Laboratory Co. of America Q2 2022 Earnings Call Transcript

Participants

Corporate Executives

• Chas Cook, Head of Investor Relations
• Adam Schechter, Chairman, President, and Chief Executive Officer
• Glenn Eisenberg, Executive Vice President and Chief Financial Officer

Analysts

• Ricky Goldwasser, Morgan Stanley
• A.J. Rice, Credit Suisse Group AG
• Taji Phillips, Jefferies Financial Group Inc.
• Jack Meehan, Nephron Research
• Eric Coldwell, Robert W. Baird
• Patrick Donnelly, Smith Barney Citigroup
• Kieran Ryan, Deutsche Bank Aktiengesellschaft
• Derik De Bruin, Bank of America Co.
• Rachel Vatnsdal, JPMorgan Chase & Co.
• Matt Larew, William Blair
• Kevin Caliendo, UBS Group AG

Presentation

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Labcorp Second quarter 2022 Earnings Call. [Operator Instructions]

Thank you. Chas Cook, Head of Investor Relations, you may begin your conference.

[Chas Cook, Head of Investor Relations at Laboratory Co. of America]

Thank you, operator. Good morning, and welcome to Labcorp's Second Quarter 2022 Conference Call. As detailed in today's press release, there will be a replay of this conference call available via telephone and Internet. With me today are Adam Schechter, Chairman and Chief Executive Officer; and Glenn Eisenberg, Executive Vice President and Chief Financial Officer. This morning, in the Investor Relations section of our website at www.labcorp.com, we posted both a press release and an Investor Relations presentation with additional information on our business and operations, which includes a reconciliation of the non-GAAP financial measures to the GAAP financial measures discussed during today's call as well as a presentation on additional information on the spin-off of the clinical development business. Additionally, we are making forward-looking statements.

These forward-looking statements include, but are not limited to, statements with respect to the estimated 2022 guidance and the related assumptions; the proposed spin-off of the clinical development business; the impact of various factors on the company's businesses, operating and financial results, cash flows and/or financial condition, including the COVID-19 pandemic and general economic and market conditions; future business strategies; expected savings and synergies, including from the LaunchPad initiative and from acquisitions; and opportunities for future growth. Each of the forward-looking statements are subject to change based upon various factors, many of which are beyond our control. More information is included in our most recent annual report on Form 10-K and subsequent quarterly reports on Form 10-Q and in the company's other filings with the SEC. We have no obligation to provide any updates to these forward-looking statements even if our expectations change.

Now I'll turn the call over to Adam.

[Adam Schechter, Chairman, President, and Chief Executive Officer at Laboratory Co. of America]

Thank you, Chas, and good morning, everybody. Today, we announced we are pursuing the spin of our clinical development business, and we released our second quarter results. It's an exciting day for Labcorp, and we have a lot to cover. So I'll start with the spin. We are pursuing the spin of our clinical development business to shareholders through a tax-free transaction. This transaction will create two leading, independent and global public companies that will each be well positioned to innovate, grow significantly and enhance shareholder value. This announcement marks the beginning of an exciting new chapter for our businesses and is a testament to our team's growth mindset, resilience and determination over the last several years. The decision to spin off the clinical development business resulted from our Board and management team's ongoing review of opportunities, including discussions with third parties, that best position us for growth, success with our customers and shareholder value creation. When we announced the conclusion of our strategic review in December of last year, we determined that the company's structure was in the best interest of stakeholders at that time. We reiterated that management and the Board were committed to continuing to evaluate all avenues for enhancing customer and shareholder value.

We have now determined that spinning off the clinical development business is the best path forward to achieve this objective. The planned spin will position our businesses to thrive as two independent companies with greater strategic flexibility and operational focus to innovate, to pursue their distinct priorities and to better meet customer needs and capture growth opportunities. Each company will benefit from its own capital structure, enhanced investor alignment through a more targeted investment opportunity and a differentiated value proposition. Each will be well capitalized and positioned to generate substantial top and bottom line growth with strong free cash flow and attractive returns. We expect this transaction to drive significant value for shareholders as we'll provide investors with the opportunity to participate in the significant upside potential of two leading global businesses in the health care sector. This transaction allows Labcorp to move forward as a strong, global, innovative laboratory services business with significant growth potential. The Labcorp business will include routine and esoteric labs, central labs and early development research labs. In 2021, these businesses reported testing for 82% of the therapeutics submitted to the FDA, tested patients grew over 100 countries and performed over 650 million tests globally.

Each is a leader in their respective markets. The combination of these businesses creates a cohesive global provider of laboratory-focused services with complementary resources, significant scale and a diverse customer base poised to grow in a global addressable market of over $150 billion. Labcorp's customers will continue to benefit from its deep scientific expertise, our innovative mindset, our vast health data and insights as well as our advanced global laboratory network. With a more focused platform for growth, we expect Labcorp will be able to capture upside as we advance innovations to deliver on our customers' future needs. Over the last four quarters, the lab businesses delivered total revenue of $12.7 billion or $10.5 billion excluding COVID testing revenue. These businesses grew at a 5.5% CAGR from the second quarter 2019 and the second quarter of 2022, excluding COVID testing revenue. Going forward, Labcorp is expected to deliver mid-single-digit annual revenue growth, and we remain firmly committed to our capital allocation strategy and to maintaining an investment-grade credit rating. The clinical development business will continue to be a leading global provider of Phase I through Phase IV clinical trial management, market access and technology solutions, serving a broad customer base, including pharmaceutical and biotechnology organizations. It will be positioned to compete and to win in a growing and dynamic market, including extending its leadership in oncology, cell and gene therapy, rare diseases and other emerging therapeutic areas.

