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Alere (NYSE:ALR)

Q2 2013 Earnings Call

July 31, 2013 8:30 am ET

Executives

Doug Guarino - Director of Corporate Communications & Corporate Relations

Ron Zwanziger - Chairman, Chief Executive Officer and President

David A. Teitel - Chief Financial Officer, Principal Accounting Officer, Vice President and Treasurer

Namal Nawana - Chief Operating Officer

Analysts

Jeffrey Frelick - Canaccord Genuity, Research Division

Gregory J. Simpson - Wunderlich Securities Inc., Research Division

Anthony Petrone - Jefferies LLC, Research Division

Zarak Khurshid - Wedbush Securities Inc., Research Division

Jonathan P. Groberg - Macquarie Research

Isaac Ro - Goldman Sachs Group Inc., Research Division

Nicholas Jansen - Raymond James & Associates, Inc., Research Division

Operator

Good morning, and welcome to the Alere, Inc. Second Quarter 2013 Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mr. Doug Guarino. Please go ahead.

Doug Guarino

Great, thanks, and good morning, and welcome to the Alere conference call to discuss our results for the quarter ended June 30, 2013.

We are joined today by Ron Zwanziger, Chairman and CEO; Dave Teitel, CFO; and Namal Nawana, COO. Before we get to that discussion, though, I would first like to draw your attention to the fact that certain matters discussed in this conference call will constitute forward-looking statements within the meaning of the U.S. securities laws, including statements about future organic growth, potential divestitures, anticipated reductions in our leverage ratio and cost, product launches and regulatory filings. These statements reflect our current views with respect to future events or financial performance and are based on management's current assumptions and information currently available. Actual results and the timing of certain events could differ materially from those projected or contemplated by the forward-looking statements due to numerous factors, including, without limitation, our ability to successfully complete plain divestitures; acquire and integrate our acquisitions and to recognize the expected benefits of restructuring, operational initiative and new business activities, including the benefits of our recent acquisitions of Epocal and certain assets of Liberty; our exposure to changes in interest rates and foreign currency exchange rates; our ability to successfully develop and commercialize products and services; our ability to develop enhanced Health Information Solutions through the integrated use of innovative diagnostic and monitoring devices, and to recognize the expected benefits of this strategy; the impact of health care reform legislation; the content and timing of regulatory decisions and actions, including the impact of the FDA warning letter and the OIG subpoena, as well as the impact of changes in reimbursement policy and budgetary constraints, both in the United States and abroad; and the risks and uncertainties described in our periodic reports filed with the Securities and Exchange Commission, including our Form 10-K for the year ended December 31, 2012, as well as in our quarterly reports on Form 10-Q.

Our company undertakes no obligation to update forward-looking statements. Additionally, please note that during this call, we may discuss non-GAAP financial measures. For each non-GAAP financial measure discussed, a presentation of the most directly comparable GAAP financial measure and a reconciliation of the differences between the non-GAAP financial measure discussed and the most directly comparable GAAP financial measure is available on the company's website at alere.com.

With that, let me turn the call over to Alere Chairman and CEO, Ron Zwanziger. Ron?

Ron Zwanziger

Thanks, Doug, and good morning, everyone.

I'm pleased to report an excellent second quarter with strength in all of our business units and widespread geographic strength, as well as current stability in Europe.

In November of last year, we presented to you, our stockholders, a 3-point plan to drive higher operating margin and increase free cash flow and earnings growth. I'm pleased to report that we've made substantial progress in executing our plan.

First point in the plan was the reestablishment of historical organic revenue growth rates, and our Q2 results reflect encouraging progress towards this goal.

Organic revenue growth in our Professional Diagnostics business was 8.6%. This is a notable improvement from our Q1 results of 1.3%. Several of our key international geographies are also contributing strongly in Q2, with growth in our China operations of over 24% and in our African and Latin American businesses, over 17% in each geography. The growth in these regions was largely driven by our comprehensive Infectious Disease portfolio, which in aggregate, grew 14% in Q2.

Our organic revenue growth in Q2 is particularly encouraging, given that several of our key revenue growth initiatives have still to begin meaningfully contributing. For example, consistent with our comments on the Q1 call, our recovery in Triage sales is only expected to commence in the second half of the year.

In addition, we expect our new product revenues to accelerate over the next 12 months and beyond, with multiple launches in new geographies as more registrations are coming through, including in the U.S. We're also awaiting the launch of several new products, including our 2 rapid molecular platforms.

Second point of our plan was improved operational execution to generate dependable long term cash flow. We also made excellent progress against this goal. Specifically, we were able to report a 230 basis points reduction in our total operating expenses in Q2 of '13 compared to last year.

The third point of our plan involving deleveraging to at least 4x debt-to-EBITDA by the end of 2015 through the use of excess cash flow from operations and divestitures of non-core operations. As the company has been substantially formed, both in terms of geographic reach, as well as technological capabilities, significant cash will not be needed for acquisitions.

To accelerate our progress towards our deleveraging target, we've made -- we've been engaged in discussions with multiple parties concerning the divestiture of several of our non-core businesses. The first of these divestitures was completed this morning as we closed on the sale of Spinreact, an in-vitro diagnostic reagent developer and manufacturer located in Spain for approximately -- purchase price of approximately $30 million. There will be minimal tax leakage as a result of this sale, and we will use the proceeds to repay debt.

