Laboratory Corporation of America Holdings' (LH) CEO David King on Q2 2014 Results - Earnings Call Transcript

Jul.18.14 | About: Laboratory Corporation (LH)

Laboratory Corporation of America Holdings (NYSE:LH)

Q2 2014 Results Earnings Conference Call

July 18, 2014, 09:00 AM ET

Executives

Steve Anderson - Vice President, Investor Relations.

David P. King - Chairman and Chief Executive Officer

Glenn A. Eisenberg - Executive Vice President and Chief Financial Officer

Ed Dodson - Senior Vice President and Chief Accounting Officer

Analysts

Robert Willoughby - Bank of America

Bill Bonello - Craig-Hallum

Gary Lieberman - Wells Fargo

Darren Lehrich - Deutsche Bank

Lisa Gill - JPMorgan

Amanda Murphy - William Blair

A.J. Rice - UBS

Issac Ro - Goldman Sachs.

Frank Morgan - RBC Capital Markets

Glenn Santangelo - Credit Suisse

Ricky Goldwasser - Morgan Stanley

Dave Clair - Piper Jaffray

Operator

Good day ladies and gentlemen, and welcome to the Second Quarter 2014 Laboratory Corporation of America Holdings Earnings Conference Call. My name is Glenn and I will be your moderator for today. At this time all participants are in a listen-only mode. And later, we will facilitate a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Mr. Steve Anderson, Vice President, Investor Relations. Please proceed, Mr. Anderson.

Steve Anderson

Good morning, and welcome to LabCorp's second quarter 2014 conference call. I am Steve Anderson, Vice President of Investor Relations and with me today are Dave King, Chairman and Chief Executive Officer, Glenn Eisenberg, Executive Vice President and Chief Financial Officer and Ed Dodson, Senior Vice President and Chief Accounting Officer.

This morning, we will discuss our competitive and strategic environment, highlight progress on our five pillar strategy, discuss our second quarter 2014 financial results, and update 2014 guidance. Before we get started, I would like to point out that there will be a replay of this conference call available via telephone and internet. Please refer to today’s press release for replay information.

This morning the Company filed a Form 8-K that included additional information on our business and operations. This information is also available on our website. Analysts and investors are directed to this 8-K and our website to review this supplemental information. Additionally, we refer you to today’s press release which is available on our website for a reconciliation of non-GAAP financial measures discussed during today’s call to GAAP. These non-GAAP include, Adjusted EPS, Free Cash Flow and Adjusted Operating income.

I would also like to point out that we are making forward-looking statements during this conference call. These forward-looking statements include, among others, statements about our expected financial results; the implementation of our business strategy; and the ongoing benefits from acquisitions.

These statements are based upon current expectations and are subject to change, based upon various factors that could affect the Company's financial results. Some of these factors are set forth in detail in our 2013 10-K, and will be included in subsequent filings with the SEC. The Company has no obligation to provide any updates to these forward-looking statements, even if our expectations change.

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

David P. King

Thank you, Steve and good morning. Before Glenn discusses our second quarter results, I would like to provide an overview of the competitive and strategic environment and of the steps LabCorp is taking to drive in that environment. Although the last three years have been difficult, the lab industry is in an enviable position to grow in the years ahead due to population demographics both in the U.S. and abroad, test menu innovation and the critical role of laboratory medicine in the healthcare system.

LabCorp is particularly well positioned as our size; scale and platform provide an anchor for our business and give us great penetration into the broader healthcare system. Our lab and PSC infrastructure, logistics network, EMR connectivity, [interfaces] into physician offices and health systems and reach to consumers through our billing and collection system and our patient portals are unparalled among healthcare services companies.

Now we must build off this platform to address the needs of a changing market. Given changes in benefit plan and design, reimbursement reductions and pricing pressure sustained utilization may remain lower than historical trends and price above -- across all of healthcare services will likely continue to be under pressure, particularly driven by mix and payment policies.

This dynamic creates opportunities for LabCorp because we believe the consolidation will accelerate lower cost settings will be incentivzed and scale will be rewarded. We are seeing this across healthcare services with transactions designed to increase scale, create vertical integration, expand capabilities and leverage existing assets. Along with opportunity we can reasonably expect that interlopers will try to disrupt our business model.

To be among the winners, we know that LabCorp must excel in five ways; improve the quality and reduce the cost of care, help manage the total cost of care, serve as a performance management partner to our customers, serve a broad range of customers in multiple settings and build scalable platforms with replicable processes that can create value at many points along the continuum of care.

In recent years LabCorp has taken meaningful steps to address these systemic changes through our five pillar strategy. With respect to our first pillar, we have continued to increase our scale and competencies in clinical laboratory medicine through acquisitions ranging from routine capabilities to highly esoteric testing. We have also focused constant attention on building and growing our managed care base leaving us with a managed care portfolio that is unparalled in the industry. These initiatives give us greater opportunity to deliver value in a $60 billion market where we have approximately 10% share.

Under our second pillar we have invested significantly in information technology infrastructure and capabilities to improve the customer experience for providers and patients who order and receive testing from us. Relative to the third pillar, we have relentlessly focused on optimizing our operations to maintain our position as the most efficient provider offering the highest quality and greatest value for the healthcare dollar spent. We have also invested heavily in improving every customers experience with LabCorp. We take great pride in our significant and continuing progress in this area which is due to the efforts of our more than 30,000 dedicated people.

