Labcorp Holdings Inc (LH) 2015 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Laboratory Corporation of America Holdings' third-quarter 2015 conference call. (Operator Instructions). As a reminder, this conference is being recorded. I will now turn the call over to your host, Paul Surdez, Vice President of Investor Relations. Please go ahead.

Good morning and welcome to LabCorp's third-quarter 2015 conference call. As detailed in today's press release, there will be a replay of this conference call available via telephone and Internet. With me today are Dave King, Chairman and Chief Executive Officer; Glenn Eisenberg, Executive Vice President and Chief Financial Officer; Jay Boyle, CEO of LabCorp Diagnostics; and Deborah Keller, CEO of Covance Drug Development.

In addition to our press release we also filed a Form 8-K this morning that includes additional financial information. Both are available in the Investor Relations section of our website at www.LabCorp.com, and include a reconciliation of non-GAAP financial measures discussed during today's call to GAAP.

Finally, we are making forward-looking statements during today's call. These forward-looking statements include, among others, statements about our expected financial results, the implementation of our business strategy and the ongoing benefit from acquisitions.

These statements are based upon current expectations and are subject to change based upon various factors that could affect our financial results. Some of these factors are set forth in detail in our 2014 10-K and subsequent filings with the SEC. We have no obligation to provide any updates to these forward-looking statements even if our expectations change.

Now I will turn the call over to Dave King.

Thank you, Paul, and good morning. LabCorp had another impressive quarter in which we delivered excellent revenue growth, double-digit earnings growth and solid operating and free cash flow. Both LabCorp Diagnostics and Covance Drug Development turned in strong performances and Glenn will update you on these results in a few moments.

I would like to spend my time today updating you on our progress toward the strategic and financial objectives we set out for our combined companies following our transformative acquisition of Covance.

In January we announced our wave one priorities for our combined company. Use of data to improve trial recruitment, leadership in companion diagnostics and innovation in the use of real-world evidence. We set a goal of $150 million in incremental revenue by the end of 2018 for use of data, $100 million for companion diagnostics and $50 million for real-world evidence. Now eight months after closing I would like to tell you where we stand with these initiatives.

First, we continue to feature the utility of our patient database as a competitive differentiator. We have been awarded four major pieces of business by adding LabCorp data to Covance proposals and these wins have contributed nearly $100 million in new orders to our backlog. In tracking this figure we include only awards in which the sponsor specifically identified LabCorp's data as influencing the selection of its CRO partner.

We continue to receive multiple requests for our patient data from large and emerging pharma customers seeking insight into clinical and commercial questions across multiple therapeutic areas. Sponsor awareness of our unique capability is increasing and we are well on our way to achieving $150 million in incremental revenue by 2018.

Second, we continue to advance our industry leadership in the development and commercialization of companion diagnostics. Last month we again demonstrated that leadership in both development and commercialization as we announced the launch of two innovative diagnostic assays linked to novel immuno-oncology drugs.

Our central laboratory was the exclusive provider of testing in the registration trials that supported the regulatory approval of these tests. We have been involved in the development and launch of approximately 70% of all companion diagnostics since Herceptin in 1998 and we are actively working on a sizable number of ongoing companion diagnostic programs in this increasingly important category of Biopharma research and development.

New orders have remained strong since the acquisition with programs expanding beyond oncology and I am confident in our ability to generate $100 million in incremental revenue in this area by 2018.

Third, in addition to our unique combination of high end laboratory testing and global drug development capabilities we possess enormous assets around diagnostic information. This includes our direct connection to patients, over 15 billion test results, demographic information, an extensive database of investigators and trial sites and the largest cohort of genetic counselors in the industry.

Supported by our technology enabled solutions we are ideally positioned to create large databases, facilitate patient access to trials, gather real-world evidence of disease state prevalence and market size, provide interpretation of diagnostic results and combine patient, site and disease state information into innovative new value creators.

Customer response in these real world evidence capabilities has been strongly positive and we look forward to generating at least $50 million of new revenue in this category by 2018.

Fourth, Covance's central lab business has expanded and further differentiated its capabilities through the addition of LabCorp's genomic, genetic and anatomic pathology testing. Because of our unrivaled combination of test menu, quality, clinical and scientific expertise, we continue to strengthen our market-leading position and deliver strong results.

In short, the strategic theses of our combination are rapidly translating to financial success. And the proof of the growth opportunity for our combined company is increasingly compelling.

While I am speaking about innovation I will provide an update on BeaconLBS. BeaconLBS continues to perform well contributing $18 million, or 1.2%, to our organic revenue growth in the quarter. Although in its pilot phase it remains a drag on overall margin.

In addition, the BeaconLBS team's goal of delivering the right test to the right patient at the right time through the highest quality laboratory network is rapidly being realized. In barely six months of full implementation utilization trend in the pilot market has improved and adherence to testing guidelines has increased.

Out of network lab spend has declined leading to a decline in overall lab spend for our partner. We are optimistic that this solid evidence of achievement will continue and will expand the BeaconLBS opportunity.

To close I would like to thank all of our people around the globe. Their dedication to our strategic priorities during this period of exciting transformation is one of the Company's combined greatest strengths.

Their commitment to delivering world-class diagnostic information, bringing innovative new drugs to market faster and using information to change the way care is delivered is inspiring. And it is gratifying to see this commitment translate to concrete results on so many fronts.