In addition, we have received multiple offers for additional assets with total associated revenues of an EBITDA of $170 million, revenues of $55 million in EBITDA. Furthermore, we have received expressions of interest for our 50% ownership of our consumer joint venture with Procter & Gamble. These various negotiations are active and ongoing, and are expected to result in multiple divestitures in the near term, which should yield at least $600 million in net cash proceeds in a tax effective manner, while neither affecting our growth prospects, nor our approach to Chronic Care business. Additional non-core assets beyond initial -- in this initial value will also be divested.

Based on the progress we are making in executing our 3-point plan, we're comfortable providing the following metrics to track our performance.

Regarding organic revenue growth, we expect our current mid-single digit organic growth for 2013 to expand over the next 2 years to high single-digit growth by 2015.

Regarding operation execution, our expense reduction initiatives will allow us to exit 2014 at an SG&A rate of 28%, down from the full 2012 rate of 30.4% and our Q2 result of 29.1%. We expect 28% to be our full year 2015 rate. In addition, we would expect to hold our R&D spending at our current run rate of approximately $155 million through 2014 and '15.

Regarding deleveraging, we feel very confident in our ability to significantly reduce our original target leverage ratio, achieving a 3x debt-to-EBITDA by the end of 2015, and doing so without accessibly compromising our core business or our longer-term growth opportunities.

And now, let me turn the call over to Dave for a discussion of our reported financial results.

David A. Teitel

Thanks, Ron, and good morning.

Adjusted net revenues for the quarter were $764.6 million compared to $701.6 million in Q2 2012, and $739.9 million in Q1 2013. The effects of foreign currency translation decreased Q2 2013 adjusted revenues by $3.6 million compared to Q2 2012, and by $5.5 million compared to Q1 2013. Adjusted earnings per diluted share for Q2 2013 were $0.64.

By business segment, adjusted net product and services revenues from our Professional Diagnostics segment were $600.2 million in Q2 2013 as compared to $538.0 million in Q2 2012. Acquisitions accounted for $47.4 million of this increase.

Revenue from our North American flu sales were $2.0 million in Q2 2013 compared to $4.2 million in Q2 2012. Sales of our meter-based Triage products in the United States totaled $19.3 million in Q2 2013 compared to $40.6 million in Q2 2012. Excluding the changes in U.S. flu and Triage product sales, the currency adjusted organic growth rate for the quarter was 8.6% for our Professional Diagnostics segment.

Within our Professional Diagnostics segment, net product revenues for our Cardiology business were $118.4 million in Q2 2013 compared to $125.6 million in Q2 2012. Included in these revenues were $4.5 million of U.S. cardiac panel sales in Q2 2013 compared to $10.8 million in Q2 2012 and $4.1 million in Q1 2013.

Q2 2013 also included $14.8 million of combined U.S. BNP and D-dimer sales compared to $22.5 million in Q2 2012 and $17.1 million in Q1 2013. We sold, essentially, no toxicology panels for the Triage platform in Q2 2013 as compared to $7.4 million and $0.3 million in Q2 2012 and Q1 2013, respectively. We're still exploring options around panel configurations for our Triage toxicology products.

For all products other than the toxicology and shortness of breadth panel, we now have adequate supply, and in the latter half of the second quarter, we began working to acquire -- reacquire lost customers.

In the second quarter, worldwide meter-based Triage sales increased for the first time since Q1 2012. Additionally, during the second quarter, we saw just over 80 U.S. customers return to Triage, and we expect this momentum to increase in the U.S. for the rest of 2013 and through all of 2014.

Net product revenues in our Infectious Disease business were $157.7 million in Q2 2013 compared to $137.8 million in Q2 2012. The increase relates principally to growth in malaria revenues. Our Toxicology revenues were $165.9 million in Q1 2013 compared to $159.9 million in Q2 2012, with our recent acquisitions contributing a net $6.3 million of the increase, offset by the decrease in Triage toxicology sales that I discussed earlier.

Diabetes net product revenues were $74.9 million in Q2 2013 compared to $36.8 million in Q2 2012. Included in Q2 2013 revenues were $56.2 million of mail-order diabetes sales compared to $22.8 million in Q2 2012. Q2 2013 revenues included $29.5 million of revenue related to our late April acquisition of a diabetes business from Liberty Medical. Because of the timing of the Liberty transaction, we reached only about 2/3 of the Liberty patient base prior to the end of the quarter, and have begun serving the balance of the patients during the third quarter.

As many of you know, effective July 1, as a result of the CMS round 2 competitive bidding process, reimbursement rates for diabetes strips were cut by approximately 70%. The impact of this rate reduction on revenue will be somewhat offset by our ability to access the full patient base acquired in the Liberty transaction. And as a result, we expect revenue from our mail-order business to decrease to approximately $25 million in the third quarter. Despite the decrease in revenue, as a result of negotiated reductions in strip costs from third-party suppliers and the addition of incremental personnel to service ongoing patient fulfillment requirements in a low-cost setting, we expect the business to remain profitable in the third quarter and beyond. Our cost base, which we believe to be the lowest in the industry, will position us to compete very effectively for the supply requirements of the significant number of patients who become available as others exit the industry.

Adjusted gross margins from our Professional Diagnostics segment were 55.4% in Q2 2013 compared to 56.3% in Q2 2012 and 55.1% in Q1 2013.

Adjusted operating income in the Professional Diagnostics segment was $148.8 million or 24.6% of adjusted net revenues in Q2 2013 compared to $124.7 million or 23% of net revenues in Q2 2012 and $134.4 million or 23% in Q1 2013.