Under our fourth pillar, we have actively pursued opportunities to bring significant new test to market through licensing and internal development. We are pleased that our partners have repeatedly expressed how impressed they are with LabCorp’s science, test development capabilities and innovation. As an example of our innovation, our monogram center of excellence in infectious disease recently two NIH grants to study and develop new approaches for HIV detection.

With respect to our fifth pillar we have undertaken two internal strategic initiatives to support our customers at critical points, BeaconLBS and EnlightenHealth. Each of these initiatives was built on the premise that we can use our existing infrastructure as a channel to provide more value to our customers. Like other companies that have used their infrastructure to extend their market reach, we want to use our market penetration to offer new and value added services.

We undertook BeaconLBS in 2011 because we understood that providers need assistance in selecting the right test for their patients and payers need help in appropriately managing the utilization of expensive diagnostic testing. After extensive market analysis and the enormous amount of hard work, we invented a tool that helps our clients choose the right test at the right time and helps payers thoughtfully address concerns about both unit cost and trend.

In the fall of 2014, this innovative model will be implemented in Florida in partnership with United Healthcare. We started EnlightenHealth as an outgrowth of four initiatives, our Litholink clinical decision support program, our care intelligence data analytics program, our patient portal and our clinical trials business. These tools serve different customers from BeaconLBS. To assist physicians, we have developed a data and analytics tools that help them understand their metrics of care delivery and improved compliance with paper performance and population health metrics.

To assist physicians and patients we have developed disease specific expertise in kidney stone, chronic kidney disease, cardiovascular disease and coagulation adding more programs every year. We have also developed a web portal to deliver lab results, decision support and additional content to patients. We have greatly expanded the size and capabilities of our clinical trial central lab business to serve physicians and patients by taking advantage of the opportunity created as bio pharmaceutical companies recognize the need to go deep in specific disease dates and create vertical alignment from drug design to identification of unique patient populations that will respond to therapy.

We are focused in EnlightenHealth on four key areas of opportunity, personalized genomics, informatics, new channels to capitalize on our competencies in our clinical trials business. We will provide more detail on these opportunities in the coming quarters.

This quarter we continued our progress on all of our five pillars, let me mention several key initiatives. Under pillar three the installation of our propelled robot at our major laboratory in Tampa is complete and is now processing all of the facilities volume. We remain on schedule to install Propel in our Dublin Ohio facility at the end of this year. Propel continues to drive expense reductions, increased throughput and accuracy, and enhance specimen management in our Burlington and Tampa labs.

We continue to streamline our operations and reduce expenses through facility rationalization. In addition to our new Phoenix campus which consolidated four LabCorp facilities, we recently announced the consolidation of our facility in Monrovia, California into our Santa Fe laboratory and the consolidation of our facility in Mitchell Field New York in to our Connecticut laboratory.

We are reengineering our business to provide a better operating platform, sustainable long term savings and a world class customer experience. To that end we remain focused on our enterprise wide cost structure review and we will discuss this initiative in more detail in the coming quarters.

Under pillar four, we launched our BRCA next-generation sequencing assay which provides complete gene sequence analysis of BRCA1 and 2 and better equips us to meet the strong demand for this task. In combination with our care coordination pre-authorization service, LabCorp offers an end-to-end program that includes compliance with insurance requirements comprehensive testing and expert interpretation from our licensed directors and team of 123 board-certified genetic counselors and 9 medical geneticists.

LabCorp continues to see robust growth in companion diagnostic assays that help physicians guide targeted drug therapy. For example our HCV GenoSure NS3/4A assay is the first commercially available test to provide drug resistance data from new HCV antivirus. With respect to the drug simeprevir, the assay is required prior to its use as the test for the Q80K polymorphism that impacts the efficacy of the drug.

We have positioned LabCorp to grow to the era of healthcare reform. The time into which quality, efficiency, scale and a central role in improving care delivery and patient outcomes will be key measures of success. Our five pillar strategy will enable us to excel in all of these areas generating shareholder value for years to come. We are very pleased to have Glenn Eisenberg, our new Chief Financial Officer in place. Glenn is going to be a terrific contributor to our executive team and our company, and now I will turn the call over to him to review our financial results.

Glenn A. Eisenberg

Thank you, Dave. Sales for the quarter were $1.5 billion, an increase of 3.3% over last year. The increase in sales was the result of test volume measured by requisitions and fold-in acquisitions which was partially offset by test and payer mix. Total test volume increased 5.3% over the last year with approximately 3% coming from organic growth. Revenue per requisition decreased 2% but was up slightly versus the first quarter of 2014. Similarly managed care revenue per requisition was also up sequentially.

Gross profit for the quarter was $569 million or 37.5% of sales. This compares to gross profit of $577 million or 39.3% last year. The decline in gross profit was due to unfavorable test and payer mix and cost inflation, partially offset by higher volume and productivity.

SG&A for the quarter was $298 million or 19.6% of sales compared to $281 million or 19.1% last year. The increase in SG&A resulted primarily from an increase in the bad debt reserve consulting fees and merit increases. The increase in bad debt reflects the increased patient responsibilities for the cost of healthcare services due to higher deductibles and co-insurance. For the remainder of the year, we expect the bad debt rate to be back to approximately 4.5%.

Consulting fees were incurred as part of the company’s enterprise wide cost structure review that Dave mentioned earlier. During the quarter, the company had $7 million of restructuring in special items which was comparable to last year. The break out of this years amount has $2 million in restructuring and other special charges and approximately $5 million in SG&A. Excluding these items, operating income was $253 million or 16.7% of sales, compared to $276 or 18.8% last year. The Company also sold its remaining shares in an investment realizing an approximate $9 million gain in the quarter that was reported in other income.