As the world's largest laboratory and leading healthcare diagnostics Company, we are excited about and well positioned for the future. Now I will turn the call over to Glenn.

Thank you, Dave. I am going to start my comments with a review of our consolidated third-quarter results followed by a discussion of our LabCorp Diagnostics and Covance Drug Development segments and conclude with an update on our 2015 guidance.

Revenue for the quarter was $2.3 billion, an increase of 46% over last year. The acquisition of Covance contributed $647 million during the quarter driving 42% year-over-year revenue growth. The other 5% was driven by solid organic volume growth across both core and esoteric testing as well as benefits from BeaconLBS, price, mix and tuck-in acquisitions that were partially offset by currency.

Gross profit for the quarter was $763 million or 33.6% of revenue compared to $571 million or 36.8% last year. The increase in gross profit was due primarily to the acquisition of Covance as well as organic volume, price mix and productivity partially offset by personnel costs.

Personnel costs were up due to annual merit increases and normal headcount additions in support of our top-line growth. The decline in gross margin was primarily due to the mix impact of Covance. Excluding Covance gross margin would have been 36.7%, a decrease of 10 basis points versus last year.

SG&A for the quarter was $383 million or 16.9% of revenue compared to $306 million or 19.7% last year. Excluding special charges of $5 million related to the acquisition of Covance, SG&A in the quarter was $377 million or 16.6% of revenue, a 270 basis point reduction versus last year's adjusted SG&A.

The increase in SG&A was primarily due to Covance and personnel costs partially offset by Project LaunchPad savings. The favorable reduction in SG&A as a percentage of revenue benefited from Covance's lower SG&A rate and the reduction in our bad debt rate. Excluding Covance and special charges SG&A as a percentage of revenue would have been 18.7%, an improvement of 60 basis points over last year.

During the quarter we recorded $32 million of restructuring charges and special items primarily relating to severance and facility-related costs. Amortization expense for the quarter was $47 million, up from $18 million a year ago due to the impact of acquisitions.

Operating income for the quarter was $307 million or 13.5% of revenue compared to $241 million or 15.6% last year. Excluding amortization, restructuring and special items of $79 million, adjusted operating income was $386 million or 17% of revenue compared to $271 million or 17.5% last year. Excluding the mix impact from Covance adjusted operating margin would have been 18%, an increase of 50 basis points over last year.

Interest expense for the quarter was $56 million compared to $26 million last year; the increase was due to higher debt balances following the acquisition of Covance.

The tax rate for the quarter was 38.9%, higher than last year's 37.2% rate due to the taxable nature of certain restructuring charges. Excluding special charges and amortization the adjusted tax rate for the quarter was 35.5%, in line with our expectations.

As a result net earnings for the quarter were $153 million or $1.49 per diluted share compared to $137 million or $1.59 per share last year. Excluding amortization, restructuring and other special items adjusted EPS were $2.07 in the quarter, up 15% from $1.80 last year.

During the quarter operating cash flow was $288 million compared to $176 million last year with the increase due to the acquisition of Covance as well as improved earnings. Capital expenditures totaled $68 million, up from $53 million last year due to Covance. As a result, free cash flow was $220 million compared to $123 million last year.

At quarter end our cash balance was $713 million compared to $619 million at the end of the second quarter. Total debt was approximately $6.7 billion and our liquidity was approximately $1.7 billion consisting of cash and available credit.

During the quarter we invested $8 million in acquisitions and paid down $125 million of debt, reducing the Company's leverage to 3.4 times net debt to last 12 months pro forma EBITDA.

Now I will review our segment performance. For comparative purposes segment results are presented on a pro forma basis for all periods as if the acquisition of Covance closed on January 1, 2014, and exclude amortization, restructuring, special items and unallocated corporate expenses.

Reconciliations of segment results to historically reported results are included in today's press release and the current report filed today on Form 8-K.

Now I will review the performance of LabCorp Diagnostics. Revenue for the quarter was $1.6 billion, an increase of 4.8% over last year. The increase in revenue was the result of organic volume growth measured by requisitions, BeaconLBS, price mix and tuck-in acquisitions partially offset by currency.

The increase in revenue of 4.8% includes the benefit from BeaconLBS of 1.2% and an unfavorable foreign currency translation of 1%. Total volume increased by 2.9% of which organic volume was 2.3% and acquisition volume was 0.6%. Revenue per acquisition increased by 1.7% benefiting from price and mix as well as tuck-in acquisitions that added overall revenue per acquisition higher than the segment average.

LabCorp Diagnostics' adjusted operating income for the quarter was $330 million or 20.6% of revenue compared to $306 million or 20% last year. The increase was primarily due to volume, price mix and productivity partially offset by personnel costs and currency.

Improvement in productivity was driven by Project LaunchPad which delivered approximately $20 million of net savings during the quarter bringing our year-to-date total to $45 million. We remain on track to achieve our goal of $150 million of savings over the three-year period ending 2017.

Now I will review the performance of Covance Drug Development. Revenue for the quarter was $669 million, an increase of 2.6% over last year. The stronger US dollar negatively impacted revenue growth by approximately 370 basis points.

On a constant currency basis revenue increased 6.3% over last year led by strong volume in the central lab and early development businesses while the growth rate in the clinical business improved sequentially from the second quarter.