Net revenues from our Health Information segment were $134.8 million in Q2 2013 compared to $138.6 million in Q2 2012 and $134.2 million in Q1 2013.

Adjusted gross margins from our Health Information segment were 46.4% in Q2 2013 compared to 46.5% in Q2 2012 and 44.2% in Q1 2013.

Adjusted operating income from our Health Information segment was $6.3 million in Q2 2013 compared to $3.0 million in both Q2 2012 and Q1 2013.

Product and services revenues from our Consumer Diagnostic Business segment were $24.7 million in Q2 2013 compared to $21.8 million in Q2 2012, with products and services related to our consumer joint venture of $18.6 million in Q2 2013 compared to $14.8 million in Q2 2012.

Adjusted gross margins from our Consumer Diagnostics segment were 23.0% in Q2 2013 compared to $27.1 million in Q2 2012.

Adjusted selling, general and administrative expenses were $222.2 million or 29.1% of adjusted net revenues in Q2 2013 compared to $216.7 million or 30.9% of adjusted net revenues in Q2 2012 and $217.9 million or 29.4% of adjusted net revenues in Q1 2013.

Adjusted research and development expense was $37.9 million or approximately 5% of adjusted net revenues compared to $38.1 million or 5.4% of adjusted net revenues in Q4 -- Q2 2012 and $39.4 million or 5.3% of adjusted net revenues in Q1 2013. We expect R&D to remain at approximately these levels through 2015.

Combined, SG&A and R&D expense was $260.0 million or 34% of adjusted net revenues compared to $254.8 million of combined SG&A and R&D expense or 36.3% of adjusted net revenue in Q2 2012.

This 230 basis point decrease in operating expenses as a percentage of revenues compared to the year-ago quarter was achieved despite a $1.5 million charge included in Q2 2013 related to the U.S. medical device tax. This reflects a $5.3 million reduction in SG&A related to our Health Information Solutions business despite an increase in spending of $4.3 million related to incremental investment in our connected health business as we continue to rightsize and refocus our expense base in that business. It also reflects a $3.6 million year-over-year reduction in SG&A in our Europe business as a result of our 2012 European shared service center implementation and other cost reduction initiatives.

Adjusted interest from other expense was $57.7 million in Q2 2013 compared to $50.4 million in Q2 2012. Adjusted interest expense, net of interest income, was $55.0 million in Q2 2013 compared to $53.7 million in Q2 2012.

In Q2, our adjusted tax rate was approximately 34.0% of net income -- of pre-tax income compared to 39.2% in Q2 2012. There are a number of initiatives underway to try to improve our tax efficiency, including a simplification of our U.S. organizational structure, which should reduce our overall effective tax rate, and various projects to expand the European shared service structure implemented last year to include a broader range of products and increased geographic reach.

Adjusted EBITDA for the quarter was $166.8 million, which includes deductions for restructuring charges of $8.0 million and $0.4 million of acquisition-related expenses.

Cash flow from operations for the quarter was $27.7 million, and capital expenditures were $28.5 million.

Cash flow from operations during the second quarter was adversely impacted by a $23.5 million increase in receivables and inventory related to our completion of the Liberty transaction and by the timing of interest payments related to our public debentures, which resulted in payments of interest expense of $81.6 million in Q2 2013 as compared to $24.7 million in Q1 2013.

With all the key elements of our product care platform now in place, along with our capacity to efficiently launch products and services in major markets around the world, our entire organization is keenly focused on improving operational performance.

I would now like to turn the call to Namal, who will review the progress we've made during the second quarter against this critical element of our 3-point plan.

Namal Nawana

Thanks, Dave, and good morning. My pleasure to provide an update on the progress we're making with our initiatives to improve operational effectiveness.

First, as Ron and Dave mentioned, we are able to report a 230 basis point reduction in our total operating expense compared with our Q2 2012 results, and we've delivered these improvements while accelerating our organic growth substantially to 8.6% in our Professional Diagnostics segment in Q2.

This has been achieved through the execution of numerous initiatives in our different units and geographies including our European management in service consolidation, consolidation of Toxicology operations and reductions in force in our Health Information Solutions unit. This last initiative has been a key factor in a more than doubling of year-over-year operating income in Health Information Solutions. These changes support our overall growth strategy and have included multiple-unit consolidations and realignment, which have contributed to structural improvement in our cost bases.

Furthermore, I'm pleased to report that the various initiatives in IT and global shared services, which have been underway for many months now, will deliver several million dollars in additional cost improvement by the end of 2013 and a combined $15 million in further savings for full year 2014.

Another major initiative which commenced in Q1 was the creation of our global in-sourcing center in the Philippines, offering high-quality services with substantial labor arbitrage compared to our U.S. operations. This initiative has progressed extremely well. The first phase of our plan has been focused on achieving the appropriate cost bases for our mail-order Diabetes business having anticipated the reimbursement changes that Dave alluded to earlier.

Starting in January, with just 50 employees, we now have approximately 800 in our Manila call center. The cost-saving benefit of this approach delivered $2.5 million of savings in Q2 compared to what we would have incurred had we added a similar number of employees in the U.S., including $1.3 million in June alone as we ramped our headcount significantly late in the quarter.