The clinical development business will be able to implement a capital structure that is tailored to support its growth strategy and enhance stakeholder value. Importantly, we expect the clinical development business will retain access to Labcorp's vast health and clinical data set through an arrangement to support clinical development customers with the ability to tap into Labcorp's unique data and capabilities. The clinical development business will be poised to capitalize on its innovation and technology platform to drive significant growth. Over the last four quarters, the clinical development business delivered total revenue of $3 billion. This business grew at an 8% CAGR from the second quarter of 2019 to the second quarter of 2022. Going forward, the clinical development business is expected to deliver high single-digit revenue growth. We will have a strong balance sheet and significant financial flexibility. I want to emphasize that each business has delivered strong performance, and we expect that Labcorp and the clinical development business will be poised for even greater growth as independent, more focused companies. We expect to close the transaction in the second half of next year, and we look forward to sharing more about its progress in the future. I'll now move to cover the company's second quarter performance and provide an update on progress against our strategy before turning it over to Glenn.

The Base Business in the quarter continued to perform well despite ongoing impacts from COVID, the Ukraine-Russia crisis and foreign exchange rates. In the quarter, revenue totaled $3.7 billion, adjusted earnings per share reached $4.96, and free cash flow was $429 million. In Diagnostics, Base Business revenue for the quarter was up 3.9% versus the prior year due to increased demand for both routine and esoteric testing. The Base Business CAGR was 4.3% from 2019 pre-COVID, demonstrating strong, continued underlying performance. Drug Development revenue was flat in constant currency data in the quarter versus last year, with growth in early development and clinical development offset by central labs. Central labs was impacted by the significant slowdown in COVID-related work and the Russia-Ukraine crisis. On a CAGR basis, in 2019, pre-COVID, the Drug Development Base Business grew 9%. Margins in Drug Development improved in the quarter to 14.7% and are expected to continue to increase throughout the year. Glenn will provide more detail on our second quarter results in a moment. Now I'll provide a brief update on our efforts to address the COVID-19 pandemic, and most recently, assist in the monkeypox outbreak. COVID PCR volumes totaled 2.8 million for the second quarter, averaging 31,000 per day. Time to results remained one day on average.

With respect to the monkeypox outbreak, in collaboration with the CDC and FDA, we became the first national laboratory to begin testing for monkeypox using the CDC test. I'll now turn to progress against our strategy. In addition to today's announcement, we've made significant progress against our strategy by putting science, innovation and technology at the center of all we do. The company introduced multiple innovative and high-quality diagnostics to consumers and physicians in the quarter. We continued to expand our at-home test offerings through Labcorp OnDemand, including a first-of-kind blood collection device for diabetes risk screening. In addition, we launched an FDA-approved men's rapid fertility test. For brain injuries and neurodegenerative disease, in July, we were first to begin offering a test that can help physicians diagnose conditions, including concussions, Alzheimer's and Parkinson's. Finally, we expanded our central labs kit production capabilities to improve delivery and address growing demand across Europe, the Middle East and Africa.

We announced the planned expansion of our central labs presence and drug development capabilities in Japan in collaboration with BML. Turning to oncology. We continue to deepen our leadership position by expanding our cancer-related diagnostic screening and testing portfolio and by partnering with our pharmaceutical clients. During the second quarter, we launched a new skin cancer test that give doctors actionable insights to help determine the best treatment options. The test is also expected to be used to support clinical trials. For patients with metastatic non-small cell lung cancer, we're collaborating with Lilly and using Labcorp's OmniSeq INSIGHT genomic test to help physicians make more informed and personalized treatment decisions. Moving now to new and ongoing partnerships and acquisitions. During the second quarter, we acquired select outreach business assets and agreed to provide ongoing technical support to Prisma Health's hospital laboratories. We completed our acquisition of select clinical outreach business assets from AtlantiCare in New Jersey. We reached an agreement to acquire the clinical outreach business and related assets of RWJBarnabas Health, also in New Jersey.

And the previously announced relationship with Ascension is progressing through normal regulatory approvals. We continue to have a very strong pipeline of health system and regional acquisition possibilities, and we look forward to announcing more in the future. In summary, we continue to deliver solid results, improve our performance and execute on our strategy to create long-term value for all stakeholders. We're encouraged by momentum heading into the second half of the year and by the strategic opportunity for Labcorp's growth and impact in the future.

With that, I'll turn the call over to Glenn.