Adjusted operating income was $97 million or 14.5% of revenue compared to $88 million or 13.6% last year. The increase in operating income and margin was primarily due to volume and cost synergies partially offset by personnel costs and mix. Personnel costs increased in part due to added headcount in the clinical business in advance of the initiation of awarded projects.

We captured approximately $15 million of cost synergies during the quarter bringing our year-to-date total to $30 million. We remain on track to achieve our goal of $100 million in savings over the three-year period ending 2017. Net orders during the quarter were $811 million representing a net book to bill of 1.21 while backlog at quarter end was $6.7 billion.

Now I will update our 2015 guidance. We expect revenue growth of approximately 41% inclusive of Covance as of February 19 after the impact of approximately 220 basis points of negative currency. We have assumed that foreign exchange rates stay at September 30, 2015 levels for the remainder of the year.

We expect LabCorp Diagnostics to grow 4.5% to 5.5% in 2015 after the impact of approximately 90 basis points of negative currency. This is an increase from our prior guidance of 3.5% to 5.5% primarily due to continued strong organic growth.

Covance Drug Development's net revenue is expected to be in the range of minus 0.5% to plus 0.5% versus full year 2014 after the impact of approximately 350 basis points of negative currency. This is an increase from our prior guidance of minus 1.5% to plus 0.5%.

We expect 2015 adjusted EPS of $7.80 to $7.95 as we've narrowed the range from our prior guidance of $7.75 to $8. We expect operating cash flow in 2015 to be $970 million to $995 million versus our prior guidance of $990 million to $1.015 billion, and capital expenditures to be $250 million to $275 million versus prior guidance of $270 million to $295 million.

As a result free cash flow remained unchanged from our prior guidance of $695 million to $745 million. Excluding net nonrecurring acquisition items of approximately $120 million, we expect free cash flow of $815 million to $865 million, unchanged from our prior guidance.

This concludes our formal remarks and we will now take questions. Operator?

(Operator Instructions). Bill Bonello, Craig-Hallum.

On the lab side of the business I just want to probe a bit more about the movements that we saw in volume and price growth. Can you perhaps give us some sense of how much those growth rates were affected?

You talked about some new business wins that were going to annualize during the quarter, maybe how much that impacted the volume growth and if it had a corresponding impact on the price? And then maybe just any thoughts about where you would think of volume and price maybe shaking out as we look forward from here?

Hey, Bill, this is Jay Boyle, how are you? I want to touch on the volume and Glenn will take the price. As you noted, in some of our prior calls we had indicated that we expected to see a little bit of a downward trend on our year-over-year organic growth beat, and that is exactly what is happened as we have annualized the two contracts that you mentioned.

However, we are seeing sequential volume growth quarter to quarter and we are very pleased with the 2.3% organic volume, the 2.9% overall. So that is consistent with what we thought would happen and, again, we are pleased with the result. Glenn, do you want to talk about the price?

Sure. Good morning, Bill. Yes. No, overall needless to say, we feel we had a good quarter from both of our businesses, but in the diagnostics business in particular, the strong growth in organic revenue and volume that Jay commented.

As well as obviously our price per acquisitions improving nicely as well through the combination of the acquisitions, the tuck-in acquisitions that we have done at higher price points as well as favorable test mix overall. But we continue to leverage well in the business and you see that reflected in the improvement in our operating margins.

So would it be safe to say that on the volume side most of the sequential change in the growth rate is attributable to those business wins annualizing?

Yes.

Okay, and what about on the price side? Would the same thing be true there? The increase attributable to that annualizing or other things driving that?

Bill, it is Dave. No, the price impact of the annualization was not material to the overall price. There were, as we mentioned, three components to the price growth which was largely driven by mix and then the acquisitions that we completed that were at an average revenue per requisition that was above the overall segment average.

Perfect. Thank you very much.

Michael Cherny, Evercore ISI.

Congrats on a nice quarter. So first just on the Covance drug development side, really nice sequential improvement. You talked about, from what I could see at least, improvements in all three key segments.

Is there any unifying factor that drove the improvements? Or maybe if you can give a little more color on within early development versus clinical and central lab, kind of what you saw as the key components. Particularly in areas like central lab where I know you had some issues earlier in the year with more kit mix and stuff that was out of your control versus actual health of the business.

Okay, good morning, this is Deborah Keller. So, yes, you are right, all three of our service lines had constant dollar sequential growth this quarter. And I would say it was led by central labs which, as you said, was roughly flat in the first half of the year. They had a substantial increase in their kit volume which is driving a much stronger growth rate in Q3.

Early development also is strong and they have those nice incremental drop through as well. So in our central labs, back to that, we had record level kits both in and out and we had an increase in our testing volume as well. As far as clinical, we had good sequential increased growth rate and strong orders for the quarter.

Great, thanks, Deb. And then, Dave, just one question for you. Since the last call there have been a lot of moving pieces in terms of you have a true value I think at the lab. You obviously had the PAMA decision that occurred a few weeks back. You have had a lot of noise around your private upstart competitor and what the actual value proposition they provide is.

Maybe can you use this opportunity now given, especially following these results, to kind of reestablish what makes LabCorp differentiated versus the rest of the market in terms of delivering service to the end customer?

Sure, good morning, Michael. First of all, I'll just come back to something we have been saying for a long time which is there is no healthcare system without laboratory medicine. We are about 3% of the overall spend, we drive 70% to 80% of the healthcare decisions.