The second phase of our global in-sourcing center scaling will begin in Q4 of this year and expand to support some call center functions in our Alere Home Monitoring and Alere Health units. These initiatives will scale rapidly in 2014, and I'm pleased to report that we anticipate further cost savings of greater than $10 million in 2014 as a result.

As I indicated on our Q1 call, the initiatives I have just discussed are part of a broader set of strategic imperatives, which have been presented to our Board and are now in the process of being executed throughout our global organization.

Through program-based cost reduction initiatives, we have achieved a substantial 230 basis point improvement in total operating expense compared with the prior year. Additionally, we've initiated further high-value programs, which I've reviewed today, that, when combined with our other opportunities, will enable us to exit 2014 at a 28% SG&A rate, which will be our full-year 2015 target rate.

And now, let me turn the call back over to Ron.

Ron Zwanziger

Thanks, Namal.

Since the beginning of the year, our investment focus on R&D has reflected a shift towards nearer-term priorities as the number of our recently launched or soon-to-be launched products has increased. Consistent with that plan we laid out in November, roughly half of our -- or last November, roughly half of our current R&D expenses is directed towards those products already launched or expected to be launched in the next 3 years. The remaining balance is primarily related to products to be launched in the next 3 to 5 years.

These soon-to-be-launched products, including a sophisticated handheld drug testing instrument, which we expect to file for a 510 clearance in 2014. Over time, the combination of this new technology and an emerging market in roadside drug testing is likely to result in a large global opportunity for this device.

More broadly, as it relates to our Toxicology business, we are ideally positioned as the only fully integrated, full-service provider in the space to take advantage of the massive emerging market for pain management and rehabilitation drug testing. With a benefit of approximately 3,000 office-based collection points in the U.S., along with integrated reporting systems that provide automatic test results reporting to our customers, our Toxicology unit has encouraging growth prospects for both its existing and soon-to-be launched products and services. Significant integration opportunities also remain across our portfolio of assets, which we expect to unlock over the next several years, driving accelerated margin expansion to accompany strong organic revenue growth.

On the new product front, our near-term molecular platform development programs are continuing to progress, and we are on target to launch Alere Q, which is our fully integrated point of care, rapid, quantitative molecular platform before the end of the year. The first application of this platform is a HIV viral load, which will be introduced outside the U.S. in Q4 of this year. Over time, the menu of Alere Q will be expanded to address additional therapeutic areas such as HCV.

We also have successfully completed clinical trials on our second near-patient molecular platform, the Alere i, which is focused on product range of infectious disease targets. The first assay for this cartridge-based system is a rapid flu test that deliver results in approximately 15 minutes.

Two posters evaluating the Alere i were presented at this year's Clinical Virology Symposium, demonstrating outstanding performance that exceeds FDA's criteria under the proposed reclassification scheme. We anticipate making a U.S. FDA submission later this year, with subsequent menu items to include Strep A, RSV, C. difficile and Chlamydia.

In addition, our strategy of connecting rapid diagnostic test results to health care providers and augmenting these results with decision support and tracking tools is demonstrably working and driving new business wins to several of our operating units. In addition, we're in discussion with companies, both large and small who have products on the market or in late-stage development expressing an interest in linking their products into our system to improve outcomes for our patients.

With our significant pipeline of new products and our increasingly established positioning as a global leader in chronic care management, we feel well-positioned for consistent success over the long-term.

So in wrapping up, I wanted to make 3 key points.

First, the average organic revenue rate we've reached over the first half of the year is not only repeatable, but very likely to expand as a consequence of multi near-term drivers. As a result, we expect our current mid-single digit organic revenue growth for 2013 to expand over the next 2 years to higher single-digit organic growth by 2015.

Secondly, our operational focus is already having a favorable effect on reported results and our confidence in our opportunities for near-term cost savings is sufficient to allow us to begin discussing preliminary operating expense leverage targets today, which we hope to improve on over time.

As a result, regarding operational execution, our expense reduction initiative will allow us to exit 2014 at an SG&A rate of 28%, down from 29.1% today, and we expect 28% to be our full year 2015 rate. In addition, we expect to hold R&D spending at our current run rate of approximately $155 million through 2015.

Finally, our debt reduction plan is well ahead of schedule, both in terms of divestiture progress, as well as anticipated improvements to cash flow. As a result, regarding deleveraging, we feel very confident in our ability to significantly reduce our original target leverage ratio achieving 3x debt-to-EBITDA by the end of 2015 and doing so without excessively compromising our core business or our longer-term growth opportunities.

And now, let me open the call to questions. Jessica?

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Jeff Frelick with Canaccord.

Jeffrey Frelick - Canaccord Genuity, Research Division

As you -- you talked about the organic growth moving from mid-singles to high-singles. I just wondered what should we be focusing on as new product contribution target for maybe 2013 or 2014, whatever you're willing to share?

David A. Teitel

So the new product contribution in the second quarter was almost $17 million -- was $16.7 million in the second quarter, up from $13.5 million in the first quarter. We saw a progress in both the CD4 and the Epocal numbers in the quarter. Epocal was about $5.5 million in the quarter. CD4 was $4.6 million. Those will continue to be the driver in the near-term here as we move through the rest of 2013. Looking forward, the molecular platforms that Ron has described will begin to make a difference in our growth rates in 2014, as will some other product launches we do expect to come in the near-term here.

