margin was primarily driven by organic demand and LaunchPad savings. We remain on track to deliver $150 million of net savings from Covance LaunchPad and $30 million of cost synergies from the integration of Chiltern by the end of 2020.
Drug Development delivered another strong quarter of net orders and net book-to-bill. For the trailing 12 months, net orders were $4.8 billion, translating into a net book-to-bill of 1.29 times. These results compared to trailing 12 months' net orders and net book-to-bill of $4.6 billion and 1.34 times respectively as of December 31, 2017. Backlog at the end of the quarter increased to $9.2 billion, up from $8.7 billion at the end of 2017. And we expect approximately $3.7 billion of this backlog to convert into revenues over the next 12 months.
Now, I'll discuss our 2018 guidance, which assumes foreign exchange rates as of March 31 for the remainder of the year and includes the impacts from currently anticipated deployment of free cash flow towards acquisitions, share repurchases and debt repayment. And as a reminder, all 2017 results mentioned in the guidance are restated in light of ASC 606. We expect revenue growth of 10% to 12% over 2017 revenue of $10.3 billion, which includes the benefit of approximately 90 basis points of currency translation. This is an increase over our prior guidance of 9.5% to 11% due to strong organic growth and favorable currency translation.
We expect LabCorp Diagnostics' revenue growth of 3.5% to 5.5% over 2017 revenue of $6.9 billion, which includes the benefit of approximately 20 basis points of currency translation. This is an increase over our prior guidance of 3% to 5% primarily due to strong organic growth.
We expect Covance Drug Development revenue growth of 21% to 25% over 2017 revenue of $3.5 billion, which includes the benefit of approximately 230 basis points of currency translation. This is an increase of our prior guidance of 20% to 24% due to favorable currency translation. We remain on track to deliver mid- to high-single-digit organic growth in 2018 across our businesses.
Our adjusted EPS guidance is $11.30 to $11.70, an increase of 22% to 26% over adjusted EPS in 2017 of $9.25. This range is unchanged from our prior guidance. However, it now includes the projected negative impact from ASC 606 for the full year in 2018 of $0.20 to $0.30 per share whereas our prior guidance assumed no EPS impact from the accounting change. We expect to offset this reduction in earnings due to the new accounting standard through our strong first quarter results and an improved outlook for the remainder of the year.
We expect free cash flow to be between $1.1 billion and $1.2 billion, unchanged from prior guidance.
This concludes our formal remarks, and now we'll take questions. Operator?
Thank you. And our first question comes from the line of Ross Muken with Evercore. Your line is now open.
Hi, good morning, gentlemen. So on the lab side, the volume number really stuck out to me particularly on the organic side, given most of the other results we've seen across kind of healthcare this quarter, it doesn't seem like there was a huge shift in utilization and so it feels like you guys are kind of outperforming there. I know you called out 23andMe, and that's worked well for you. But can you give us just some context for how you've been able to sustain kind of this more elevated rate particularly in the face of some of the weather issues we saw and just how that's sort of likely to trend over the balance of the year just in terms of the rest of the cadence?
Sure, Ross. Good morning. This is Gary Huff. First of all, we are pleased with the 3% organic volume growth for the quarter despite the weather. This was really driven by strength in Women's Health, 23andMe, as well as our Medical Drug Monitoring. And I will tell you we continue to expect low-single-digit volume growth for the remainder of the year. And one of the reasons why we believe in our growth organically is due to the fact of our organization's focus we started. If you were at the Investor Day, you saw that we had a significant focus on oncology, genetics, Medical Drug Monitoring, as well as Women's Health and 23andMe.
And so the organization is very focused. We have a great commercial organization that is focused. And in addition to that, the entire organization, from our couriers to our phlebotomists, our lab, our people across the organization are focused on profitable – driving profitable growth in the organization, but also delivering value in terms of high-quality results and solutions to our customers, and that is proving out to do very well for us.