For those who have ever been to the doctor and not felt well or have taken a child to the doctor who is not feeling well the first question is, what do the labs say. And so, we feel very confident that even in a time of enormous change the lab is always going to be absolutely central to healthcare and to the delivery of healthcare and to patient care.

Running a laboratory business well requires size, scale, scientific and medical capability and credibility and true innovation. And LabCorp has all of those things.

We have an enormous infrastructure, we have enormous IT capabilities, we have a dedicated and highly motivated workforce that the number one thing they think about every day is serving the patient. We have clinicians and scientists who have been at this company for 10, 20, 30, 40 years. We have invented laboratory tests that now are standard of care in the market. And I challenge anybody else to stand up to those capabilities.

And then on top of it we are the most efficient, lowest cost, highest-quality provider. And add in to the -- at the back end, Michael, that we have consistently led in innovation whether it is 70% of the companion diagnostics, whether it is always having the newest test, whether it is Beacon LBS, we have consistently been the market leaders in innovation and we will continue to be the market leaders in innovation.

So, this is a great business. We have been wise stewards of capital for our shareholders and we look forward to great, great opportunity in the diagnostics business in the years to come.

Thanks, Dave.

Lisa Gill, JPMorgan.

I just wanted to follow up with just a couple quick questions around the Covance side. Either Dave or Deborah, can you maybe talk about two things? One, Dave, you are talking about these incremental opportunities that you talked about on the revenue synergy side.

But how do we think about the trajectory going into next year? I know it might be a little early to give specific guidance, but is it reasonable to think that this is kind of a mid-single-digit grower or how do I think about this business over the next 12 months?

Good morning, Lisa, it is Dave. I think it is early to give guidance for next year, although I applaud you for trying. And I think what I would say is if you look at the historical growth rates in this business in constant currency, it is mid- to high-single-digits. And the central lab has years of very strong growth and years of less strong growth.

And we said earlier this year when central labs got off to a slow start that we expected it to rebound in the second half and here we are with a very strong rebound at central labs. Early development, the incremental margin on the business is terrific and we are being very careful about capacity and pricing in that business. And I was really pleased to see the sequential improvement in clinical revenue.

So again, we are not giving guidance, but the historical growth rate has been mid- to high-single-digits and that should be a good frame of reference at least to think about how the business ought to be able to perform in the out years.

That is helpful. And then, Dave, you talked about each of those three components of the revenue synergies bit that you had laid out when you did the transaction. And you talked about patient data and winning. But how about on each of the others?

Is there anything or revenue numbers you can put around that today for companion diagnostics or diagnostic information? You said you had $15 billion of tests, etc. But is there any way to give us a frame as to where you are on those two components?

Well, I think in my preliminary comments I mentioned that we feel like we are making -- we have made very good progress. And obviously that will be incorporated in the guidance as we give it and it will be incorporated into the overall top-line growth.

So I would think about those things as being -- they have the potential to be incremental contributors and the question is obviously translating them from orders into revenue. And that will be part of what we incorporate into the guidance for next year and the years ahead.

Okay, very helpful. And congratulations on a nice quarter.

Jack Meehan, Barclays.

I just want to start with PAMA and -- just curious whether you had some initial thoughts from the proposed rule that came out a few weeks ago. And then as you get through -- go through the comment periods today just where are the areas that you see as sort of opportunity to work with CMS?

Good morning, Jack, it is Dave. So this is going to take a couple minutes, but I want to give you a comprehensive answer about PAMA. So let's step back to why PAMA was enacted.

There was an OIG report that suggested that Medicare pricing was not market competitive with commercial pricing. And Congress enacted a statute specifically around the idea of let's find out -- let's abase Medicare on a market-based price and let's find out whether Medicare is market-based, and if it is not let's adjust it.

So that was the purpose of the statute and it was clear in the legislative history, it was clear from the floor colloquy between Senator Burr and Hatch, it was clear in the letter that they believed that hospitals were an important part of the market to consider.

Now when PAMA came out obviously hospitals were not included and that was extremely disappointing. I would point out in the first place there was a statutory misconstruction in the regulation because what Congress said was if over 50% of the hospital lab revenue came from the clinical lab fee schedule that it should be included.

What CMS put out was if over 50% of the Medicare revenue came from the CLFS it should be included. Well, as I have already pointed out in response to an earlier question and as everybody knows, lab is about 3% of the total Medicare spend. So it is structurally impossible for lab to be more than 50% of the total Medicare revenue.

The CMS also lumped the lab in with the entire hospital system in doing the calculation, which again negated any possibility that the hospitals could be included and they did that not -- by using the tax ID rather than the MPI. So from perspective CMS' proposed regulation did not faithfully attempt to do what Congress had asked it to do.

Now let me talk specifically about the decision not to include hospitals and why we think that that is erroneous. The week after CMS came out with the explanation of why hospitals were not included, the office of Inspector General released its data brief for 2014.

Medicare paid $7 billion in Part B hospital lab tests -- I am quoting directly from that data brief -- hospitals received $1.7 billion or 24% of the Medicare Part B payments through the clinical lab fee schedule.

So let's stop right there -- hospitals that CMS said are not part of the relevant market received 24% of Medicare Part B clinical lab fee scheduled payments. Physician labs received $1.3 billion or 19% but CMS decided they are part of the market.