Ron Zwanziger

And perhaps quite importantly, we mentioned that we've been getting -- many of our units are beginning to book orders involving our connected health, and while they're small for this year, they're beginning to look much more serious numbers for '14, and then they'll expand beyond that. So I think you can expect to see the various elements of our connected health, which are small at the moment, to -- and we already have some significant orders, as well as a very good pipeline. You can see that expand both in 2014 and 2015.

Jeffrey Frelick - Canaccord Genuity, Research Division

Okay. And then just a quick follow-up, Namal. Really strong infectious disease growth this quarter. I think you had mentioned malaria was a contributor. Was that kind of a onetime event? Or was there contracts secured? How should we think about malaria contribution going forward?

Namal Nawana

The malaria business did have a very strong quarter, but that's a business that we actually see good year-round orders coming through and tenders that we respond to. We're very encouraged by this result. Our fourth quarter is typically our strongest quarter in Infectious Disease. So we're looking forward to continued growth.

Operator

The next question comes from Greg Simpson with Wunderlich Securities.

Gregory J. Simpson - Wunderlich Securities Inc., Research Division

A couple for you. First of all, on Europe, it sounds like, big picture, from a new standpoint, things are stabilizing there, and it seems like maybe things are getting better for you guys. Can you address, from the environment there, and then tie it into, maybe Namal could jump in and talk about your efforts there to kind of rightsize the business or whatever the right phrase might be? And then I'll ask a couple of others.

Ron Zwanziger

Well, so we had a good quarter in Europe. And actually, we've also had a good July. And my guess is, we will have a good third quarter. But I actually would not get particularly optimistic around Europe just because we're getting current stability. Because of the state of the European budgets and because they're sort of systemically mishandled, last year, starting in middle of November and into December, the health allocate -- or cash allocated to health budgets started running out. And so there was a precipitous decline in a whole range of orders. So my guess is, that they probably even we -- now, we've taken that into account in our own thinking, but my hunch is that it may even end up being worse this year as they continue to kind of dodge around and not quite deal with their issues. So on the fact that we're seeing current stability, which we saw in Q2, we're seeing so far in Q3, my hunch is Q4, many companies are going to catch a cold in Europe in Q4.

Gregory J. Simpson - Wunderlich Securities Inc., Research Division

So if I had asked my question more directly, so it sounds like your organic growth guidance going forward for both the rest of this year and the next couple of years, the expansion on organic growth really isn't contingent on an improvement in Europe. That's not really built into that guidance?

Ron Zwanziger

No, and nor is it built on our particularly significant improvement in the U.S. particularly. I mean, the reality is we're getting double-digit growth, a significant double-digit growth around the world. And bear in mind that we're still adding, in many jurisdictions, additional products. So -- of a kind which are very necessary to improve outcomes. So that's what we're seeing the growth expect to continue to. And -- but we took that into account, as we talked about, our mid-single digit growth growing higher over the next couple of years.

Namal Nawana

I think a good way of framing that also just relates to our Q2 results, China growing more than 24%, both Africa and Latin America growing more than 17%. Now we're really focused on being strong in the right geographies where we can drive that organic growth with our broad portfolio. Getting back to your earlier question on some of our operational initiatives in Europe. I think Ron's comments regarding the headwinds that all industries and companies are seeing in Europe in terms of the market, we planned for that. And we have -- on the first quarter call, I talked about some of the organizational design adaptations that we've made, one of those key initiatives has been for Europe, where we have changed our management structure, enabling us to focus our energies on facing the customer in key geographies and limiting overhead to manage the businesses. And the now stronger execution around our shared service initiatives, which started in 2012, which include gains from that, and therefore, now ability to manage our cost bases successfully this year as well and then going forward. So I think we've made some good operational moves to support that.

Gregory J. Simpson - Wunderlich Securities Inc., Research Division

Okay, great. Dave, real quick on the tax rate. It seems like there'd be a very nice opportunity to do something on that front as you addressed. Any long-term thoughts on where that could possibly get to? Or is that premature?

David A. Teitel

So it's a little early for that. Clearly, the initiatives we have underway should drive it down, but it is a very geographically mix-sensitive numbers, so it will move from time to time. But the steps we're taking will produce absolute dollar savings and will show up in the rates over time.

Gregory J. Simpson - Wunderlich Securities Inc., Research Division

Okay, great. And then final question for me. On -- you guys gave cost-saving numbers for a lot of the different pieces of the business. I got interrupted during the call. That's what happens when you guys beat by $0.16. But is it right to sum up -- I'm not trying to get into guidance or kind of a backdoor way into giving -- having you guys give guidance. But is there a way to kind of sum up where you're at so far? And what you -- I could go back to the transcript, obviously, and sum things up, but kind of where you're at on cost savings and kind of what the targets are for next year?

Namal Nawana

So yes, first of all, we -- the 230 basis point improvement that we've achieved to date has been, I think, a good sign on, first, execution throughout the organization. But also this focus on programs-based initiatives. So we want to have key programs that deliver on large savings, enabling us to refocus also our resources on the right initiatives and right geographies to drive growth. And that's what I think is the broader comment is around. Yes, we see forward opportunities getting to a 28% SG&A rate by Q4 of 2014, and then have that rate going forward. But it also needs to be coupled with our organic growth targets, which we are saying we feel should improve. So we're going to make sure that we fund the right business and drive high quality earnings with good growth going forward and continue to move around our allocation of resource to the right opportunities. So above the 28% rate by end of 2014, but needs to be coupled with our overall growth strategy.