Interest expense for the quarter was $26 million compared to $23 million last year; the increase was driven by higher debt balances as a result of the company’s debt financings in the fourth quarter of last year, partially offset by the benefit of the company utilizing fixed to floating interest rate swaps on a portion of its debt.

The tax rate for the quarter was 39.1% unchanged from last year. As a result, net earnings for the quarter were $141 million or $1.64 per diluted share. This compares to $152 million or $1.62 per diluted share last year. The increase in EPS over last year benefited from the $0.06 per share gain on the sale of an investment as well as the company’s share repurchase program.

Adjusted earnings per share which excludes amortization, restructuring and special items was $1.84 in the second quarter compared to $1.80 a year ago. The company continued to generate strong cash flow. During the quarter, operating cash flow was $207 million compared to $138 million last year as the company benefited from improved working capital including a one day improvement in DSO to 49 days.

Capital expenditures totaled $48 million in the quarter which was essentially unchanged from last year. As a result, free cash flow or operating cash flow after capital expenditures was $159 million compared to $89 million last year. During the second quarter, the company repurchased $56 million of its stock bringing its year-to-date share repurchases to $163 million. The company ended the quarter with approximately $890 million remaining under its board authorized share repurchase program.

Liquidity at the end of the quarter was approximately $1.5 billion comprised of $480 million in cash and $1 billion of availability under our revolving credit facility. The company’s guidance for 2014 is for sales growth of approximately 2% given our performance in the second quarter and outlook for the year we have increased our 2014 adjusted EPS guidance to $6.50 to $6.75.

Operating cash flow was targeted at $780 million to $820 million while capital expenditures are projected to be $185 million to $205 million. As a result, free cash flow is projected at $575 million to $635 million. This ends the company’s formal remarks and we’ll be now happy to answer any questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Robert Willoughby, Bank of America. Please proceed.

Robert Willoughby - Bank of America

Good morning. Glenn, with the inclusion of the full financial statements of the quarterly results for the first time since we started asking for them in 1996 you are already my favorite LabCorp CFO so congratulations there. Can you build on that momentum and actually speak – do you know what an organic volume number or growth number was in the quarter or is that we’re still not able to break that out?

Glenn A. Eisenberg

Well the good news is that one, appreciate your comments. We did break that out actually in our comments if you will. As you know the volume for the company year-over-year was up over 5% and we said around 3% of that was organic and the other 2% were from acquisitions that had been done and were timing related. So the company is continuing to see some very good organic topline growth.

Robert Willoughby - Bank of America

Excellent so I missed that. And yeah Dave, we’ve [asked] some prior calls you know your portfolio of investments there are there any more good guys in there and it didn’t sound like there was a tremendous amount of opportunities left but this was obviously a good one, I guess it’s a continuation of a prior investment here divesting the last, but are there likely -- are we likely to see more investment gains this year or is it – are we pretty much done for the year there?

David P. King

Bob, we never know the exact timing of our investments. You are correct that the gain recorded in this quarter was the balance of what you saw in the first quarter, the disposition of that asset. We do have some other good guys in the portfolio, they are not at present as big a good guy as this particular investment and again, we don’t – we don’t have a good sense of the timing of how these – the investments will liquidate.

Robert Willoughby - Bank of America

Okay. Thank you.

Operator

And your next question comes from the line of Bill Bonello, Craig-Hallum. Please proceed.

Bill Bonello - Craig-Hallum

Hey good morning, thanks a lot. So just a couple of questions, I guess the first one is just trying to get a handle on how you guys are thinking about profitability. I mean you had the $48 million growth in revenue with the $22 million decline in operating income not much color at this point on your re-engineering efforts, just what sort of your commitment to returning the operating growth, can you not grow operating income with you know 3% plus revenue growth you know are these re-engineering efforts necessary just to pull the line, how should we think about this?

Glenn A. Eisenberg

Let me Bill, take the first part of it. To your point obviously its disappointing to see your topline growing but at the expense of our earnings. We talked about the pricing pressure if you will that’s essentially the mix between our test and payers that as we now get through, call it the first half of this year maybe a little bit into the second half you’ll start to see the year-over-year comps now start to level off, so effectively that our operating margins should effectively be leveling off.

Going forward especially we’re taking up some of the unusual items as we continue to see the good topline growth we would expect to leverage our cost structure better, so if we can hold call it the price mix relatively flat for comparable periods, additional volume we should be able to get the leverage from. I think the recognition that the company is looking at this overall call it cost structure review really speaks to the fact that we know there are pressures, we know there is mix pressures, payer pressures that Dave eluded to in his opening remarks and as a result we believe that given this company we should be able to as any company continue to improve our cost structure improve the way we do our business and that should either help mitigate the pressures that we are seeing or hopefully help improve our operating margins going forward.

David P. King

Yeah Bill, it’s Dave. I would just add that the challenge here is test and payer mix and payer payment policies, so we see very strong volume growth at the same time we know with MoPath for example that some of that volume is just not getting paid for. So that has a negative impact on price, negative impact on margin, I mean it goes up and down the P&L or infact you could even argue that it has a negative impact on expenses because we are performing molecular testing and not getting paid for, so we are -- there’s a double whammy effect.