[Glenn Eisenberg, Executive Vice President and Chief Financial Officer at Laboratory Co. of America]

Thank you, Adam. I'm going to start my comments with a review of our second quarter results, followed by a discussion of our performance in each segment and conclude with an update on our full year guidance. For reference, we've also included additional business information that can be found in our supplemental deck on our Investor Relations website. Overall, the company performed well in the quarter. Revenues for the quarter were $3.7 billion, a decrease of 3.7% compared to last year due to lower COVID testing and the negative impact from foreign currency translation. This was mostly offset by organic Base Business growth and acquisitions net of divestitures. COVID testing revenue was down 42% compared to COVID testing last year, while the Base Business grew 1.2% compared to the Base Business last year. Organically, in constant currency, the Base Business grew 1.6%. Operating income for the quarter was $526 million or 14.2% of revenue. During the quarter, we had $66 million of amortization and $64 million of restructuring charges and special items, primarily related to acquisition and integration costs, facility rationalization and other LaunchPad initiatives.

Excluding these items, adjusted operating income in the quarter was $656 million or 17.7% of revenue compared to $840 million or 21.9% last year. The decrease in adjusted operating income and margin was primarily due to a reduction in COVID testing, higher personnel expense and other inflationary costs, partially offset by organic Base Business growth and LaunchPad savings. The tax rate for the quarter was 24.7%. The adjusted tax rate was also 24.7% compared to 25.1% last year. The lower adjusted rate was primarily due to the geographic mix of earnings. We continue to expect the adjusted tax rate for the full year to be comparable with last year at approximately 25%. Net earnings for the quarter were $359 million or $3.87 per diluted share. Adjusted EPS were $4.96 in the quarter compared to $6.13 last year. Operating cash flow was $572 million in the quarter compared to $487 million a year ago. The increase in operating cash flow was due to higher cash earnings and favorable working capital. Capital expenditures totaled $143 million, up from $97 million last year, primarily due to timing. As a result, free cash flow was $429 million in the quarter. During the quarter, we invested $100 million on acquisitions, paid out $67 million in dividends and repurchased $400 million of stock, representing 1.7 million shares.

At the end of the quarter, we had $1.1 billion of share repurchase authorization remaining. Now I'll review our segment performance, beginning with Diagnostics. Revenue for the quarter was $2.3 billion, a decrease of 4.7% compared to last year due to organic revenue being down 5.7%, partially offset by acquisitions of 1.2%. COVID testing revenue was down 42% compared to COVID testing last year, while the Base Business grew 3.9% compared to the Base Business last year. Relative to the second quarter of 2019, the compound annual growth rate for Base Business revenue was 4.3%, primarily due to organic growth. Total volume decreased 2.7% compared to last year as organic volume decreased by 3.1% partially offset by acquisition volume of 0.4%. COVID testing volume was down 45% compared to COVID testing last year, while Base Business volume grew 3.4% compared to the Base Business last year. We continue to see Base Business volumes improve as we're now up 0.6% on a compounded basis compared to the second quarter of 2019. Price/mix decreased 2% versus last year, primarily due to an organic decline of 2.6%, partially offset by acquisitions of 0.8%. The lower organic price/mix was primarily due to COVID testing as the Base Business was relatively flat. Base Business price/mix benefited from esoteric growing faster than routine testing, but was negatively impacted by payer mix.

Diagnostics adjusted operating income for the quarter was $516 million or 22.9% of revenue compared to $663 million or 28% last year. The decrease in adjusted operating income and margin was primarily due to a reduction in COVID testing. COVID testing margins were down compared to last year due to lower testing demand while the company continued to main capacity. In addition, margins were negatively impacted by COVID testing payer mix. Base Business margins were lower due to higher personnel expenses and other inflationary costs partially offset by organic growth and LaunchPad savings. Going forward, we expect the second half Base Business margins to be up year-over-year due to improved demand and labor efficiency. Now I'll review the performance of Drug Development. Revenue for the quarter was $1.5 billion, a decrease of 2.9% compared to last year, primarily due to foreign currency translation of 2.6% and lower COVID testing of 0.6%. Organic-based growth was negatively impacted by lower COVID-related work, the Ukraine-Russia crisis and lower pass-throughs. Excluding these impacts, organic Base Business revenues grew in the mid- to high single digits. Base Business revenues compared to Base Business last year declined 2.3%, but was up 0.4% on a constant currency basis. Early development experienced good growth as did the clinical business, which was constrained by lower pass-throughs. Central labs was down year-on-year but up 6.7% on a compounded basis versus the second quarter of 2019. The decline year-over-year included the impact from lower COVID-related work and the Ukraine-Russia crisis.

We expect central labs revenue to be up in the second half year-over-year based on the strength of its backlog. Drug Development segment revenue was up 8.8% on a compounded basis relative to the second quarter of 2019 primarily driven by organic growth. Adjusted operating income for the segment was $213 million or 14.7% of revenue compared to $221 million or 14.8% last year. The decrease in adjusted operating income and margin was due to a reduction in COVID-related work, the Ukraine-Russia crisis and inflationary costs. These impacts were partially offset by organic Base Business growth and LaunchPad savings. And in addition, personnel expense was lower due to cost reduction actions and variable compensation. In the second half, we expect top line growth and continued cost reductions to drive margin expansion such that the full year Base Business margin will be comparable to 2021. We ended the quarter with backlog of $15.2 billion, and we expect approximately $4.8 billion of this backlog to convert into revenue over the next 12 months. Now I'll discuss our updated 2022 full year guidance, which reflects our first half performance and outlook and assumes foreign exchange rates effective as of June 30, 2022, for the remainder of the year.