Ron Zwanziger

On your tax rate question, Greg, the previous question. Look, clearly, we're out of line on that and there's clearly a lot of work to be done. We do have earnings, which are U.S.-centric, which have an impact to have a higher growth rate, but we're working on all these issues. And while it is premature, we're quite optimistic that we can drive the tax rate down.

Operator

Next question comes from Anthony Petrone with Jefferies.

Anthony Petrone - Jefferies LLC, Research Division

The first is for Dave and maybe Namal. Can you actually walk through the overall gross margin expansion in the quarter? And maybe give some details on the breakout across the segments. There was a slight uptick in the Diagnostics gross margin, but also a big uptick, 220 basis points, in the Health Management margin. And I know, Namal, you spoke to improving the service margin last quarter, so maybe some detail around that.

David A. Teitel

So in the Diagnostic segment, there was a bit of an uptick. Some of that came from the very strong Diabetes revenue in the quarter. We made very good progress over the course of the quarter in reducing our box supply cost from suppliers, and that definitely did help the rate. But overall, the margins from the Infectious Disease products that we sell in a number of geographies are also pretty favorable. So despite the fact that this is the quarter where flu drops off from Q1 to Q2, we saw good improvement across a number of our business units and that is what showed up in the overall aggregate. On the Health Management side, much of that improvement was in the core Health Management business and really reflected good performance against some performance measures that are built into a lot of the larger contracts. We've been much more thoughtful, I think, over the last couple of years in terms of setting out targets that are more easily measurable and achievable, and I think that benefit clearly did show up in the margin this quarter.

Namal Nawana

And there's a part of your question on service margin, and so I talked about the global in-sourcing center, and we scaled that initially for -- to support our Diabetes initiatives. But as I've said that starting in Q4, that initiative will expand to our Health Management and Alere Home Monitoring units and start contributing to our service margin or cost to serve basis for those businesses going forward.

Anthony Petrone - Jefferies LLC, Research Division

Great, and a couple of follow-ups for Ron. Ron, can you just touch again on where you are in the Diabetes strategy? Did Liberty in April. Are there still assets out there still to be acquired to position the business to be really in line with what your strategy is for Diabetes?

Ron Zwanziger

Well, we -- as you must have noticed, we've not been active in Diabetes. And at the moment, it's hard to see why we would actually make any more moves, because as we already commented in the quarter, our cost bases for being a supplier is improved no end because we've taken, obviously, advantage of the pricing pressure caused by the CMS move and have had tremendous pricing now, enabling us to compete more effectively, therefore, taking down the need to be a direct supplier ourselves. I mean, if we have a dramatic -- if we could somehow end up with a dramatic cost basis, I suppose that will be different. But in practice right now, we're pretty comfortable where we are. We have a number of internal programs to expand further, and we think that in the difficult environment that's been caused by the CMS decision, we're very well-positioned to see considerable expansion. And in the short term, that's where our focus is.

Anthony Petrone - Jefferies LLC, Research Division

And the last one for me, Ron, is if we look at the Healthcare Information Exchange, can you give an update specifically where that is in terms of scale, in terms of number of hospitals, providers and patients within the network? And then over time, where do you see that going in terms of number of patient data capture within the Alere Healthcare Information Exchange?

Ron Zwanziger

So we're seeing great opportunity, and we've actually started landing contracts on a regular basis and have a very large number of negotiations going on at the moment. And the reason is that there is such confusion and such -- and changes in the health care industry. You've got health plans realizing that unless they figure out how to improve outcomes for the patient group that they're ensuring, they have difficulties. And so, for example, we've received 1 order recently of notable scale with potential for a considerable scale, which is from an insurer, wanting to provide the access to the physicians in their community and creating a linkage system which will improve outcomes particularly when linked in with the patient-centric approach with our diagnostics. On the other hand, we've also -- where we started, and continuing to see tremendous interest and growth and getting new orders from providers wanting to have greater control over their data as a way of making sure that they can actually provide better outcomes, and in so doing, position themselves as potential risk-taking entities themselves, effectively becoming ACOs with risk-taking abilities. So we're seeing growth there. We've even had an example, which I think is very peculiar, but tells you what's happening is that a group of doctors are now trying -- and we'd probably see more of this, want to link themselves up in order to -- into a network in order to position -- to give them greater competitive position for them as physicians within the sort of changing environment. So we're finding that we're now beginning to make significant headway. We're winning significantly. We've had some significant wins. And interesting, the wins we have are almost always against the sort of "the names that you might expect," sort of bigger names who might be better known in health care IT, and we're winning these on an increasing basis for, really, 3 reasons. The first is because our technology and our interoperability and our data analytics are clearly superior, and upon demonstration, people can actually see that. So on the technical merits, we win, per se. But we're also viewed as a safe pair of hands because we're not biased because we're not embedded being an insurance company and therefore have biases from that perspective. And also, we're not trying to sell existing, sort of large-scale systems, such as we're not into selling hospital IT systems or EMRs, so we don't have a bias. So we're viewed as not only -- we are viewed as a reliable independent entity with a superior technology. So we're feeling very good about the Health Information Exchange. And in fact, some of the best orders we've had and expectations of orders we've had is using the exchange with our parent customers in through our Alere Health business.

Operator

The next question comes from Zarak Khurshid with Wedbush Securities.

Zarak Khurshid - Wedbush Securities Inc., Research Division

Ron, it looked like the TOX business was quite strong as well. Can you maybe just talk about what you're seeing there? And are there any elements of that business you may be looking to divest?