So I agree with Glenn, I think between a combination of continuing to have strong topline growth, looking at the expense side of the ledger and also either resolving through getting paid or resolving through testing process you know the process of not doing testing that we are not going to get paid for. We do have opportunity and we’ve said, we are strongly commitment to operating income growth in 2015 and we continue to believe that we can accomplish that.

Bill Bonello - Craig-Hallum

Okay, that’s helpful. And then just a second follow question, in your prepared remarks Dave you noted interlopers trying to disrupt the business model and lately there has been a lot of press about [indiscernible] a potentially disruptive force in the lab industry, yesterday there was someone even saying you ought to assure the big lab starts because of it. Can you give us your thoughts on sort of that assessment not the shorting but that – will disruptive to the lab industry and if so how at all you might be responding to that threat?

David P. King

Yeah, Bill. I’m not going to comment on any specific competitors in anyway. I don’t think that’s an appropriate thing for me to do. We are always interested in and evaluating potential innovation opportunities for our business. As everybody knows, point of care testing has been extremely challenging over the years from the perspective of the sensitivity and specificity of the testing, the reproducibility of the testing, how the results are delivered particularly in a more electronic era having a test drifted that prints out of an instrument that is not going to be helpful to physicians.

And so we continue to evaluate every potential opportunity for changing the model, that’s what reengineering, the business is about. I would simply say that if there is going to be any kind of a successful point of care testing model with our 1,700 patient service centers, with our in office for [botanists] with our electronic interfaces into physician and hospital systems to provide results seamlessly into electronic health records.

We’re going to be extremely well-positioned to capitalize on whatever developments occur in that frame work. So again, I’m not going to talk specifically about any one thing or another. A lot of people are working on innovation. It’s great, that’s part of what our venture fund is designed to do is to invest in those innovations and see how they play out. But we welcome innovation and I think it provides LabCorp with great opportunity over time.

Bill Bonello - Craig-Hallum

All right. Thanks a lot.

Operator

Your next question comes from the line of Gary Lieberman, Wells Fargo. Please proceed.

Gary Lieberman - Wells Fargo

Good morning. Thanks for taking the question. Maybe if you could just update us on the some of the payment issues that you mentioned on the molecular pathology front and some of the resolution and where you are on the states and then few comments about at some point you’ve made these comments in the past that you reached a decision of maybe not doing the test kind of where are you with all that?

David P. King

Gary, it’s Dave. I think we’re seeing recognition by payers that they need to address this situation and we have recovered some of the outstanding balances of some states particularly some state Medicaid programs and we’ve not made progress with others. So, it continues to be a mixed bag. Specifically with TRICARE on June 18, DHA indicated that they were initiating a three-year demonstration program to pay for some molecular testing that they had stopped paying for in 2013, including extended coverage for prenatal and preconception, cystic fibrosis, carrier screening.

The complete list of test has not been published. And so, I can’t give you any further clarity there. But we are encouraged that TRICARE has recognized that they have a responsibility to their patients and to the physicians who serve those patients to cover that molecular testing.

In terms non-performing the testing, obviously that’s a complex decision and what I would point to there is, the idea behind BeaconLBS is just to let the physicians know at the point of service, the testing is not going to be covered or is not going to be paid for and to let the labs know at the point of service that testing is not going to be covered or paid for.

So, we actually have a tool that will allow payers to implement these policies in appropriate way at the front end as opposed to the lab performing the service and then simply getting a denial and not being paid at the backend.

So, there are lot of ideas in-flight as to how we can execute on this, but we remain very much committed to resolving MoPath either consensually with the payers and if not then by explaining to the physician community that we can’t continue to do significant amounts of high value testing that we’re not going to be paid for.

Gary Lieberman - Wells Fargo

Any better visibility into the timing of resolving that is it likely this year or we have to wait longer for that?

David P. King

I think it just going to be a long process. We’ve recovered money against some of what we were not paid last year. We started getting paid by some payers that were not paying us last year. But we’ve not seen any material overall improvement in the landscape, and so we continue to work hard to try to accomplish that improvement.

Gary Lieberman - Wells Fargo

Is there any dollar amount that you’ve kept track of what you have not gotten paid for or what you have not accrued that you would have otherwise accrued if there hadn’t been these issues?

Glenn A. Eisenberg

Yeah, the only thing that we’ve said was that the run rate last year was approximately $52 million in uncollected MoPath payments and to repeat what I said previously, we haven’t seen any material improvement in that situation.

Gary Lieberman - Wells Fargo

Okay, great. Thank you very much.

Operator

Your next question comes from the line of Darren Lehrich with Deutsche Bank. Please proceed.

Darren Lehrich - Deutsche Bank

Thanks. Good morning everybody. Welcome Glenn. I wanted to just follow on actually to the molecular pathology denial question. So I guess, just as it relates to the TRICARE announcement itself, is it fair to say that you are waiting for them to publish their list, so you have certainty around what you’ll be able to build and collect is that we’re now waiting for. So it’s the first question on TRICARE? And then the other part of it is, when we think about the $52 million, Dave, was TRICARE a material part of that?

David P. King

Darren, with respect to the list, yes, we do know that they have agreed to cover cystic fibrosis, which was probably the single largest test that was not being covered. And we don’t know what the other tests on that list will be and we are waiting to determine that.

In terms of whether they were a material part of the $52 million? They were a significant part of the $52 million. And so, we’re optimistic that as payment policies are put in place that that will improve on a prospective basis.

I don’t think we’ve resolved the question with them, the question of what they’re going to do with respect to the payments that were not made from January of 2013 to April 2014.