Ross, it's Dave. I would just add, part of it is the integrated sale to the physicians' office, particularly the OB/GYN and primary care around Women's Health, around genetics, around Sequenom. So I think we have a very comprehensive set of services, and we're offering them in a way that is attractive to the customer and highlights the one-stop shop opportunity that really makes us differentiated.
Excellent. And just on the guide, can you just give us a feel for how you're able to kind of manage through that $0.20 to $0.30 headwind because that's pretty significant relative to what we were first contemplating and tease out a bit where in the P&L you sort of had the confidence that that will sort of carry through for the rest of the year? I mean, obviously, you beat the Q1 number, but you still have quite a bit left to go in the year, and that's a reasonable step-up. And so is it really on the margin side where you've got some flexibility or were there other elements kind of contemplated on capital deployment, et cetera?
Hey, Ross. This is Glenn. To your point that the growth that we experienced in the first quarter organically, margin improvement through our LaunchPad initiative was all coming through. We had a very strong first quarter. As we look to the remainder of the year, we continue to see a good outlook, better organic revenue. You saw that we bumped up our guidance, if you will, and revenue within our Diagnostics business. We also did have the benefit of favorable currency in the quarter, and the outlook for the year contributes as well. But overall, we're feeling pretty bullish about our businesses and it's reflected in our guidance.
And Ross, it's Dave again. Just the acquisitions are outperforming our preliminary view of them when we made the acquisitions that applies to PAML, that applies to Chiltern. So those will annualize at some point, but we still feel this underlying performance in the business is very strong and gives us confidence that we'll be able to offset the impact of this accounting change.
Helpful, Dave. Thanks.
Thank you. And our next question comes from the line of Lisa Gill from JPMorgan. Your line is now open.
Thanks very much. Good morning. Dave, you commented that on a combined basis, you're seeing accelerated growth versus what either company could do on a standalone basis. Is there any way to quantify that? I mean is there contracts that you've won or something that we can look to from our side to better understand that?
Good morning, Lisa. I think that it sort of sounds like a circular answer, but it's not. I mean I think you just have to look at the results. You look in particular at the progression in Covance of the book-to-bill, the net orders and the backlog. Obviously, a lot of that is due to good leadership, and it's due to strong operational improvement, but it's also due to the LabCorp capabilities that we bring around companion diagnostics. It's due to the LabCorp capabilities that we bring around data and recruitment.
By the same token, you look at the strong LabCorp performance and again the numbers speak for themselves, but underneath that is the Covance capabilities that we bring to health systems with patient recruitment, the Covance capabilities that we bring with access to trials and cutting edge medications, not only in major academic centers but in health systems that have rural delivery – that deliver services in rural settings where the patients otherwise might not be able to access cutting edge medicines for acute conditions like advanced cancer, and so we bring something that is different and something that is attractive.
So again, I think the numbers are the best reference point, but I also think those numbers would not be achievable without the combination of the two capabilities. And if you look at the performance of peers, you see that our numbers are better, and they're better because of the combination.
So if we think about this, if we look at peers and look at your number, is it fair to say the growth rate that you have that's incremental versus a peer potentially comes from that combination or is it really hard to quantify?
I think it's very hard to quantify. Again, we can talk about specific contracts in Covance that we won because of the LabCorp data. We can talk about specific companion diagnostics contracts that we've won in Covance because of the LabCorp capabilities and the dedicated laboratory. But it's going to be hard to put a number on it other than to say I go back to the outperformances for a reason, and it's great people, it's great talent, it's great leadership, but it's also the value of the combined organization and the global scale and reach.
Great. And then, Glenn, I know you said that the legal settlement helped to offset weather in the quarter. But is there a way to quantify what the legal settlement was, one; and two, what it was for?
I'll take the first part, which is the financial impact. We've talked about it mostly offsetting the adverse impact from weather, and we did quantify that at around 1% impact on volume. So the adverse weather, call it, is around $10 million of operating income. And so we talked about that the legal settlement essentially is at least mostly offsetting it, so it gives you the magnitude or the range of what that number would be as well.
And, Lisa, it's Dave. We can't comment on what the legal settlement is for due to confidentiality. But again, it's one of those things where we incurred some legal liability, and we were able to recoup some of that liability through the settlement.