Ron Zwanziger

Well, not only was that business strong, but it was, despite having problems in the Triage, which Dave went to into great detail in his remarks. So the business is performing, as I've said, in an integrated fashion. It's doing particularly well. The whole pain management side is going to continue to grow, and we have considerable growth prospects in that business. It may be -- there may be 1 or 2 element in there, which, perhaps, might be -- we might consider divesting, but certainly not in the first round or even the second round that we're going through now, but it is a possibility. It is a possibility. And you might've noticed that when we talked about deleveraging, and we're now going down to 3, we said we would do so without excessively impacting our growth rate. And so that's why we put it in just in case we have to resort to some asset sales closer to our core mission.

Zarak Khurshid - Wedbush Securities Inc., Research Division

Understood. And then just curious if you could get a little bit more granular on the kind of recovery in Europe. Is it across-the-board? Is it -- are there certain areas of Europe that are accelerating faster? Can you also be maybe more specific on what tests or products are kind of recovering?

David A. Teitel

So, a, I wouldn't characterize it as a recovery in Europe as much as a stabilization in Europe on the top line and actions we've taken on the bottom line to manage our cost basis and rightsize it for the business environment. So we haven't seen sort of the dramatic drops in business we saw over the past couple of years in response to all the cuts. Europe still remains a challenging place to do business, so it definitely has not helped our organic growth rate over the past few quarters. But at least we've been able to take some cost out of the business and help manage the operating earnings contribution.

Operator

The next question comes from Jon Groberg with Macquarie.

Jonathan P. Groberg - Macquarie Research

One, just a bigger picture question, Ron, and then a couple of details for Dave. But Ron, I guess, if you think about -- can you just maybe help us think how you came up with these numbers, which I appreciate, for 2015? I think they're very useful. Maybe just kind of the process that you used to make you think that those are the correct numbers, and maybe why you brought down your target leverage. I think it had been 4x, as you mentioned, down to 3x. Can you maybe just give a little insight there?

Ron Zwanziger

Well, the targets are based on exhaustive work that we've been doing on sort of bottoms up across all the units and across all the products. And so that's a result of a lot of work. On the reduction on the leverage, I guess, there were 3 reasons -- there were 3, I suppose, reasons for that. The first one, the very practical. With the passage of time and because we've been in the market out talking to many people, we've got a much better sense of the value of these assets, which we're deleveraging and feeling much more comfortable about. The amount we will get, actually, is a lot higher than we had expected. And also, with the benefit of time, since we talked about it, we also have been increasingly more comfortable about our cash flow generation. So those are the main 2. And then more recent -- and then the final reason is in talking to our investors, as we did last summer and fall, about the leverage ratio, when we said it -- and in talking to some of our investors recently, they felt that a slightly lower number than the 4 would make them more comfortable. And so we know we can do it. It does impose slightly more risk to the business. That's why we said without -- to get there without excessively risking, I mentioned that earlier, risking the growth rate. But those are the 3 reasons.

Jonathan P. Groberg - Macquarie Research

Okay, that's helpful. And if I -- just kind of 1 quick follow-up for you, Ron. In the past, I mean, you've often talked about being in discussions and looking at selling businesses. And if you take your comments now, I think run rate of about 155 -- I'm sorry, run rate of about $170 million revs and $55 million in EBITDA. What -- I guess, what would stop some of these deals from -- I guess, I'm just trying to understand how would you describe kind of the conversations you're having this time versus maybe some of the comments you've made in the past and what would maybe stop this event from happening?

Ron Zwanziger

Well, first of all, as you probably noticed, we did actually sell an asset, which we mentioned on the call. Look, these assets that we're divesting, which are non-core, are very attractive. You can see from the numbers, they're making a lot of money. And there's a lot of people interested. So when you have those -- that combination, then it makes a sale possible. And as we said, we expect significant funds near-term. And that's because the negotiations are at an advance stage and there's multiple ways of doing it.

Jonathan P. Groberg - Macquarie Research

Okay. And then Dave, just 2 kind of quick follow-ups for you. One, can you, given this latest acquisition, can you just let us know, and it sounds like you're not going to be acquisitive going forward, can you let us know kind of for the second-half of the year, what you expect from the acquisitions that you've done? And then on gross margins, can you maybe, for the second-half of the year, what you expect the Diabetes gross margins to be, given the reimbursement cuts you mentioned, but also the reduction in supply cost? And any impact you expect on gross margins from trying to get Triage back in the market?

Ron Zwanziger

Just so I understand the question, the question about acquisitions in the second-half. Are you referring to sort of residual performance payments that we might have come to if various targets are met from past acquisitions is...

Jonathan P. Groberg - Macquarie Research

No, no, sorry, the revenue. I hadn't -- I think you did $47.7 million. You said it was acquisition in Professional Diagnostics. I think, you just completed 1 in April and so I just -- I want to make sure I had the right number in terms of revenue contribution from acquisitions in the second half.

David A. Teitel

So that's a year-over-year number. Some of the items included in that -- some of the businesses included in that anniversary on July 1, so the impact forward will be less than it was in the second quarter. And the contribution from Liberty, in particular, will be less in the second quarter, just given the cut in reimbursement rates. So it is a number. Our overall numbers are getting easier to compare year-over-year. The impact of acquisitions is much less significant, obviously, than it's been in recent times. On the second part of your question on the Diabetes margins, clearly they are -- in the quarter, they were well above our average in the Professional Diagnostics space. They will remain above average from a gross margin standpoint in that business today and despite the cuts as the impact of the box have been significant enough to keep us very competitive in that space moving forward.