Darren Lehrich - Deutsche Bank

Okay. But I thought there it was reported in the press more than anything, but I thought they had made the decision to go back to Jan 1, 2013, so is that not your interpretation?

David P. King

I think if they have made that decision, we’re still waiting to see the full impact of it.

Darren Lehrich - Deutsche Bank

Got it, okay. So we -- do you think we’ll some resolution to all this related to TRICARE in Q3, is that a reasonable expectation?

David P. King

I would hope so, I mean, they have encourage -- they have said that they are working on the list and through ACLA and directly obviously we’ve been we have been encouraging them to provide the list as soon as possible so that we and the other laboratories in the industry can take appropriate steps to make sure that we’re going to get paid for the services.

Darren Lehrich - Deutsche Bank

Okay. Thanks for clarifying that. I guess the one other question I had for you is with regard to revenue diversification. And I guess we’ve noted in your proxy that the incentive comp programs are putting higher weight on diversification. I guess the question here is what qualifies as a diversified revenue source for you guys and can you just talk a little bit about the types of things we should be thinking about in that context?

Glenn A. Eisenberg

Sure. There’s a long list of things that could qualify as -- in my view as revenue diversification. Starting with share gain from hospital laboratories, which is an area in which we have a significant amount of revenue, but as everybody knows, there’s a lot of revenue going through hospital labs that from an economic perspective could be served at lower cost and at very -- in my opinion at higher quality by going through independent laboratory. So that’s one area.

Our clinical trials central lab business is an important business for us. It’s a business that’s grown significantly over time. It doesn’t -- we don’t get paid there by managed care or by the government. We get paid by different parties and so that certainly is a revenue diversification opportunity.

More direction interaction with consumers is a revenue diversification opportunity. International is a revenue diversification opportunity. The BeaconLBS and the EnlightenHealth platforms are revenue diversification opportunities, because within each of those there are ways of generating revenue that are not going to be subject to either direct payment from managed care or direct payment from the government.

So as we think about revenue diversification Darren, I would not characterize it as, and I want to be clear that, we don’t characterize it as we’re going to go do something that is vastly outside the scope of our core competencies. I think if revenue diversification of how can we take those core competencies and how can we generate revenue from different payer sets, from the payer sets that are generating the bulk of our revenue today.

And if we can do that, we can use our core capabilities, but we can generate different streams of revenue that overtime will allow us to offset some of the pressures that you’re seeing in the business today.

Darren Lehrich - Deutsche Bank

Got it, that’s helpful. Okay. Thank you.

Operator

Your next question comes from the line Lisa Gill, JPMorgan. Please proceed.

Lisa Gill - JPMorgan

Thanks very much, and good morning. Dave, I was wondering if you could talk about anything specific to ACA volumes in the quarter and kind of your expectations as we move throughout the year.

David P. King

Good morning, Lisa. I think we -- I said at the end of last year and in the beginning of this year, that we felt that ACA would probably be a net neutral to us. I think from a volume perspective, it’s hard to argue that we’re not getting the benefit. I think, we are getting a volume benefit from ACA just because if you look at the enrollment numbers in Medicaid and managed Medicaid, in private exchanges, the data clearly suggest that enrollment is up, uninsured, the number of uninsured patients coming to see us is down.

So I think we are getting a volume benefit obviously from a pricing perspective, one of the consequences of the ACA is, you are seeing very rapid growth in the Medicaid population, you’re seeing very rapid growth in the managed Medicaid population that has an impact on price, not so much from a unit price perspective, but from a mix perspective and also from a payment policy perspective.

So particularly managed Medicaid payment policies tend to be very restrictive for molecular and high value testing and that’s part of why you’re seeing the pressure on price. So net-net clearly in my mind ACA is a benefit to our volume growth and it has been somewhat of a weight on price.

Lisa Gill - JPMorgan

And then just going back to your earlier comments talking about disruptors, talking about your potential shares in the hospital market, can you maybe just give us some indication as to what you think would be the key drivers for example, on the hospital market finally getting that business out of the hospital lab. Is it as hospitals take more risk and a CEO type relationships? Is it managed care driving that? And over what time frame do you think that you can really show meaningful market share movement?

Glenn A. Eisenberg

Well, as you know, this has been the biggest opportunity for independent labs, pretty much for the history of the industry and I think it remains the biggest opportunity. It’s certainly going to be -- market share moves slowly. I do think that hospitals are re-looking at all of their ancillary services and you’re seeing in a number of areas, ambulatory surgery, wound care, you’re seeing hospitals forming partnership with other companies to provide those services in a lower cost and less acute side of care. And I think, we’ll see that over time with the hospital labs, but again, it takes times, these are complex transactions and we just have to be aggressive and patient.

Lisa Gill - JPMorgan

Thank you.

Operator

Your next question comes from the line of Amanda Murphy, William Blair. Please proceed.

Amanda Murphy - William Blair

Hey thanks. I just had a question on the legislation that just came out around future Medicare reimbursement. You know there was obviously a meeting earlier and there was a lot of different discussion around sort of how CMS should look the last date in terms of collecting data and who should be involved in that. So I’m curious just how are you guys thinking about the puts and takes there? And then, sort of how LabCorp physicians, if you think about Medicare reimbursement 2017 and on?

David P. King

Well, so the legislation requires CMS to engage in a rule making and my understanding is the first rulemaking is about how they’re going to conduct the market surveys and that rule is due to be published at some point next year.