Okay, great. Thank you very much.
Thank you. And our next question comes from the line of Jack Meehan from Barclays. Your line is now open.
Thanks, good morning. So I wanted to focus on Covance. What was organic growth in the quarter? Can you talk about bookings, how they compared to under the prior methodology? And then finally, in early development, are you seeing any new opportunities given consolidation and other factors impacting some of the smaller players?
Sure, I'll take that, Jack. This is John Ratliff. In terms of book-to-bill and the actual ED and then finally getting into the other part, book-to-bill in the 8-K shows we were in the old methodology at about 1.36 times, and then in terms of now 1.34 times. That's over the last 12 months. Under the new, it was 1.34 times going to 1.29 times. The key here is strong operating performance no matter what view you take. And so that's even with annualizing probably our strongest quarter last year. So significant strength across each of the segments, early development, as well as in the labs as well as the clinical.
As to the revenue, it's consistent with our guidance that we gave for the year in the single-high to mid-digit growth, and so showing actual accelerated growth in all the segments of the business.
And then finally, in terms of the early development business, we're seeing actual real strength in terms of the safety assessment, metabolic lead optimization as well as the chemistry areas, accelerating momentum organically and actually adding capacity in certain areas, as we've actually given visibility to, as an example, the CMC area, but also adding capacity within our present facilities, so seeing the biopharma area, showing the biotech area showing real strength underneath and a significant participant in our backlog.
Thanks, John. And then in terms of the data strategy, any updates on how the Walgreens collaboration could benefit Xcellerate and any update on how the check-in tool is impacting patient opt-ins?
Jack, it's Dave. So the check-in tool is being introduced into the Walgreens environment as we move to the next set of stores, and we're optimistic that it will support an increase in opt-ins. We're talking about a number of what we think are very attractive options to expand the things that we're doing with Walgreens beyond just the drawing of blood in the stores. And we'll have more to say about that probably over the next couple of quarters opposed to this morning.
Thanks, Dave.
Thank you. And our next question comes from the line of Erin Wright from Credit Suisse. Your line is now open.
Great, thanks. Could you speak to any of the nuances in test mix I guess that may have influenced that revenue per requisition? And can you speak to how sustainable that trend is? Thanks.
Erin, it's Dave. So MDM and Women's Health are probably on average at a slightly higher price point than our average test mix, which would give us a little bit of positive impact. 23andMe, as we've said, is below our average price point. I think it's important to remember, however, that when you think about 23andMe, also think about the fact that we don't do a blood draw, we don't do logistics, we don't do the typical things that we would do in procuring a specimen. So even though it's below our average price point, that is not in any way to suggest that it's not great business for us because it's terrific business. So what you get in the total mix is you get up from Women's Health, up from Medical Drug Monitoring, up from Genetics and Oncology, with some offset from 23andMe. And that's why we mix to the 70 basis points positive.
Okay, great. And then on the Covance side of the business, if you could, comment on general RFP flow more on the clinical side. And were there any significant cancellations or anomalies that you would call out? Thanks.
Sure. The amount of proposals is consistent with past quarters, very nice proposal flow. And in terms of cancellations, we're within the range that we've seen in the past. There's nothing abnormal about that.
Okay, great. Thank you.
Erin, Dave. Just one more thing, I should also have mentioned. I think it's obvious, but nonetheless I should have mentioned that PAMA has an impact on revenue per requisition this quarter in the year-over-year comparison.
Great, thanks.
Thank you. And our next question comes from the line of Patrick Donnelly from Goldman Sachs. Your line is now open.
Great, thanks, maybe just one on the United contract. I know last quarter, you said you were having accelerated conversations with them. I'm just wondering, an update there, any thoughts on timing, how we should be thinking about that one.
Good morning, Patrick. It's Dave. We continue to be involved extensively and consistently with United. And as soon as we have something to tell you about, we absolutely will tell you about it.