Hospitals receive 25% of the payments for the top 25 tests which accounted for $4.2 billion of the spend. So they received an even higher percentage of the top 25 tests, again CMS decided they were not part of the market.

Furthermore, CMS cut the outpatient prospective -- the OPPS, the hospital outpatient prospective payment system, by 2% for 2016 and specifically stated in making that cut that it was because $1 billion of lab testing that they thought were going to go through the OPPS in fact went through the clinical lab fee schedule in 2014.

CMS also stated they were reducing the OPPS not to recoup the prior overpayment but to eliminate the future overpayment, implying they expect that $1 billion to continue to go through the clinical lab fee schedule. So, this is obviously a concession by CMS that significant hospital lab payments will continue to go through the clinical lab fee schedule and it squares with what the OIG said.

Now, go back to what is the market? And it is difficult for me to understand how CMS comes to the conclusion that entities that are receiving 24%-25% of the payments are not part of the market. I also just took a quick opportunity last night, because again, it's what is the market to look at the Blue Cross Blue Shield of North Carolina website? This is publicly available data that anybody can see.

A lipid panel, one of the top 25 tests, Quest and LabCorp price approximately $8 to $10. Rex Hospital $79, University of North Carolina $93, Duke $102. The assay of thyroid stimulating hormone, TSH, one of the top 25 tests, Quest and LabCorp $12, Rex Hospital $66, University of North Carolina $86, Duke $98.

That is the competitive market and that is what Congress asked CMS to look at to determine if Medicare pricing was market-based. And again, it is difficult to understand how CMS concluded that that data is all irrelevant.

Finally, I would just point out that the timing that has been imposed here is quite unrealistic. We are supposed to start submitting data before the final rule is even completed. And CMS is apparently going to analyze that data and put out results in 2017 based on a six-month period even though they stated in the regulation that the year period is what would be preferable.

So, obviously it is a preliminary rule. I think you can tell from my commentary we have a lot of comments as to the rule that CMS has promulgated. But that's is our perspective on the PAMA regulation.

Yes, thanks, Dave, that was very well said. Maybe just one follow up for Glenn on the lab business, give you a little break. The pricing growth that came through, I know some of that was related to the genomic and esoteric volumes coming through.

I was surprised some of that better growth didn't fall through on the gross margin line. So could you -- and I know you talked about I think 10 bps higher year-over-year. Just any other granularity around that would be great.

Sure, Jack. No, overall, as you said, the gross margin excluding the impact of Covance would have been down around 10 basis points. Including in that you heard earlier the pilot program that we have at Beacon, which Dave commented, while it is a contributor to the revenue that we wouldn't have had a year ago in its pilot stage is not contributing to profitability.

So that had a, call it, the headwind on gross margin. So were it not for that our gross margin was favorable. And again, most of the pricing, if you will, we have talked about was from the benefit of the acquisition mix up as well as just overall call it test mix.

But overall we feel we have leveraged well, we leverage the diagnostics segment in excess of 30% on the incremental revenues and saw a 60 basis point improvement in our operating margin. So overall we are getting the benefit of that additional volume as well as our continued productivity improvement initiative through LaunchPad.

That makes sense. Thanks, guys.

Robert Willoughby, Bank of America.

Dave, can you give us anything you can on the food safety business? You obviously did a deal there. But how are you sizing that market to growth opportunity to margin profile? And where can that business be three to five years down the line for you? And maybe also just the synergy with the base business, if anecdotally you can point us to areas where you have a real advantage growing that business.

So, when we made the acquisition we identified nutritional chemistry and food safety as a growth opportunity because it is a significantly growing market and it is a global market. Obviously with the increase in food importation, with the increase also in the number of detected concerns about food safety, we saw this as a nice opportunity for growth.

So we look at the business, the market size is substantial, obviously it is not the size of the total lab industry, but the market size is substantial, it is in the billions of dollars of global opportunity. We look at the margin profile as being attractive.

And we look at the opportunity around what LabCorp and Covance bring together as there are two aspects of the food safety business, one is the chemistry side and the other is the microbiology side. Covance has always had great expertise on the chemistry side.

LabCorp, obviously from our core lab testing, brings a significant amount of expertise on the microbiological capabilities and also on the infrastructure. So it is very important to be close to the customers because the food is sitting, waiting to be shipped. So, the combination of infrastructure, microbiology and chemistry really positions us we think to take a market leadership position.

On the nutritional side the analysis of ingredients and purity, again, all of the controversy around organic food, genetically modified food and what is safe food -- this is another nice opportunity for us to grow the business.

And again, it is a global opportunity. We actually have a food safety lab in Singapore as well as our large lab in Madison. And we are very, very excited about adding International Food Network and the National Food Laboratory to these capabilities.

Can you size your opportunity may be three to five years out and what kind of spend you need to get there? Is it an expensive build?

We have aspirations -- I am not prepared to talk about them specifically, but we have aspirations that this business will be in the nine figures in revenue and hopefully the mid-nine figures, but they are not -- these are just pure aspirational ideas for our Company. And there will be some which we'll do through acquisitions.

As we demonstrated, we are ready to do the Safe Foods transaction and there will be some that we will do by organic growth. I don't think it is something where we think about there will be an enormous amount of investment to get there.

Interesting, thank you.