Then the market surveys will be conducted in 2016 basically and towards the end of 2016 there’ll be a Clinical Lab Fee Schedule rule in which they will propose subject to notice on comment that the changes to the fee schedule.

So from my perspective, the rule that determines how they’re going to define market is going to be very important. And ACLA and LabCorp and all lab constituencies I think its fair to say are very much engaged with CMS and trying to create a survey that would be fair, but they will accurately represent the market for laboratory testing.

Then once the surveys are done and completed, CMS will have the opportunity not kind of the way that the fee schedule has been addressed before which was with the blood instrument of across the board cuts, but CMS will have the opportunity to on a CPT code, by CPT code basis address individual testing that they want to adjust valuations.

And I would say that, I’m sure CMS’s view is that there are some tests on the Clinical Lab Fee Schedule that are -- that should be reduced in price. And the industry feels very strongly that there are lot of tests on the Clinical Lab Fee Schedule particularly complex molecular testing, lot of CPTs that need to increased in price because they don’t reflect what the commercial market pays.

So, its very hard to predict what will happen in 2017, but I think its -- I think, again its fundamental to highlight that the agreement between the laboratory industry and Congress was that these surveys were to consider the entire marketplace, Senator O. Hatch specifically stated during passage that the intent of the bill was to ensure that Medicaid rate reflect true market rates and that all commercial payment rates to all sectors of the lab market should be represented including independent laboratories and hospital outreach laboratories.

So we expect that the industry in CMS will work together to faithfully execute the intension to bring laboratory, Clinical Lab Fee Schedule pricing to market price and we think that that ultimately will lead us to a fair outcome.

Amanda Murphy - William Blair

Got it, that’s helpful. And then, just a follow up on some of the discussions around mix, obviously you’ve launched some new genetic tests and have maybe an increased focus there with BRCA and some of the cancer panels. At what point or is there a point in your mind where mix could eventually become a positive for you to the extent that those testing start to contribute some real growth to volumes?

David P. King

Yeah. I think if you look historically up until probably even 2012 mix was always a positive for us. I mean, you look at the innovations in testing cystic fibrosis, vitamin D, micro arrays, prenatal genetic screening and mix is -- we could pretty much count on about a percent or percent and a half of mix improvement which was reflected in price over the years. It’s been in the last couple of years that mix has turned and again there is two parts of mix, there is test mix so what tests are we performing in getting paid for and then there is payer mix, so who is the ultimate entity that’s paying for the services.

Test mix has been heavily influenced by the growth in toxicology as we said on a number of occasions, and has also been reflected in price by the fact that we are not getting paid for the molecular pathology testing which is at a higher price point. Payer mix is affected by the move from uninsured to the exchanges where people are moving into high deductible plans and it’s also affected by the move from uninsured to managed Medicaid or from commercial -- from fee for service Medicaid to managed Medicaid and even from commercial into managed Medicaid.

So all of those things have been what you’ve seen in the -- and what’s reported as the weight on price particularly in the last couple of quarters. Obviously tests like BRCA and the cancer panels and the ACD testing that I referenced in the prepared remarks, all of these things are – have the potential to be a positive impacts on mix and BRCA has a very strong potential to be a positive impact on mix. So we – as Glenn said earlier, we expect that we will see the leveling off of the price decline and we will start to see improvement in the mix driven price.

Amanda Murphy - William Blair

Okay. And sorry if you said this, but in terms of the MoPath and guidance, are you just assuming then that its just status quo with MoPath payments for 2014?

David P. King

Yes, we are.

Amanda Murphy - William Blair

Okay. Thank you guys.

Operator

Your next question comes from the line of A.J. Rice with UBS. Please proceed.

A.J. Rice - UBS

Thanks, hi everybody. First of all just let me try to make sure I understand. When we are talking about the cost structure review, I know at one point I guess that was a sense that maybe you guys would have a sort of significant announcement where you talk about a restructuring, I guess you mentioned a couple of things and your prepared that are sort of ongoing cost restructure. Are you still thinking that at some point of time you are going to lay out a grand or a cost restructured program or is it going to be sort of incremental from here?

Glenn A. Eisenberg

A.J. this is Glenn. We are currently in the process of looking at all the opportunities in the company to streamline to potentially restructure where we feel we can be more efficient and take out cost, so what we are looking at is a fairly comprehensive program. So at the appropriate time we would expect that we would announce this comprehensive program so which would be all the cost that would incur to achieve it as well as what we believe the long term benefit of the program is. It’s just premature to talk about it currently as we are continuing to go through the work ourselves.

A.J. Rice - UBS

Okay. And then on with you coming on board Glenn, the capital deployment thinking regard to capital deployment I know on the share repurchase front, it looks like there was a moderation in the current quarter in the pace of buybacks, are you taking a review of capital deployment strategies as well and is that what’s going on and maybe tie that end to relative priorities for capital deployment going forward.

Glenn A. Eisenberg

Yeah obviously one of the attractive nuances of this company as we intend to generate a fairly significant free cash flow, so obviously we have to use that capital wisely and there are a lot of opportunities to do it. Historically, the company is used a fairly balanced approach of acquisitions as well as share repurchases utilizing our balance sheet we are currently in that call it 2.5 times that the EBITDA targeted range, albeit that will fluctuate a bit.

So wouldn’t get to focus necessarily on what we are doing quarter-to-quarter. In particular, again the second quarter was probably a little bit later once you have repurchased that historically, but we’ll continue to evaluate where we can put it, again acquisitions and buybacks being the two principle modes outside of just organic needs and so overtime you’ll continue to see us redeploy it where we feel we’ll get the best return for the share holders.