Fair enough. And then just on capital allocation, how are you guys feeling about the M&A pipeline? Do you see more activity on the lab side now that PAMA has been out there for a few months? And how should we be thinking about lab versus CRO for your M&A?
It's Dave again. I would say on the PAMA side, there's certainly activity in the pipeline. There's certainly engagement of a number of parties that are looking at their options. At the same time, we have to recognize that we as LabCorp and the industry through ACLA [American Clinical Laboratory Association] and our industry colleagues have been working very aggressively both within the court system and with the legislative system to try to fix the error that CMS made with PAMA, and so I think there's some watchful waiting in terms of what's going to really happen before we see a strong pickup in activity.
In terms of the allocation of resources, I would just repeat what we have said previously, which is we're fortunate that we generated significant cash flow. We're going to deploy that cash flow judiciously. We look at every deal individually. There's no bias toward the CRO side or the lab side. We look at every deal individually in terms of what is the best deployment of capital, where are we going to achieve the best return. Both of the organizations are in the process of significant integration activity. And obviously, you saw we announced yesterday that we've expanded the partnership with Mount Sinai to do more things with them. So we don't have a bias. We will continue to be active in M&A, and we're going to look at where we can achieve the best return on the dollars we're investing.
Great, thanks.
Thank you. And our next question comes from the line of Amanda Murphy from William Blair. Your line is now open.
Hi. Good morning. I actually had a couple of questions on the CDx side. So I guess, first, wondering if you could talk a little bit more about your plans. You mentioned plans to expand globally. Is that with specific partners? And how would we think about where the testing is done, regulatory dynamics? Maybe just some more color there would be helpful.
Amanda, it's Dave. It would be with partner or partners. And it would involve performing the testing outside the U.S., but obviously in environments where we felt comfortable with all the things like quality, reproducibility, laboratory certification. And it would involve in all likelihood sharing of our operating procedures and processes for performing the testing. So as you know, the biopharmaceutical companies see large markets for some of these companion diagnostics outside the United – or some of the therapeutics outside the United States, and we want to be able to provide the companion diagnostic testing that's associated with.
Okay. Got it. And it feels like there's momentum shift on the CDx side for various reasons. Obviously, the MCD that was just published by Medicare, but I'm curious how your pharma partners are thinking about it. So you've got some that are maybe focused more on an all-comer-type strategy, some are thinking about it more from a segmented perspective. So just curious how you think about that just in terms of pre-market or clinical trials versus post-market, are your pharma partners interested in pursuing markers more generally at this point just given the pipeline?
I'd say yes to the very last point. We're seeing that extensively through chiefly both on the post-marketing side as well as in really the Phase II up. And so almost every discussion, every partnering discussion we're having that extensive capability review even at the early Phase II timeframe. But clearly we're seeing strength. We believe we're seeing the majority of the market, and that's why you're seeing our backlogs and our order rate go up by a factor of 3 and 4x from the time of the LabCorp acquisition of Covance. So we're seeing it in both areas, both the post-marketing area as well as in the Phase II/III, and pharma is extensively looking at the biomarker space and the capabilities in terms of the companion diagnostics with respect to the partnering – strategic partnering of Covance and themselves.
And it's Dave. I'll just add, beyond the dedicated companion diagnostics laboratory and our goal of achieving global delivery, we also have resourced a biomarker center of excellence within Covance to collaborate with pharma partners, and that is supported obviously by all the biomarker where we've historically done at LabCorp. So again, it's just another example of how the combination adds more to our service offerings than either of us would have alone.
Okay, thanks very much.
Thank you. And our next question comes from the line of Kevin Ellich with Craig-Hallum Capital. Your line is now open.
Good morning. Dave, I have two quick questions for you. First one, you gave a good detail to Erin on the revenue per requisition increase, but I don't think you guys have stated what the impact of PAMA was this quarter. Could you give us that?
Yeah. This is Glenn. We've talked about that the impact of PAMA for the year was going to be roughly around $70 million, and it is we expected and actually we experienced in the first quarter pretty close to being kind of pro rata. So we expect it to be pretty evenly spread throughout the year.
