Scott Frommer - VP, IR Dave King - Chairman and CEO Glenn Eisenberg - EVP and CFO John Ratliff - CEO, Covance Drug Development.

Lisa Gill - JP Morgan Jack Meehan - Barclays Dan Leonard - Deutsche Bank Nicholas Jansen - Raymond James Amanda Murphy - William Blair Kevin Ellich - Craig-Hallum Erin Wright - Credit Suisse Bill Quirk - Piper Jaffray Ricky Goldwasser - Morgan Stanley Tim Evans - Wells Fargo Securities Mark Massaro - Canaccord Genuity Ralph Giacobbe - Citi Dave Windley - Jefferies Isaac Ro - Goldman Sachs Rohan Abrol - KeyBanc Capital.

Good day, ladies and gentlemen, and welcome to LabCorp’s Third Quarter 2017 Conference Call. [Operator Instructions] As a reminder, this conference call may be recorded. I would now like to turn the conference over to Scott Frommer, Vice President, Investor Relations. You may begin..

Good morning, and welcome to LabCorp’s Third Quarter 2017 Conference Call. As detailed in today’s press release, there will be a replay of this conference call available via telephone and Internet.

With me today are Dave King, Chairman and Chief Executive Officer; Glenn Eisenberg, Executive Vice President and Chief Financial Officer; Gary Huff, CEO of LabCorp Diagnostics; and John Ratliff, CEO of Covance Drug Development. In addition to our press release, we also 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 benefits 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 2016 Form 10-K. We have no obligation to provide any updates to these forward-looking statements even if our expectations change. Now I’ll turn the call over to Dave King..

Thank you, Scott, and good morning. LabCorp delivered record results in the third quarter, with year-over-year revenue growth of 10%, adjusted operating margin expansion of 20 basis points and adjusted EPS growth of 9%.

We also reported another quarter of solid free cash flow, enabling us to raise our full year outlook to a new record of nearly $1 billion. During the quarter, we remained active with capital deployment, highlighted by our strategic acquisition of Chiltern, and the continued return of capital to shareholders.

In Diagnostics, we have outstanding results, driven by robust organic and total volume growth, even more impressive given the drag on growth of approximately 100 basis points from the impact of the hurricanes. Organic growth was broad-based, led by women’s health, medical drug monitoring and our strategic collaboration with 23andMe.

In addition, the integration of Mount Sinai’s outreach business and PAML are proceeding as planned, contributing to our strong performance.

Speaking of the multiple hurricanes, our employees and operations team in the impacted regions performed remarkably in the face of adversity, swiftly restoring operations for our patients without any substantial disruption in processing collected specimens.

All of our colleagues also contributed generously to relief efforts for each other and for the affected areas. We appreciate their outstanding efforts on behalf of patients and communities in need.

In drug development, we had a solid quarter, highlighted by strong net orders and a continuation of our improving trailing 12-month book-to-bill to 1.33 versus 1.11 at year-end 2016. We continue to invest strategically in our team and expand its capabilities, positioning the business to grow organically in line with historical performance in 2018.

Before I update you on our key strategic priorities, I will briefly comment on PAMA. We find CMS’ actions deeply disappointing and continue to highlight that its actions may significantly reduced beneficiary access to critical laboratory services.

In PAMA, Congress specifically instructed CMS to determine market pricing for commercial laboratory services. Market price is to be determined by a survey of the industry, which the congressional board dialogue expressly stated was to include hospital laboratories and to represent the entire market.

Unfortunately, CMS overlooked the statutory intent and designed a survey that vastly over-weighted the pricing of independent laboratories, ignoring higher-price physician office and hospital labs, which as we have repeatedly demonstrated, typically charge commercial customers anywhere from 1.5 to 5 times as much as independent labs.

CMS also apparently overlooked OIG reports warning that no hospital labs were expected to report their pricing. Thus, it is not surprising that the preliminary rates published by CMS last month do not reflect market-based Medicare rates for lab testing.