A.J. Rice - UBS

And your thoughts on the current status you leverage the 2.5 times, is that your sort of comfort zone or do you think you could take on more, I know there’s been some talk about taking that off.

Glenn A. Eisenberg

Yes that effectively the 2.5 is just one metric that we would look at. It’s really more of the philosophy of the company that we want to maintain an investment grade balance sheet. So 2.5% times is roughly that proxy. Having said that, we have additional liquidity, we are able to go higher than that, we believe and still maintain investment grade with the understanding that going forward we would use the free cash flow and continue to bring it back down to that level. So as an example, should there be an acquisition or a larger buyback that ultimately would take us higher than that level with a commitment that will use the future cash flows to bring it back down. So it’s you know a proxy for us, it gives us some flexibility, but we do think that its utilizing the balance sheet well and redeploying capital in appropriate fashion.

A.J. Rice - UBS

Okay, alright thanks a lot.

Operator

Your next question comes from the line of Issac Ro, Goldman Sachs. Please proceed

Issac Ro - Goldman Sachs

Yeah good morning guys, thanks for taking the question. I wanted to spend a minute on bad debt the comments you made there is I think about the sort of the year-on-year comp into the middle part of the year. You know fewer uninsured people in the system, those people obviously tend to drive the majority of your bad debt, so theoretically that should improve. But is sounds like on a year-over-year basis atleast in 3Q you are expecting bad debt to go up, so I’ll be just curious if you could talk a little bit about how the rise of ACA coverage is impacting bad debt relative to your expectation.

David P. King

Issac, its Dave. First of all what we said in the prepared remarks is that in 3Q and 4Q we expect bad debt to go back down to 4.5. So we are not expecting bad debt to go up. Second, part of the impact of transition of patients from uninsured or from their prior insurance into exchanges is that although there are premiums set to these in the exchanges, there is very limited deductible subsidies, so you actually have people transitioning in the plans, where although they are getting premium subsidies the average deductible that is before the patient gets $1 of payment in a silver level plan is about $3000.

So there is more dollars out to patients as these high deductible plans take effect and in the first and second quarters of the year before patients get through the deductibles you see more dollars of responsibility going out to patients, that’s why we topped off the bad debt rate in this quarter. But overtime as Glenn said in his prepared remarks, we expect bad debt to go back to the 4.5% for the balance of this year and to decline with the overall impact of ACA with more patients gaining coverage.

Issac Ro - Goldman Sachs

Got it. I was looking at the bad debt year-on-year but in sequential terms the comment there makes sense, thanks. And then just second on testing categories, I was just wondering if you call out any areas of unusual strength or weakness in 2Q with regards to mix and then how your expectations there maybe shape up for the back half, just trying to make sure I understand any specific dynamics around testing mix that could factor into your margins?

David P. King

Well we had strong growth in core testing, obviously on a year-over-year basis we had strong growth in BRCA, in our new swab testing, in our Hepatitis-C, both the screening and the reflex testing. So there’s good solid mix of growth in both the core business and in HSR testing. And then, we did continue to have strong growth in the toxicology pay management and drugs of abuse area as well.

Issac Ro - Goldman Sachs

Got it. Okay thanks.

Operator

Your next question comes from the line of Frank Morgan, RBC Capital Markets. Please proceed.

Frank Morgan - RBC Capital Markets

Good morning. You just mentioned your commentary about the bad debt outlook in the second half of the year. I was hoping you could just hit on other items that are implied in your updated guidance, what you think for both volume and pricing and do you expect to see any investment gains in the balance of the year is that contemplated in your guidance?

Glenn A. Eisenberg

Frank, this is Glenn let me take a cut of that first with the latter part of the question. No investment gains are forecasted in the second half and obviously to the extent that we would have any, we will break that up for you. As you think its more broadly about the implied guidance for the second half, we are looking at relatively comparable topline growth in the company, so in order to hit kind of that 2% rate, we are going to go close to 3% kind of growth at the topline through the second half of the year and that’s obviously seasonality as you look first half to the second half like fourth quarter historically up a low quarter for the company.

Similarly we expect from a profitability to be comparable, so again this goes back to the comments that Dave and I mentioned that we’re kind of leveling off plus or minus on the operating margins with where we are. The big positive though is that the spike kind of second half, first half being comparable we expect to see very improved free cash flow in the business which again it tends to be more seasonal for us as well as we tend to generate cash from working capital in the second half of the year versus the first half, but nothing frankly unusual that we would expect to see in the second half other than against continued topline growth trying to leverage that realizing that we still have some of the headwins from the test and payer mix issue.

David P. King

And Frank its Dave. Just again agree with everything Glenn said, excluded from the guidance is any share repurchase after June 30, any benefit from the enterprise re-engineering that we mentioned and any improvement in the MoPath position, those are all not included.

Frank Morgan - RBC Capital Markets

And acquisitions or will acquisitions be included?

David P. King

There’s no significant acquisition that is contemplated in the guidance. As you know we do tuck in acquisitions and we do them regularly and so we might do some of those and that would effect where we come out in the range, but there is no material acquisition contemplated.

Frank Morgan - RBC Capital Markets

I got you. One more and I’ll hop. Just how do you see the margin profile playing out on these new areas with Beacon and Enlighten and what kind of margin profile will that business have and then how long do you think it will be before we really have some impact? Thanks.