Great. That's helpful, Glenn. And then I know we're early in the year still, Dave. And there is typically a wide range of potential outcomes, but free cash flow guidance was maintained at $1.1 billion to $1.2 billion despite seeing the strong organic growth. Just wondering what your thoughts are in terms of how the business trends are and is that just your typical conservatism or how should we think about the free cash flow guide?
While I don't even know what I need to answer the question, you answered it for me. So it's early in the year. The guidance encompasses a wide range of outcomes. I'm not going to comment on my conservatism versus my aggressivism, if that's even a word. But look, it's a very substantial amount of free cash flow. Certainly, there are things that we did in operational performance that make us optimistic about our ability to do better, but it is the end of the first quarter. The guidance does encompass a wide range of outcomes for earnings and obviously that translates into cash. We had said that we're going to make some incremental capital investments this year as part of the benefit of tax reform in the business, so we feel very comfortable maintaining the free cash flow guidance as it was in the quarter.
Sounds good. Thanks, guys.
The only thing I just add to that. Just, as you know, when you look at the seasonality of our business, our first quarter historically is in the 10% of our total year's cash flow. So we kind of came within that range doing $82 million, again out of a $1.1 billion to $1.2 billion total number. So obviously, as the year unfolds as we generate the bulk of our free cash flow throughout the year, we'll continue to give the updates on where we feel hopeful coming on.
That's helpful. Thanks, guys.
Thank you. And our next question comes from the line of Bill Quirk from Piper Jaffray. Your line is now open.
Good morning. This is Tyler Etten on for Bill. I was wondering if you could talk about the opportunity with CMS approving next-gen sequencing. We're starting to see some small private payers follow suit. Are you guys viewing this as a coverage trend or maybe a little bit more conservative on that front?
Good morning, Tyler, it's Dave. I think we've been in the forefront of next-gen sequencing again both on the clinical trial central lab side as well as on the clinical diagnostics side. We do see it as a significant opportunity particularly around our genetic testing. At the same time, private payer coverage remains less than robust at this point. And so we see the CMS coverage decision as probably the beginning of a trend, but we're going to follow the trend carefully and adjust accordingly.
Got it. Thanks. And then do you think that most of the negative weather effect is behind us now that we're at the end of the quarter or should we expect some weather effects in Q2?
I would say forecasting is an art. It's not a science. And I think we'd all agree that the worst forecasters tend to be the weather predictors. But from our perspective, we assume normal weather throughout the rest of the year, which is within the guidance. But as you recall, when we had the third quarter a year ago, we had adverse weather. So barring normal weather, we actually should see a pickup from weather in the third quarter, but obviously things that we don't control, which is why we don't forecast it to be anything other than kind of normalized.
Got it. Thank you.
Thank you. And our next question comes from the line of Ralph Giacobbe from Citi. Your line is now open.
Thanks. Good morning. Wanted to go to margins. They were down year-over-year, and I think you mentioned mix and acquisitions in the release. Maybe if you could flush that out for us. And more importantly, help frame the opportunity around sort of either margin expansion versus just holding the line or maybe even having margins contract in sort of the years ahead given PAMA?
Ralph, it's Dave. So we have been very clear that Diagnostics margins are going to be down this year as a result of PAMA. And the assumption would be that if PAMA is fully implemented as planned, we'll have margins headwinds in 2019 and 2020 as well. The other side of that is LaunchPad cost reductions, things that we're doing in the core diagnostics business to improve efficiency. Obviously, organic growth helps us to improve those margins as well as the test mix.
On the Covance side, obviously we saw 200-plus basis point improvement in year-over-year margins with the initial steps from LaunchPad. LaunchPad is a three-year program to improve service delivery and sustainably improve margins as well. So for the Diagnostics business, the likelihood is we're going to see pressure on margins. For the Covance business, margins expansion. And for the enterprise – for the enterprise as a whole, our goal, as we said in our third priority, is to continue to protect them and optimize them over time. I'm sorry. I misspoke. The Covance margins were up 120 basis points as opposed to the 200 that I overoptimistically stated. That will be for John to do next quarter.