(Operator Instructions). Isaac Ro, Goldman Sachs.

Let me try one question with two parts. On the CapEx side you guys tracked a little better than your guidance. Can you talk a little bit about handicapping the potential for CapEx to kind of run rate from here? Is there a little bit more potential for that number to come down?

And then secondly, any updated thoughts on potential for -- or how you're thinking about cash return, specifically the potential for a dividend? Thank you.

Hey, Isaac, this is Glenn Eisenberg. On the CapEx side, as you know, we are not a very capital intensive company overall and we continue to manage fairly tightly. We did bring down our guidance for the year based upon the current trend of capital spending that we have.

And obviously the level of spending is a function of just projects and opportunities that we see including our LaunchPad initiative where we are going through some structural investments. But overall we have been tracking around call it $70 million per quarter and you might see that go up a little bit in the fourth quarter, but still tracking at call it around our depreciation level.

As far as the cash returns, as you know, historically we have been a strong supporter of bringing excess cash back to shareholders in the form of share repurchases as opposed to dividends. And obviously, given the acquisition of Covance and our higher leverage, we are focused now on using some of that cash flow to pay down debt. But as the Board convenes effectively every quarter, we do talk about our capital allocation, our return of capital back to shareholders. Dividends is part of a discussion, as is share repurchases. And we will continue to have those discussions and let you know each quarter what we do with our capital.

Got it, thanks a bunch.

Nicholas Jansen, Raymond James.

Nice job. I just wanted to get a little bit more detail on the volume in the quarter. You have seen from the hospital companies, your largest competitor, talk a little bit about some level of market softness maybe in the first half of the quarter. And I just wanted to kind of get your views on the overall market trend and then maybe why you are competing to capture market share relative to your peer group. Thank you.

It's Dave, I will start and then if Jay has anything to add, I know we will welcome that. I think Jay gave a very precise explanation of why you saw the organic volume decline year over year. We had specifically called that out and identified it. We had nice sequential volume growth. And I attribute it to, we have a great leadership team, we have a great team of people on the ground and they are executing well.

We are seeing nice growth in the core business. We are seeing nice growth in the esoteric business. We are bringing new tests to market. So the only commentary we can give is I think the numbers speak for themselves, and the numbers show that we are performing very well and that volume continues to grow.

Great.

Amanda Murphy, William Blair.

I just had a quick follow-up question to what Lisa asked earlier. So, again, recognizing you are not giving guidance at this point, but can you just put your comments in context around that high single digit -- mid-to-high single digit growth framework for Covance in context with the Sanofi situation?

Because I think that's that 2% to 3% headwind for you guys next year. So do you still think you can do that, that mid-to-high -- that high single digit growth on the back of that Sanofi contract situation?

Amanda, it is Dave. Again, we are not guiding. And so when we come out with the guidance, we will have all of the puts and takes incorporated. And again, what we said is that the historic growth rate is mid-to-high single digits. And Sanofi will be incorporated into whatever guidance we give. And there will be other puts and takes in the businesses as well.

So I don't think we should single out any one thing and try to extrapolate what that is going to mean to the overall guidance. We will give the guidance in February when we give the guidance, and we look forward to being -- to over time seeing Covance achieve the growth rates that the industry historically has turned in.

Amanda, maybe I'd just add one thing just relative to this year and, again, won't comment or if we can annualize for next year. But if you just wanted to isolate on Sanofi, you'll obviously be able to get into our implied guidance in the fourth quarter for Covance overall, which has continued good year-over-year growth in the business. That will be impacted by Sanofi as that contract expired at the end of October, as you know, having around call it a $12 million impact in the fourth quarter.

So that will impact the growth rate, if you will, by 1.8%. But obviously, we have got a lot of other business that is coming in to replace that. But our guidance, if you will, for the rest of this year is inclusive with not having that contract for the last two months of the year.

Got it, very helpful. Thank you.

Ricky Goldwasser, Morgan Stanley.

Hey, good morning, this is Zack Sopcak for Ricky. I wanted to go back to test mix for a second and just ask, you used to have a goal, I think it was 45% esoteric testing. Can you give an update on where you are relative to that? And if the better mix was driven by any test in particular, like BRCA or something else that's longer-term sustainable?

Ricky, this is Glenn, I will just give you (technical difficulty) of the other ones. Clearly growing esoteric is one of the main strategies of the Company with the new tests that we are developing and it continues to grow and we are seeing favorable test mix from that area. It hasn't quite gotten to call it the 40% of the Company, it's still kind of that aspirational goal but it is moving in the right direction.

And it is Dave. I would say that the major drivers of growth in the esoteric category were continued strong performance in NuSwab, BRCA, noninvasive prenatal testing -- we actually even in the quarter already started to get orders for the companion diagnostics that we mentioned in the prepared remarks. So there was nice progress across the board.

Got it, thanks. And then can I just ask on the bad debt improvement. Can you give any color how much of it was driven by Project LaunchPad versus just overall more coverage from the ACA?

Yes, this is Glenn. We continue to focus a lot from our LaunchPad initiative and revenue cycle management and in particular one of the key aspects is the bad debt. We continue to see the rate coming down. We came in on the diagnostic side probably around 30 basis points year-over-year.

And so, even though call it our volume, our revenue was going up, our bad debt expense is going down. So, the savings on the rate is even greater because you are still getting obviously new business.