David P. King

I think it’s early to say what the margin profiles would be for those businesses and we know for example we know what the margin is for the clinical trials business but other parts of – health that were developing it. You know, we have some expectations but I don’t think we have and then we are prepared to say. Beacon, we need to get it up in working and then we’ll be able to talk more about the margin profile overtime. So I think it will be premature to make any estimates there.

Frank Morgan - RBC Capital Markets

Okay. Thanks.

David P. King

We’ve got about five minutes before the hour and so we’ll have time to take a couple more questions. I’d encourage you please not to repeat questions that have already been asked and answered.

Operator

And your next question comes from the line of Glenn Santangelo with Credit Suisse. Please proceed.

Glenn Santangelo - Credit Suisse.

Oh yeah thanks Dave. I apologize in advance, but I do want to follow up on this revenue per requisition you know in the current quarter you are clearly only down 2% which is a little bit better than the 3.3% in the first quarter. So I’m wondering if you could dimensionalize a little bit exactly. I think you gave us some of the payer mix changes that may be weighing on that pricing component. Could you give us and if you can give some color on test mix, but as I sort of dimensionalize that 2% could you split it out between what’s payer mix and what’s test mix?

David P. King

Glenn, we don’t split out the payer mix and test mix. We haven’t historically and I don’t think it will be a good practice to start, so we are still resting on our laurels from probably will be in – in putting the full financial statements and that’s as far as we’ll go.

Glenn Santangelo - Credit Suisse.

Okay. And then maybe I’ll just ask a second quick question. I think in your prepared remarks you suggested that you are not willing to go vastly outside of the scope of your core competency but you did sort of mention from a strategic perspective that international maybe something that could be interesting to you, are there any sort of markets that you sort of keeping an eye on that, that could be interesting for LabCorp?

David P. King

I think that the most interesting markets and we outlined this a little bit in our investor presentation. The most interesting markets are going to be markets where there is growing attention to provision of healthcare in the middle care, there is growing private wells, there is infrastructure to support the kind of business that we run, so roads, airports, transportation infrastructure and there is recognition of the importance of diagnostics. And I think largely those are going to be what I would characterize as developing markets, but higher end developing markets as opposed to mature markets.

Glenn Santangelo - Credit Suisse.

Okay, thanks.

Operator

Your next question comes from the line of Ricky Goldwasser with Morgan Stanley. Please proceed.

Unidentified Participant

Hey good morning, thanks this is [Zach] for Ricky. I just wanted to check on market growth versus your organic growth and I think in the first quarter your organic was 2.5% this quarter 3%, so do you imply that it’s [gaining] share or that the market is growing faster?

David P. King

[Zach] – it’s Dave. You know these numbers were always subject to interpretation. I think from the perspective of looking at our business and looking at the markets around us, and looking at what I think is a really excellent job of execution that we are doing at the operational level. I think it’s hard to look at these numbers and say that share gain is not a big component of how we are growing. So we are pleased about that and obviously our goal is to continue it.

Unidentified Participant

Okay, thanks. And a quick one just on the tuck ins, is it fair to assume that those are dilutive to price per requisitions to their negative mix impact?

David P. King

No I don’t think that’s fair to assume

Unidentified Participant

Okay, thanks.

Operator

Your next question comes from the line of David Clair with Piper Jaffray. Please proceed.

Dave Clair - Piper Jaffray

Hi, good morning everybody thanks for taking my questions. So I was just hoping you could give us any metrics, the type of cost savings you are seeing after installing Propel in the lab? And how big of an opportunity is this as you kind of roll that out?

David P. King

In terms of metrics, the only metric I would give you is that we see completion times, significantly improve so when we are getting the results out to the physicians we see reagent cost being reduced as a result of less retesting and more accurate placement of the specimens on the instruments and we do see a reduction in labor cost just because we have automated the front end. We haven’t specifically spoken to and don’t intend to specifically speak to you know the exact impact of any given initiative like this. As we say we’re always looking at the cost structure or comprehensively reviewing the opportunities to re-engineer Propel as a perfect example of how we would not re-engineer the front end to make it work better and that’s all we are going to do with the rest of the company as well.

Dave Clair - Piper Jaffray

Okay and what are your plans to roll out enlightenment and kind of beyond the initial launch here?

David P. King

I think the answer to that is stay tuned, because we’ll roll out specific, I mean some of those components like the care intelligence platform, the decision support platforms and the clinical trials business are already out and the question is our ability to grow them. Some of the components like the genetic and genomic focus and they are applying our competencies to new areas, we’ll continue to evolve overtime and we’ll talk about them as we get them up in running.

Dave Clair - Piper Jaffray

Okay. Thank you.

Operator

At this time we have no further questions. I would now like to turn the call over to Mr. Dave King for his closing remarks.

David P. King

Thank you all very much for listening this morning. I like to again reiterate what I said in the prepared comments, which is, we have positioned LabCorp to grow and thrive in this area of healthcare reform. We are confident that quality, efficiency, scale and the role that we are playing in improving fair delivery and patient outcomes through our core business through our specialized testing, through BeaconLBS and through EnglightenHealth will be key measure of success overtime. And we are excited about the opportunities ahead in our ability to excel and in generating shareholder value in the years to come. Thank you and good day.

Operator

Ladies and gentlemen that concludes today's conference. Thank you for your participation. You may now disconnect and have a great weekend.

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Laboratory Corporation of America (NYSE:LH): Q2 EPS of $1.84 beats by $0.07. Revenue of $1.52B (+3.4% Y/Y) beats by $20M.