The enterprise guidance also includes the impact from currently anticipated capital allocation with free cash flow targeted to acquisitions, share repurchases and dividends. We expect enterprise revenue to decline 2% to 6% compared to 2021. This is a decrease at the midpoint from our prior guidance of 50 basis points due to the change in currency. This guidance now includes the expectation that the Base Business will grow 5% to 7.5%, while COVID testing is expected to decline 50% to 60%. We expect Diagnostics revenue to decline 9% to 13% compared to 2021. This is an increase at the midpoint by 250 basis points driven by our updated expectations for COVID testing. COVID testing is now expected to decline 50% to 60%, while our Base Business is expected to grow 4% to 6%, unchanged from our prior guidance. At the midpoint of our Base Business guidance, the compound annual growth rate compared to 2019 is 4.5%, primarily driven by organic growth. We expect Drug Development revenue to grow 1.5% to 3.5% compared to 2021. This is a decrease at the midpoint of our prior guidance of 475 basis points. The decline includes 130 basis point change from foreign currency translation as well as the impact from lower COVID-related revenues and lower pass-through revenues. Compared to last year, the guidance range of 1.5% to 3.5% growth includes the negative impact from foreign currency translation of 230 basis points.

This guidance also includes the expectation that the Base Business will grow 2% to 4% compared to 2021. Excluding lower COVID-related work and the Ukraine-Russia crisis, the constant currency growth rate would be in the high single digits compared to 2021. At the midpoint of our Base Business guidance, the compound annual growth rate compared to 2019 is 9.3%, primarily driven by organic growth. Our guidance range for adjusted EPS is now $19 to $21.25, an increase at the midpoint of $0.50 compared to our prior guidance. This increase is primarily due to the impact from COVID testing. Free cash flow guidance remains unchanged at $1.7 billion to $1.9 billion. In summary, the company had a solid quarter. We expect to drive continued profitable growth in our Base Business for the remainder of the year, while COVID testing volumes are expected to decline relative to the first half of this year. We expect to continue to use our free cash flow generation for acquisitions that supplement our organic growth while also returning capital to shareholders through our share repurchase program and dividends.

Operator, we will now take questions.

Questions and Answers

[Operator]

[Operator Instructions] Your first question comes from the line of Ricky Goldwasser with Morgan Stanley. Your line is open.

[Ricky Goldwasser, Analyst at Morgan Stanley]

Hi, Good morning, This is Ricky Goldwasser and Erin Wright from Morgan Stanley. So Adam and Glenn, congrats for moving forward with elements of the strategic sort of program. Question I have is, as we think about sort of the clinical business, can you give us some context as to the margins that are associated with that business and how it compares to what's staying with sort of kind of like the core Labcorp or central versus early development? And then I have another follow-up after that.

[Adam Schechter, Chairman, President, and Chief Executive Officer at Laboratory Co. of America]

Sure. First of all, thanks for the question. And I'll give you some context, and I'll ask Glenn to give some additional context. The first thing is that the clinical development market is a very exciting market. It's probably about more than $25 billion in potential revenue. So it's a very large market, and it grows very quickly. And if you look at the business that we're spinning out, historically, it has about an 8% CAGR. And what we expect for the future is that it will have high single-digit organic growth. So it is a fast-growing business in a very large market. That's part of the reason we think it makes sense to spin it out at this time. When you look at the margins, we don't give the exact margin yet. And the reason why is because we still have a lot of shared services, and we have to break out those shared services to understand what the full margin picture will look like. Historically, what we've said is that we've seen margin improvement in that business year-over-year for multiple years now. And as we look to the future, and we said there'd be margin expansion, we've always said that the clinical development business has the greatest potential for additional margin expansion.

[Glenn Eisenberg, Executive Vice President and Chief Financial Officer at Laboratory Co. of America]

Yes. The only thing I'd add, Adam, is that, Ricky, as you know, when we've done the enhanced disclosures, so we provide the full Drug Development segment, obviously, revenue down to margins. When we gave the enhanced disclosure of the three businesses that comprise it, obviously, clinical being one of them, we didn't provide the margins essentially for the reason that Adam had said, that we have a lot of shared resources. They're not necessarily stand-alone businesses. They're part of the segment. I think directionally, it's fair to say that when you look at the margins of the businesses, they all have different characteristics. And in the case of the clinical business, it is the one business that has, frankly, over 20% of its revenues that are pass-through revenues. So obviously, would constrain the margins of that business relative to the other businesses that wouldn't have that. But as Adam said, it's a very profitable business and a business that each year, we've seen margin improvement continue, and we expect that to continue going forward.

[Operator]

Your next question comes from the line of A.J. Rice with Credit Suisse. Your line is open.