But overall it is mostly a function of, again, just the continued hard work of all of our people identifying where the issues are and tackling it, and we expect to see that rate continue to improve.

Yes, it is Dave. I don't think the ACA had a material impact this year. I think most of the ACA benefit in terms of enrollment is annualized. So as Glenn said, I think it is LaunchPad, it is sustained and focused effort by our revenue cycle management team, and it's just really good diligent hard work on the ground to collect the monies that are owed to us.

Great, thank you.

Bill Quirk, Piper Jaffray.

A two-part question. First is just update on BeaconLBS, when we might see that move out of the pilot program in Florida? I guess not necessarily assuming it is going to go to national right away, but just kind of curious what the latest thoughts are there.

And then secondly, on the $30 million in cost synergies that you guys have dialed in over the past two quarters, strikes me that the $100 million target by 2017 is a little conservative. So I would love to hear some color on that as well. Thank you.

Bill, it is Dave. I can answer the first part of the question quickly and that is on BeaconLBS we continue to have discussions about expanding to additional markets and with additional customers.

We feel great that BeaconLBS is proving out exactly as it was designed to. And I compliment the BeaconLBS team on again great effort, great execution, great accomplishment. And we will look forward to updating you as we enter new markets and agree to new business opportunities with new partners.

And, Bill, this is Glenn. On the Covance cost synergy side, our target still is the $100 million over the three years. It is going to be weighted a little differently as we go --.

$150 million.

This is the Covance -- (multiple speakers).

Oh, I'm sorry, Covance. I thought he was talking about LaunchPad. My apologies.

On the $100 million over the three years it is going to be a little bit lumpy. We obviously have gotten a lot of benefits early on by taking out the redundant public company cost, leveraging the purchasing power of our two businesses.

But it will take some time further to get through the lab consolidation, so that is why it is a little more back ended as we have to continue to finish through all the trials that are being done in those facility.

So we are off to a very strong start. We expect it to continue to improve year-over-year, but we are looking still at the -- call it the $100 million over the three years.

And I would be remiss if -- because Dave is sitting next to me, that we always strive to exceed the targets that we have established, but we will do that after we first achieve the targets that we have established.

Understood. Thank you.

Whit Mayo, Robert Baird.

Wanted just to go back to the Capex question just for a second. Your original range at the beginning of the year was about $325 million to $350 million and you dialed it down to $250 million to $275 million over a couple of quarters. And I guess I am just curious what the biggest difference is between then and now?

I understand and can appreciate that some projects can get pushed out and delayed, but just trying to get a sense of what we should see going forward and whether or not any of these perhaps delayed projects pick up into next year?

Whit, this is Glenn. Needless to say, when we put together our plan and our guidance in the early part of the year it is with going through a business planning process with the businesses, identifying where they feel there are capital investment opportunities in addition to just the normal maintenance and so forth.

So we start off with that premise, but as the year unfolds we continue to look at each of the investments and we look at it relative to others. Some new ones will come in, some other ones may get deferred based on timing.

But the level of spend that we have we feel is in line with our averages. We are actually spending less this year than in prior years if you look at it on a pro forma basis which is positive. And we have always said we would trend a little bit to that because both companies in fact had made some sizable investments in systems, facilities and so forth.

But we are comfortable with the spend. As you can see by our implied guidance, we expect a higher spend in the fourth quarter than we did over the last couple. Hopefully we will be below that, but we continue to evaluate each project as a standalone investment and we make the decision whether or not we will go forward. But we see a lot of good opportunities to invest that capital.

And, Whit, it is Dave. I would just add parenthetically we are not under spending or starving the businesses of capital to reduce the number. We are being very thoughtful about how we invest the capital.

But it is not that we are pushing projects out that are going to come back next year, it is that we are looking at every single project rigorously and saying do we need to spend the capital dollars here or are there better places to deploy?

Yes. No, I was -- I mean the free cash flow is just getting to be a pretty big number, so I was just trying to make sure people appreciate that.

And I guess my last question is I think you've got maybe a $250 million senior note due this year. And just curious if those are gone now and do you plan to be in the market to refinance those or just take them out right altogether, just thoughts on that would be great.

Sure, Whit, this is Glenn. We have $250 million of bonds that are due in December of this year and our current intention is to use cash on hand to pay down the debt.

Great, thanks a lot.

A.J. Rice, UBS.

Just two quick questions, I appreciate the commentary around PAMA and the frustration with the hospitals not being included. I'm just curious if you take the proposal as is, CMS has put in there an impact analysis of about a 4.5% cut in 2017.

Do you have any reaction to that impact as the average cut to the industry would experience? And then is there any commentary on the 2016 proposed rule which has also come out, any opportunities or challenges that creates?

A.J., it is Dave. It is hard to size the 4.5% assessment that CMS gave, obviously because we are not privy to the data that they use to analyze it. However, it does reinforce something we have been saying all along which is we don't see a draconian negative outcome here for the industry. So it does reinforce our sense that this is not the doomsday scenario that many people had painted.

In terms of the rest of the proposed 2016 rule, we are looking at it carefully. Obviously there are some proposed changes around drugs of abuse testing, there are some proposed changes around next gen sequencing, there are some proposed changes around panels. None of them appear to be material to us at this early stage, but we will continue to analyze them and obviously file comments as appropriate.