Fair enough. And then I was hoping you could maybe delve a little bit more into the Walgreens expansion. The incremental intent (52:42) is encouraging, but maybe help on what may or may not be potentially prohibiting much faster expansion. Is this something that you want Xcellerate more and Walgreens more reluctant to or the other way around, or is it not that dynamic, sort of not in play? And if there are any exclusivity, remind us around the relationship or could there be sort of – and if there was sort of interest from other retailers, is that something you could pursue? Thanks.
Sure. So, on the question of exclusivity, there's exclusivity within the markets, but there's no blanket exclusivity. And so there could be other retail opportunities that we would pursue presumably. In fairness, there could be other lab opportunities that Walgreens might pursue. We have been very pleased with Walgreens as a partner. As I said earlier, we've talked a lot about other opportunities beyond what we're doing with the draw stations, and we expect this partnership to expand both in number of stores and in scope over the balance of 2018 and into the future.
In terms of the number of stores, we want to be selective and careful about the markets. We want to think more broadly now that we're demonstrating the success of the model about how we can use the Walgreens service center locations to change the model of how patients engage with us at our current service centers. So I don't think there's any hesitation on either side to scale the program. What we are doing is being very careful about the way that we roll it out to make sure that, one, we don't damage service levels or reduce qualities because we're trying to expand too fast. Two, we're both very interested in integrating the kiosk check-ins into the broader structure of their pharmacy in our lab, and so that requires some IT work that we're looking at. So there's just a number of reasons, but I would not take it as any hesitation on either side to scale up the project.
Okay, thanks for the comments.
Thank you. And our next question comes from the line of Dan Leonard from Deutsche Bank. Your line is now open.
Thank you. Just a couple of questions on the EPS guidance. First off, Glenn, can you help me better understand what changed as you assess the impact of ASC 606 because I thought that accounting change was already in your prior guidance. And then secondly, the offset that enabled you to maintain EPS guidance despite that headwind, how much of that would you characterize as organic versus other items like the legal settlement or tax coming in lower than we thought? Thank you.
Sure. First, I guess on the EPS and ASC 606 and the guidance. As you saw when we gave our preliminary assessment and when we came out with our guidance, we did give preliminary restated revenue numbers for 2017 and then our growth rates for 2018, which was effectively adding the investigator fees and the other pass-through expenses. And so, as you saw in our change in guidance or the updating of our guidance, none of the growth rates on the revenue side were due to ASC 606. It was due to the strength of organic revenue growth within Diagnostics as well as the change in the currency.
On the earnings side, it's a little bit more challenging. There, while we did a sampling of the contracts that we have, and again, over 800 of them, the impact on the earnings was fairly negligible. We assume that over when we got to all 800 contracts going through the detailed review that they would be offsetting because effectively they were all pass-through. When we did the analysis and updated it, again, for every one of the contracts, what we saw was that, relative to the sample that we used initially, our contracts tended to be earlier stages of completing of the trials. And because the investigator fees and the other pass-through expenses tend to be more weighted towards the middle of the contracts, we were more weighted with earlier-stage contracts. And as a result, they caused our percentage of completion to change where effectively it moved it out a little bit.
So the earnings, and use 2017 as an example, there again we would assume that it would have a nominal impact. It had around a $55 million impact in earnings that will again be pushed out to future periods. And then similarly now in our guidance for 2018, as we roll those contracts forward, we have around, call it, $35 million of reduction in earnings relative to the old accounting standard, so less than the impact in 2017. But again, those earnings will be pushed out in the future as well.
With regard to the offsetting of the $0.20 to $0.30 impact from ASC 606, we talked about the strength of our organic revenues. We've talked about the impact that currency was favorable as well. When we gave our original guidance, at that point, we knew the adverse impact from weather other than there was some still bad weather later in the period, but the bulk of it was early. And we knew about the benefit of the legal settlement that was effectively going to be an offset to that. So relative to the guidance we provided, both of those were kind of muted out. The change really is driven off of the strong performance we had in the first quarter, and again, an improved outlook for the remainder of the year.