[A.J. Rice, Analyst at Credit Suisse Group]

Hi, Everybody, Congratulations on the deal announcement. I might just ask you, in the Base Business, Drug Development, one of the things throughout this year is how the margin is planned to step up over the course of the year, and you had good margin improvement from, I think, 11.6% in the first quarter to 14.7% in the second. But you're also reiterating that you think you'll be similar to last year, which I think is 15.2%, implying further step-up. What allowed you to show the 300 basis points of margin improvement from first quarter to second? And what further gets you that back half margin improvement that's embedded in guidance?

[Glenn Eisenberg, Executive Vice President and Chief Financial Officer at Laboratory Co. of America]

It's Glenn. I'll start with that one. When you look at where we were in the first quarter, and the margins were low, and we kind of explained where they were. We felt pretty good that we made the comment that still for the full year, we would expect margins to be comparable year-on-year, in part because of the run rate where we were ending that quarter. So we did see what we saw towards the end of the first quarter. And again, came in margins now comparable to last year. Frankly, they would have been up compared to last year if you took out the COVID testing that we did last year. So as we think about the second half, we have still the expectation of continued top line growth, but also a lot of the cost reduction initiatives, LaunchPad and so forth, that was, call it, late in the second quarter. We're going to now get the full quarter benefit as we go into the third and the fourth. So between the top line, between the cost reduction initiatives that we have in place, similar to the end of the first quarter as we finished the second quarter, we're frankly at a run rate now that supports the higher level of margins that we would need to see in the second half to continue to believe that our full year margins will be comparable on a Base Business level, comparable to what we did last year.

[Operator]

Your next question comes from the line of Brian Tanquilut with Jefferies. Your line is open.

[Taji Phillips, Analyst at Jefferies Financial Group]

Good morning, This is Taji Phillips on for Brian. So just going back to your most recent news about the announcement of the spin-off, can you provide some color on your thinking and the strategy moving forward? Specifically, given that clinical business is typically a strong pipeline for central lab work, how do you see that dynamic playing out between the two independent companies after the spin-off?

[Adam Schechter, Chairman, President, and Chief Executive Officer at Laboratory Co. of America]

Yes. Thank you for that question. And as we look at the strategy overall, I mean, the reason it makes sense to do the spin and to do it now, it really is going to give strength and strategic flexibility and operational focus so that we can pursue the specific market opportunities and customer needs in each of those areas. The market for our laboratory services is different than that of the clinical trials. It gives us the focused capital structures and capital allocation strategies to drive the growth that we're looking for. And I think it also provides shareholders with more target investment opportunities. We are going to have arrangements between the companies that will enable -- that will enable us to make sure that the new business will have access to some of the data and the insights that we get from the diagnostics, which is a big part of the advantage that I think the Drug Development business has. In terms of looking at the central laboratory business, what's interesting is our central laboratory business, the vast, vast majority of our business comes from companies outside of ours. And in fact, it's only about 15% to 20% of the central laboratory business that comes from the clinical trials that we're running. So I think we actually will have expanded opportunities to do even more central laboratory work as we open it up and we're no longer only related to one Phase I through IV organization.

[Operator]

Your next question comes from the line of Jack Meehan with Nephron Research. Your line is open.

[Jack Meehan, Analyst at Nephron Research]

Morning guys, Big announcement this morning. So I had two questions for you. First is on the timing, why announce it today versus back in December? What's changed over the last seven months? And then second, how did you decide where you wanted to draw the line? I see the rationale to hold on to the clinical testing piece. But specifically, I wanted to hear your thoughts on why it makes sense to hold on to safety assessment.

[Adam Schechter, Chairman, President, and Chief Executive Officer at Laboratory Co. of America]

Yes. No, thanks so much for the question, Jack. I appreciate it. The first thing I'd say is we did the strategic review the majority of last year. And at the end of last year, in December, we announced five things that we're going to do. We were going to do a dividend, a large share buyback program, of which we'd accelerate part of that. We announced the LaunchPad initiative. We gave long-term guidance, and we also announced that we would have increased disclosures. And we gave time lines for each of those things. And I hope you see we met every deliverable that we committed to in the time line that we committed to. But importantly, in December, we said that we decided that the current structure was in the best interest of stakeholders at that time. And we were very clear to say at that time because we knew that post the review, the Board was going to continue to evaluate avenues to enhance value, including potential transactions. We were going to talk to more external people. At this point, we see strong growth in each of the businesses. So we feel really good about the business profiles. We've determined that a separation by spin will enhance value, but it's also going to give both companies the ability to get sustainable growth.

And to me, having focused capital structures is really important because there's a lot of business development opportunities out there. And I think the way you prioritize those could be very different between the two businesses. And the last thing I would say is the COVID environment, if you remember, at the end of last year and the beginning of this year with Omicron was pretty dire. And we were very focused on making sure we could do all the tests we could, that we could do all the drug development studies that we were involved in, and it wasn't the right time for any type of distraction or disruption. So overall, we believe now is the right time to move forward. Second part of your question was, where do you draw the line? It's very clear that the laboratory business has a very different capital structure, equipment needs, very different needs than the structure for a clinical development business, which is basically people out on the street. And there's no doubt that when you think about having a global footprint for diagnostics, it will enable us to bring diagnostic testing around the world.