Okay, thanks a lot.

Gary Lieberman, Wells Fargo.

Maybe if you could talk about commercial pricing a little bit, where you are in your contract negotiations. And then is there any potential for any fallout from the PAMA decision sort of working your way through commercial reimbursement?

Gary, it is Dave. I will let Jay comment on the commercial negotiations. I don't see the PAMA rule having any impact on commercial pricing with the exception of one very small area, which is there are some Medicare Advantage plans that are tied to the Medicare fee schedule. As I say it is a very, very small part of the business.

Other than that our negotiations with commercial payers are based on value, they are based on individual CPT codes, they are not -- obviously the Medicare fee schedule is always a frame of reference, but they are not based on that fee schedule.

And so, I would say when the Medicare fee schedule goes up, that doesn't get is an increase with the commercial payers. And when the Medicare fee schedule goes down that doesn't get us a decrease.

And, Gary, the only thing I would add on the commercial pricing is obviously we feel very good about our managed care relationships and our current contracting initiatives. There are no major contracts that are coming up through the end of this year. We have great relationships with our managed care partners and we feel great about the opportunity to continue to provide them with the level of service that we have.

Great, and then maybe if I could ask a follow-up. Dave, you have talked a lot in the past about how the value proposition is so strong for LabCorp. We are seeing at least some movement towards accountable care models and some bundled payment models. Are you seeing any benefit from that or do you think we are on the cusp of starting to see some benefit from that?

I think it is very early days on the Accountable Care and the bundles obviously. I think right now, my understanding, most of the bundles are just putting all the payments together and then distributing them out pretty much as consistent with the status quo for the bundle.

I think over time this is a great opportunity for us, again, as the highest quality and most efficient provider. And as the bundles start to include more services without more dollars behind them.

Reference back to my observation about the commercial pricing for hospital laboratory services earlier, people are going to look for the highest quality, highest value service. And we are going to be in a position to provide that.

And so, I think we are going to continue to see -- we're going to continue to see volume shifting and share moving in our direction as a result that change in the marketplace.

Great, thanks a lot.

It is right at 10:00 -- excuse me, operator. It is right at 10:00, we have four questions in the queue. So we will do the lightning round here, but let's please try not to ask questions that have previously been answered. Thank you.

Donald Hooker, KeyBank.

So real quick I guess, maybe the preclinical sort of toxicology business. I know it is small but there is a lot of leverage there I think over time. So can you talk a little bit about some of the trends in pricing and how much capacity you have there over the next couple years? I mean how long can you grow that business before you need to add capacity?

Okay, thanks, this is Deb. Globally we are at about 70s as far as capacity. Utilization in the US is slightly higher and Europe is a little bit lower. Obviously we are glad to see our capacity filling, it is a much improved situation versus a few years ago.

We do run a global business and that has been to our advantage because it allows us to move studies around to maximize our capacity globally and that we can leverage it. We do monitor our capacity obviously daily.

As far as pricing, we have seen some low-single-digit price increases generally speaking. It is different for different types of studies and in different parts of the world. And again, it is much better than the price decline we have seen a few years ago. And with our global capacity we do have some flexibility about capacity additions.

Dave Francis, RBC Capital Markets.

Congrats on the quarter. Real quick bigger picture for either Dave or Deb. Given some of the political and media noise around drug pricing and marketing that some of your customers are experiencing right now on the drug development side of the business, are you seeing any change in their behavior or your type of discussions with them relative to some of the things that they are dealing with there real-time? Thanks.

Yes, this is Deb I will start out and then I will turn it over to Dave. As far as from an early development standpoint, our orders continue to be strong from all segments, emerging, midsize and large pharma. So at least thus far we have not seen it impacting.

And I would just quickly add, the drug development business is about innovation and innovation is going to continue to be the answer to improved delivery of healthcare. So we don't see any reason why the current controversy should affect the desire over the long term for innovative drugs to market and for Covance being an absolutely essential part of bringing innovative new medicines to patients.

Great, thank you.

Brian Tanquilut, Jefferies. Brian, if your line is on mute can you please unmute it? We'll move on to the next question. Mark Massaro, Canaccord Genuity.

So your large competitor commented that they saw utilization dip. I wanted to ask if you agree with that assessment, if it was anything beyond the customary July/August seasonality from the summer.

And secondly, Dave, can you comment on your update -- or can you update your commentary on launching a direct-to-consumer business by the end of this year?

Yes, first of all we don't comment on other people's comments. So we comment on our results and, as we said, we had a very strong quarter from a volume perspective and we are very pleased with the outcome there.

In terms of the direct-to-consumer business, we have always said that when we launch our direct-to-consumer business it's going to be responsible, it is going to be compliant, it is going to focus on the LabCorp quality and service with the medical and clinical support that we have always provided in our business-to-business, if you will, side of the business with physicians and hospitals and other customers.

So, we think the direct-to-consumer opportunity is important, it is a market that is growing and consumers are more and more engaged in healthcare. But as we always do, it is going to be done in a clinically, medically and regulatory compliant fashion and we are excited about the opportunity.

Thank you.

Thank you. That concludes the Q&A session. I will now turn the call back over to Dave King, CEO, for closing remarks.

We thank you for joining us this morning and wish you a great day.

Thank you. Ladies and gentlemen, that does conclude today's conference. You may all disconnect and everyone have a great day.