Jonathan P. Groberg - Macquarie Research

Okay. And then on the Triage? Are you expecting that to give up some price to win these customers back? Or is that not expected to be a major impact?

David A. Teitel

So I expect Triage to be a positive contributor forward. We are winning back business. As I talked about in my comments, that business comes at above average gross margin. And as the manufacturing process continues to improve and yields continue to improve, we'll see less unfavorable variances. So the Triage contribution forward should be helpful, as well as the return of the respiratory season over the balance of the year.

Operator

The next question comes from Isaac Ro with Goldman Sachs.

Isaac Ro - Goldman Sachs Group Inc., Research Division

Just a couple of cleanup items for me. On the molecular strategy, I think you reiterated that the Q system will launch by year-end. Is that, just to be clear, x U.S.? And I know you're still on track to file with the FDA this year.

Ron Zwanziger

Well, x U.S., sure, we are on track to how the filing, but you asked is if it was to the same issue. The filing is not on the same platform. The one that we're launching x U.S. is the Alere Q, the quantitative HIV, and we expect to get it out towards the end of the year. The filing in the U.S., which is on track, is for molecular flu, and that's the isothermal version.

Isaac Ro - Goldman Sachs Group Inc., Research Division

Got it. And then just on the gross margin drivers on the quarter, is it fair to say -- I'm just trying to weigh sort of the most important issues. Is it Triage progress, or is there another element there that would sort of be worth keeping track of as we move forward sequentially, as well as next year?

David A. Teitel

Again, one of the bigger impacts was the impact of the Diabetes business, where you have effectively the old rates against reduced box cost that will be hurt in the third quarter when the rates come down. The box prices still have a bit further to fall from a supply standpoint as we make further transitions and get the benefit of selling off the older, higher cost inventory. But net, that will hurt margins in the third quarter, offset by the Triage impacts that I talked about, as well as the return of the respiratory season.

Isaac Ro - Goldman Sachs Group Inc., Research Division

Got it. And is there any sort of material restructuring opportunity as well in the growth margin line item as we move forward?

David A. Teitel

Sure. There are, Namal has talked less about those at this point just because the kinds of things you do in cost of sales around factories and automation tend to take a little bit longer, so there are significant number of programs, which I'll let Namal comment on. But we are optimistic that we can continue to make progress in that space as well.

Namal Nawana

Yes. So our goals on the upside globally have been to continue to improve our automation and increase our automation. This year, what we have done is already implemented or started 2 further automated triage lines as we get back to market with Triage. And I think that's going to be a significant gain. And then Epocal product. Epoc is going to be a great platform for us going forward, and we've initiated investment of a second line in our Ottawa plant for Epoc. So we have various other initiatives as well.

Operator

The next question comes from Nicholas Jansen with Raymond James.

Nicholas Jansen - Raymond James & Associates, Inc., Research Division

A lot's been covered, so maybe just an update on the patient's health testing business, your growth expectations there from a volume standpoint. And then kind of looking ahead, I know there are some reimbursement cuts in the proposed fee schedule, so maybe just your thoughts on kind of the top line growth heading into next year?

Ron Zwanziger

You're talking specifically about the anticoagulation program, right?

Nicholas Jansen - Raymond James & Associates, Inc., Research Division

Yes, Ron.

Ron Zwanziger

Yes, so we have seen sustained, almost every month, growth in new patient, net gain in new patients, even as all these new drugs have been coming out. And we anticipate that, that will continue and expect to see continued growth in that business. I mean, we are clearly demonstrating good outcomes and keeping patients in therapeutic range effectively. And so I think you'll see that, that business, regardless of any changes in reimbursement, will continue to grow despite the new drugs. I mean, it's clearly what's happening with the new drugs. They've been actually expanding the market, and there's been a relatively small fall-off on impact on Warfarin Coumadin takers, and really, the market has been expanded. And it's been going a while now. We're actually occasionally seeing people come back. So we expect to see continued growth in the business.

Nicholas Jansen - Raymond James & Associates, Inc., Research Division

And then maybe 1 quickly on Diabetes. The cuts that go effect on July 1, we're kind of 30-month -- 30 days in. Anything of surprise of note surrounding kind of that transition in kind of a -- is it too early to see kind of new patients coming aboard as some of your competitors kind of drop out of the space?

Ron Zwanziger

Well, yes, I think it is a bit early. We did actually started seeing an increase even before, sort of some patient switch in anticipation. And so yes, we are seeing switch. But I don't -- we're not going to see significant growth until the patients start running out of the supplies. Many of the companies, particularly those dropping out, took an opportunity to send the maximum amount of product to the patients in the closing month, the maximum they could. And so they took these patients out of the market. So you're not going to see those folks showing up for perhaps another few weeks. But in a way -- but it is too early.

Operator

With no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Ron Zwanziger for any closing remarks.

Ron Zwanziger

Well, with your support, we will ensure that the momentum, which is evident in our results, will continue, and our excellent outlook for earnings growth and value appreciation for all of us will be fully realized. As you know, I'm one of the largest individual shareholders of our stock and I'm one of the largest shareholders of all shareholders, and so you and I are aligned in wanting to enhance the value of our shares. And with your support, as always, I'd like to thank you, and for your continued support and interest. Thank you.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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