The other thing that's important is when you think about companion diagnostics and personalized medicine, much of that is done very early in development. So as we think about having laboratory services, it's going to enable us to have a global footprint to do personalized companion diagnostics, which is becoming more important, and to bring that out around the world and has a very, very different growth profile, a very different capital structure needs and so forth. So we were very thoughtful and made sure that we're making very thoughtful decisions as to what we keep with laboratory versus what we spin out with clinical development.

[Operator]

Your next question comes from Eric Coldwell with Baird. Your line is open.

[Eric Coldwell, Analyst at Robert W. Baird]

Thanks very much. I apologize if I missed this early in the conversation. I had a hard time getting on to the call. Late in the second quarter or as we kind of went into a quiet period, there was a fair amount of market chatter about some realignments going on within drug development broadly. I'd love to get your take on what exactly happened, reduction in force, compensation realignment, things of that sort. Is that included in the LaunchPad savings characterization? Or was there something more specific to drug development that was an additional action at the end of the quarter to help get the margin profile in line with what you were targeting?

[Adam Schechter, Chairman, President, and Chief Executive Officer at Laboratory Co. of America]

Yes. Thank you for the question, Eric. And sorry you had a problem getting on the call. We'll look into that. With regard to the drug development, we put the LaunchPad initiatives in place back in December, and we had a pretty strong understanding of what we were going to do. We did accelerate some of the LaunchPad initiative. But a big part of what we did in the second quarter was we realized that in central laboratory, we were not doing much new COVID-related work. And because of that, we were able to reduce a significant number of people, particularly those that were making kits by hand. And we had a lot of people doing that. I said before that we were keeping extra people in both drug development and in the diagnostic areas because we didn't know what we potentially need in the future for COVID. We've determined that for central laboratory, we do not believe we're going to have a lot of new COVID-related work moving forward, and therefore, we didn't need to have those people that were making the manual kits. So that's probably a lot of what you heard. As we move forward, we're going to continue to have other LaunchPad initiatives in place. A lot of those are about how we can improve efficiency and effectiveness, but also, we believe that we're going to continue to have margin expansion in that business as well based upon the run rate that we are at right now.

[Operator]

Our next question comes from the line of Patrick Donnelly with Citi. Your line is open.

[Patrick Donnelly, Analyst at Smith Barney Citigroup]

Hey, Thanks for taking the questions. Maybe just quick ones on the Covance business. Can you just talk generally about kind of the cancellation environment? It seems like it's been a little mixed this quarter across CROs. Are you seeing any uptick there? And then secondarily, in terms of the spin, will you guys consider kind of strategic options over the next year in terms of kind of selling it to a larger player? Or is it kind of set on kind of the tax-free spin?

[Adam Schechter, Chairman, President, and Chief Executive Officer at Laboratory Co. of America]

Yes. Thank you for the question, Patrick. And when you look at the RFP environment in drug development, it remains very healthy. And in fact, if you look even our central laboratory, we had a decline this quarter because of the COVID-related work. But we're confident in the growth in that business for the Base Business going forward because of the orders that we see and the book-to-bill that we have. So we have not seen an increased cancellation environment. We continue to see a very strong environment for all aspects of the Drug Development business as we move forward. With regard to the spin, we've looked at all the different options. And based on all those options, we believe a spin is the right thing to do. Of course, there may be other things that people come to us. But I think we've shown as a management team, we're open. We listen. We really analyze whatever comes our way. But based on everything we know, as we sit here today, we think the spin is the best path forward for really capturing both customer and shareholder value.

[Operator]

Your next question comes from the line of Pito Chickering with Deutsche Bank. Your line is open.

[Kieran Ryan, Analyst at Deutsche Bank Aktiengesellschaft]

Hi, there. This is Kieran Ryan on for Pito. Starting with the Diagnostics business. It looks like base margins came down again depending on what assumption you want to use around COVID margins, but your key competitor was talking about some margin contraction on COVID revenues due to a higher mix of retail tests as well as some reimbursement pressure. So I was just wondering if that's something you're seeing as well and then also just how you think about that retail channel opportunity and balancing those extra volumes with the margin side.

[Adam Schechter, Chairman, President, and Chief Executive Officer at Laboratory Co. of America]

Yes. No, thank you for the question, Kieran. The first thing I'd say is we think the Diagnostic business is performing very well. The Base Business revenue grew 3.9% versus the prior year, and the Base Business volume was up 3.4% compared to last year. And the growth was coming from both routine and esoteric testing. In fact, if you look at the Base Business CAGR, it was 4.3% versus 2019. So you see good, strong underlying performance. When you look at the PCR testing, you'd see the decline. You saw a decline from first quarter to now. And in fact, we did about 31,000 tests per day on average. When you do less tests, it has some impact on the margin. We've also seen a payer mix switch. We used to have the uninsured firm, HRSA. We no longer have that. That was higher-margin business than the retail sector.