Okay, that's helpful. Thank you.
Thank you. And our next question comes from the line of Ricky Goldwasser from Morgan Stanley. Your line is now open.
Hi, good morning. Just a couple of follow-ups here. When we think about just pricing, outside the United contract and outside PAMA, are there any other factors such as other contracts or renewals, or anything else that we should consider when we think about pricing beyond this year? And I understand that this is the beginning of 2018. But just conceptually, how should we think about the other factors that are either headwinds or tailwinds to price going forward?
Ricky, good morning. It's Dave. So I think you've essentially stated it correctly. The things we need to think about are PAMA. I'm not – I wouldn't – obviously, the United contract doesn't have any impact on our 2018 pricing unless and until there's a change in the contract status. The impact of acquisitions and the annualization of acquisitions, so PAML and the price point of PAML probably being higher than our typical in-counter price. And remember, a lot of that is reference work that comes from hospitals. So that annualization will certainly have an impact.
Generally, what I would say is our private pricing has been relatively stable over the last several years, as we've said. We don't see anything that is going to have an immediate impact on that. And so the major impact, as we've said, is mix, which is not unit price and unit pricing relating to PAMA.
Okay. And then on the cost-cutting side, I appreciate the comments on margin. But how should we think about the cadence of the cost-cutting throughout the year?
Again, it's Dave. We are not guiding to quarter-by-quarter impact of LaunchPad. I would say, remember that there were some reductions that we did last year that we're getting the full-year impact of this year that will annualize. And then the impact of things like global service delivery, which started in the first quarter, will actually accelerate throughout the year.
So I guess the best way to put it is think about the Covance LaunchPad and the Chiltern synergies as essentially being spread ratably over the three-year period. And then within that period – within each year, you'll typically see a relatively even distribution subject to some ups and downs.
Okay, thank you.
Thank you. And our next question comes from the line of Mark Massaro from Canaccord Genuity. Your line is now open.
Hey, thank you. Obviously, 23andMe has seen massive growth from at-home testing with saliva for genetic testing. Dave, can you speak to the impact you think you might have from your at-home blood collection device and maybe speak to some of the test menu that will be available?
Sure. The at-home device is designed to open another channel to consumers and patients. The initial test menu will be probably in the range of about 20 analytes, and will focus on things that are of high interest to consumers like hemoglobin A1c and also to payers.
And there are several ways that we think about why this is important. One, just in conversations with leaders of large payers, one of the things that I'm hearing over and over again is the costliest patients are the patients who are sick at home. They're not engaging with the system. That's why they're showing up in acute crises in the emergency room, and we need to find a better way to reach them.
So you're seeing a lot more activity around home health. You're seeing a lot more activity around home monitoring. And for us, this is a simple way of supporting not only the consumer who wants to know about the status of their health through labs, but also the payer community, including the government payers, in being able to reach patients in the home in a convenient and low-cost manner.
So I'm not going to make an estimate in terms of what is the market opportunity or where is it going to go, but I think it's a really important initiative for us again to open another channel to reach consumers and then to think about is this kit available for sale in the retail setting, is it delivered through a distributor or a wholesaler who has a home business. These are potential further legs of the business as we roll it out.
Great, thanks. And my second question, at the risk of oversimplifying or handicapping the outcome of the ACLA versus HHS case, is it fair to speculate that relief to the 2021 to 2023 is the bull case here in terms of the cuts that could be rendered in those next three years or do you see another alternative that could be even more appealing than that?
I've said all along that, first of all, any time you sue the government, it is an uphill battle. Nevertheless, on the merits – and they're dense legal papers but I have read them. On the merits, we have a very convincing and powerful case. Congress wrote a statute in which it specifically instructed the Secretary to do something, and that something was do a market survey that included hospitals. The Secretary wrote a rule that excluded over 90% of the hospitals in the United States. So the Secretary didn't do what Congress said. And legally, I believe that means that rule should be set aside, and that is what we're seeking in relief. We're not seeking change in the payment cuts. We're seeking that the rule be set aside and the Secretary be told to go back and do what Congress said to do.
So to me, the right case is the judge rules in our favor, the rule is set aside, the Secretary restarts the process of rulemaking, and we end up with a rule that carries out congressional intent. And that would have the impact of resetting the 2018, 2019, 2020 reductions and coming to a market assessment of the lab industry, which is exactly what Congress asked for the Secretary to do. Congress said to the Secretary get Medicare to market. It didn't say get Medicare to the absolute lowest price on every single test, which seems to be what the Secretary is trying to achieve.
Great. Thank you.
Thank you. And our next question comes from the line of Brian Tanquilut with Jefferies. Your line is now open.
Hey, good morning. Glenn, just a quick question on tax. So you're maintaining the tax rate at 25%, but with the exclusion of the tax benefit from stock comp, am I right in thinking that your effective baseline tax rate assumption actually went down?
No. We guided – we assume that we would be roughly 25% on an adjusted basis, and we continue to believe that. The first quarter is always going to – I shouldn't say always. Obviously, hopefully, we're always seeing our share price appreciation, so we're getting a benefit from the stock-based comp impact on taxes. But we know that when we provide our guidance. So our stock comp, if you will, vests in February in the first quarter, you'll have seen that in the trends that same quarter a year ago that we'll have a lower effective tax rate. And then throughout the year, we do not forecast any more change relative to stock comp. So to the extent that people are exercising shares that we obviously can't forecast, there could be a benefit from that going forward, but we don't model that. So we still feel the 25% is the right number for the year with the first quarter coming in, call it, around 23% and obviously implies that we'll be a little bit above 25% for the remaining three quarters.
Got you. And then for John, are you seeing any changes in how your customers are making decisions based on data enablement? And then are there any wins you can call on Xcellerate at this point?
I do think that most of our customers are using data with respect to decisions on patient recruitment strategies, on site selection, on protocol optimization. Now certain therapeutic areas are more applicable to the use of that data, but almost consistently across the board, whether it's our central lab data, whether it's our diagnostics data, they are utilizing that to their benefit in terms of the strategies of the aforementioned three years.
So, specific wins, I think as Dave said, we obviously have over a (1:08:46) quarters and on track to the revenue goals that we had before, but as you know, Brian, those decisions when they're made on "data" are also made on the project team, the medics, the capabilities of strategy. It's never just one thing. And so we do look at this as a hugely differentiating factor and the reason why we're winning to the extent we have with the strong book-to-bills of around 1.3 times.
Got it, thanks.
Thank you. And our next question comes from the line of Rohan Abrol from KeyBanc Capital. Your line is now open.
Hey, good morning. Just wanted to find out if you're seeing any changes with respect to your full-service versus FSP demand in Covance?
The program versus FSP, I'm not seeing a swing to one way or another. The greatest thing in terms of the – or one of the areas that the Chiltern acquisition benefited us greatly on was the capability within the FSP areas, especially around the biometric space and now adding the strength of a legacy Covance in the monitoring space having that now enterprise offering, but we're seeing real strength on the programmatic side as well and across therapeutic areas, the oncology area. And I'd have to say the investments in the talent, team, therapeutic areas, et cetera, that LabCorp Covance have made in the past are assisting with the programmatic wins as well. I'm not seeing a shift one way or another, to answer your question.
Okay. I appreciate that. And then did you guys comment on the amount of project awards associated with access to patient lab data this quarter?
It's Dave. I think as John just said, we exceeded $0.5 billion. We're not updating that number, but you can assume that it continues to grow.
Okay, thank you.
Thank you. And that concludes our question-and-answer session for today. I'd like to turn the call back over to Dave King for closing remarks.
Thank you very much for joining us this morning. I think what you can gather from this call is that we are intently focused on two things. One is execution. The other is innovation. And our focus on execution and innovation is delivering impressive results, and we're excited that we will be updating you on those results in the quarters to come. We wish you a good day.
Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program and you may now disconnect. Everyone, have a great day.