We've seen more of our business move to the retail sector, where also it challenges our margins a bit. Margin right now for PCR testing is about 60%, but we'll continue to do everything we can to manage that. And we see the retail sector as an opportunity. But frankly, we're really focused on our Base Business. We're really focused on the hospital and the local laboratory acquisitions that are before us. And to me, that's the long-term growth that we see. So we'll continue to do what we can in PCR testing, but long term, we're really focused on getting that base business to perform well, and I think you've seen that in the quarter.

[Glenn Eisenberg, Executive Vice President and Chief Financial Officer at Laboratory Co. of America]

Yes. The only thing I'd add to that, and Adam commented that it's still at a very attractive margin. So we've commented in the past that last year, we were kind of in the 70% margin, so obviously very attractive. But to still be at 60% speaks to the fact that, one, volume levels are down, we continue to keep the labor force to make sure that we have the capacity because we don't know if there'll be future spikes. So obviously, from a labor efficiency, we're absorbing that. And obviously, as Adam said, too, as we do more in the retail setting, it has a mix. But again, as we look to the outlook for the year, and part of the reason for the improved outlook in our earnings guidance that we have is that we're actually performing more COVID testing than what we had expected, and that's why we continue to keep the excess capacity available for the unknown.

[Operator]

Your next question comes from the line of Derik De Bruin with Bank of America. Your line is open.

[Derik De Bruin, Analyst at Bank of America]

Hi, Good morning, Thank you for taking my question. I jumped on late, so my apologies if I repeat. On the can you talk a little bit about the embedded expectations on the current acquisitions you have, just what the M&A contribution is? And Specifically just on performance, have these been any bigger drag than you thought on the margin? Particularly thinking of the Personal Genome Diagnostics business as you sort of ramp that up and take that through. So just some incremental color on M&A contributions and just sort of like the margin impact that you see.

[Glenn Eisenberg, Executive Vice President and Chief Financial Officer at Laboratory Co. of America]

Yes. I guess, first, to your comment, when we announced PGDx and also when we announced Ascension, which obviously hasn't closed yet, we commented that both acquisitions were very strategic and we believe would provide a very attractive return on our investments. However, both, especially initially, would be dilutive to our margins. So with the advent of PGX (sic) PGDx having closed in part of the business, mostly impacting, even though it's spread a little bit across both of our segments, mostly into the drug development side, it does have a constrain on their margins. So as we think about margins year-on-year when we talk about that we expect margins to be comparable to a year ago, that's even with a little bit of pressure on the margin from the PGDx acquisition. Within Diagnostics, again, our margins most of the acquisitions tend to be a mix positive to us. The large hospital systems, especially when you're doing the in-hospital lab work, tends to put some pressure on the margins.

So similarly, we would comment that for the year overall, Diagnostics margins would be relatively flat kind of from that base organic. But ultimately, once Ascension is closed and then goes into the results in Drug Development, you will see some pressure on the margins. So the way that we look at margins overall for the company is that this year, year-on-year from our Base Business margins, call it, organically would be, call it, flattish. They will be down a little bit because of the dilutive impact on the margins from PGDx and Ascension. But all the other acquisitions that we've announced and that are in the pipeline would be more of the traditional kind of tuck-ins even though there's still hospital systems that we have in there.

But overall, with the outreach being a component of that, we expect it to not be a big impact on the return on our revenues. We have commented though that with the impact on EPS, really only PGDx was one that we acquired that we felt would be dilutive to earnings this year. Having said that, the other acquisitions that we were doing, Ascension as well as the others, would be offsetting that. So from an EPS standpoint, relatively neutral. From a margin standpoint, a little bit dilutive.

[Operator]

Your next question comes from the line of Rachel Vatnsdal with JPMorgan. Your line is open.

[Rachel Vatnsdal, Analyst at JPMorgan Chase & Co.]

Hi, thanks for taking the question. So digging deeper into that earlier margin question, when Covance was last public and would split margins out, it looks like clinical and central lab combined for roughly 23% EBIT margins. So should we assume that central lab is materially higher and that clinical will also be around there given the expansion since then and the Envigo acquisition? And then also on the same side of that, should we also think about how early stage margin has expanded from that 12.5% EBIT margin level in 2014?

[Glenn Eisenberg, Executive Vice President and Chief Financial Officer at Laboratory Co. of America]

Again, when obviously, the acquisition of Covance was a long time ago and since then, a lot of changes from acquisitions to the growth of the businesses, Again, the reason we haven't broken out the individual components of it is the way we operate the business. It's integrated and a lot of shared resources and allocation of costs so that ultimately, when we carve out, if you will, the clinical development part of the business and make it a stand-alone business, we'll be able to give you exactly the profitability, the margins that will be there, and we'll actually do it going back for a three-year period with audited financials.

So I think what we're trying to say is directionally, you've heard us say that the clinical side of the business, while very profitable, is impacted by the impact of pass-through revenues, which, again, when we acquired Covance, we were under 605 accounting where over 20% of the revenues today, they would not have had in their margins. So obviously, that would constrain the margin. But again, very profitable, margins that continue to grow, and we'll be in a much better position once we do the carve-out financials and have it as a standalone business with the corresponding costs specifically related to that business. We'll provide it. But again, it's at an attractive level.

[Operator]

Your next question comes from the line of Matt Larew with William Blair. Your line is open.

[Matt Larew, Analyst at William Blair]

Hi, Good morning, Just a quick two-parter on the spin. Maybe first, just following up to Rachel's question, given the close is targeted for second half '23, when do you think you might start to be able to untangle the web and disclose more in terms of the margin profile in that business? That's part one. The second part is, given market conditions and your strong balance sheet, the next year seems it might be an active M&A environment. Obviously, you've been active in the past year as well. Anything about your process to prepare for and spin the asset that would constrain capital deployment activity on either side of the business?

[Glenn Eisenberg, Executive Vice President and Chief Financial Officer at Laboratory Co. of America]

So I'll go ahead and start, Matt. So again, the timing to effectuate the spin, we're calling call it, look, the second half of next year and a lot of processes that you go through in spinning a company from obviously, we're going to make sure that it's a tax-free exchange. We're working with the IRS to again, doing the audited financials plus you're effectively standing up a company that has been part and integrated into an overall organization. I think what we've said at this point was we're announcing our intent to spin it strategically and that we will, over the course of effectuating the spin, continue to communicate and provide you with additional information as we have it that's really more relevant at the times. Once those decisions are made, once the accounting and the standup of the margins, I think, directionally, we've given you a good sense of where it is. The positive, frankly, from the company standpoint, especially as it relates to the balance sheet, we have a very strong balance sheet, a commitment to continue as Labcorp, investment grade with the same targeted leverage ratios that we've had before.

We are below those targeted ranges right now. Obviously, we've been increasing the amount of our share repurchase program, and we've been increasing the amount of M&A that we've seen. So we purposely have kept a very strong balance sheet to continue to be able to pursue all of our capital allocation initiatives, including the initiation of a dividend. If you were to pro forma the company, even as if we didn't have the clinical business, we would still be within the, call it, the targeted range of our leverage right now. So it really speaks to the fact that we don't believe there will be a constraint on our ability to continue to pursue acquisitions for the for both companies as they're both part of Labcorp today. But when we stand up the spin company, while we haven't commented specifically on its capital structure other than to say both businesses will be well capitalized such that they'll be in very good positions to continue to pursue growth strategies, both through organic or internal investments as well as through acquisition opportunities.

[Operator]

Your next question comes from the line of Kevin Caliendo with UBS. Your line is open.

[Kevin Caliendo, Analyst at UBS Group]

Hi, Guys, I apologize for earlier. First question, the I noticed a couple of things were larger this quarter. The unallocated cost or the corporate cost line was much higher than normal. Can you talk through that? And also the capex number grew quite substantially this quarter. Can you just talk through what drove both of those?

[Glenn Eisenberg, Executive Vice President and Chief Financial Officer at Laboratory Co. of America]

Sure, Kevin. First, on the unallocated corporate, which was up $29 million, if you will, year-on-year. We talked about there were two changes in kind of the methodology of how we're treating corporate unallocated on our prior call. So the first is that for Drug Development, part of its bonus that is tied to enterprise results is reflected in corporate unallocated or said differently, all of the incentive compensation for Drug Development that's tied to the Drug Development business is resident in the Drug Development segment. So that way, as you look at our Drug Development business relative to the peers, it's all related to that business. So that's part of the increase. And until that annualizes, you'll see an increase year-over-year. And again, the reason why it's a big number is, again, the strong performance that we're seeing within the enterprise, driven in part by higher-than-expected COVID testing.

The other methodology change was really including in corporate unallocated our investments in oncology and R&D, specifically, that's not targeted or supporting current revenue streams. So it really had two impacts. One, so that it's now centralized, so we kind of manage and look at R&D as an enterprise, but also with the acquisition of PGDx, which has a high component of its cost structure, if you will, more of an R&D business than we've had historically. You also have the year-over-year impact because it was an acquisition. So those numbers wouldn't have been there. If you take those out, you've explained virtually all of the increase year-on-year. And I guess another way of thinking about just modeling going forward is that our unallocated corporate expense relative to, call it, Base Business revenues will be in, call it, 1.5% to 2% kind of range as an ongoing normal kind of environment.

Relative to capex, we talked to it was a higher level of capex spend this quarter versus a year ago. We do expect that for the year, our capital spending, we normally talk about around 3.5% of our revenues on base revenues, is still there. So we quarter-to-quarter, there's always some timing differences that affect it, but we're currently on pace with our expected capital spend for the year.

[Adam Schechter, Chairman, President, and Chief Executive Officer at Laboratory Co. of America]

All right. So I want to thank everybody who joined us today. Labcorp continues to be at the forefront of science, innovation and technology, and we continue to deliver on our strategic priorities. As always, I also want to thank our more than 75,000 employees around the world for their tireless work carrying out our mission to improve health and improve lives. We look forward to talking with all of you soon.

[Operator]

[Operator Closing Remarks]