How could they, when fewer than 1% of the labs Medicare paid in 2015 even reported data? In fact, only 1,106 physician office labs and 21 hospitals in the entire country reported their commercial rates.

It is disappointing that in its first attempt to implement the desirable goal of market-based pricing for Medicare, CMS has missed the mark so badly and proposed unmerited cuts in the critical service that consumes only 3% of Medicare spending in the first place.

We in the industry have again submitted comments to CMS, and we will continue to work closely with Congress and all stakeholders as we explore possible remedies, including legal action as appropriate, focused on aligning the implementation of PAMA with Congress’ clearly expressed intent.

Now I will update you on our progress on key strategic priorities, beginning with our initiatives focused on the combination of Diagnostics and drug development.

We continue to advance innovative solutions and patient recruitment into studies that utilize the combination of LabCorp Diagnostics’ real-world patient and provider data and Covance’s global physician investigator performance data. During the quarter, we won multiple awards based on this unique capability.

For example, we were involved in the competitive bid process to conduct a global Phase II liver disease study for a biopharmaceutical sponsor that has not previously used Covance.

Using lab parameters such as mitochondrial antibody level and total bilirubin, we matched the sponsor’s protocol criteria against the LabCorp patient population, identified a large number of potential patients and secured the award.

In another example, we had previously been selected to run a global ulcerative colitis study for a sponsor that has not previously engaged Covance.

We followed up this quarter by conducting indication-specific outreach to ulcerative colitis patients who have provided their consent to LabCorp to be contacted about potential clinical trial opportunities, resulting in the identification of protocol-eligible individuals interested in being placed in an active Covance study.

Beyond direct engagement with patients and physicians, we continue to work closely with health systems that have expressed interest in becoming preferred partners for LabCorp and for Covance’s clinical trials.

We have signed agreements with several major health systems to form such partnerships, which will enhance efficiency and patient recruitment, increase access to diverse patient populations and deepen our broad-based health system relationships. We continue to lead the industry in our capabilities around companion and complementary diagnostics.

We delivered another quarter of double-digit revenue growth year-on-year and won more than $50 million in new awards from a broad mix of pharma and biotechnology customers. These unique capabilities have established LabCorp as the go-to partner in precision medicine.

During the quarter, we entered into an agreement with Thermo Fisher Scientific to join its NGS Companion Diagnostics Center of Excellence program, and we have launched the Thermo Fisher Oncomine Dx target panel for non-small cell lung cancer patients.

We also entered into an exclusive agreement to distribute OmniSeq’s immune profile and tumor profiling tests, strengthening our oncology offering to U.S.-based physicians and global biopharmaceutical customers.

In addition to progress on enterprise-wide initiatives, both our Diagnostics and drug development business delivered important successes this quarter. In Diagnostics, we made strong progress in consumer and patient-facing initiatives. Our LabCorp-Walgreens collaboration is off to a terrific start.

We are pleased with patient volumes, Net Promoter Scores and patient feedback on the experience at these sites. We expect to expand LabCorp-Walgreens to additional sites in 2018. We continue to make progress in other elements of our consumer strategy.

We are introducing LabCorp Express, a solution that allows patients to check in at select PSCs through a custom-built tablet that automatically scans the customer’s insurance card and driver’s license.

We also deployed LabCorp PreCheck, a mobile-optimized web application, which allows patients to complete demographic and insurance verification steps prior to arrival at the PSC.

These solutions enhance our patients’ experience and convenience by streamlining PSC workflow, reducing wait times, helping to reduce bad debt by improving the quality of patient information that we collect and create opportunities for patients to learn more about clinical trial opportunities.

We will also launch a mobile app version of LabCorp Patient early next year, which will be available for download at various app stores. In our drug development business, we are focused on driving future profitable growth through expanded solutions and enhanced operational capabilities.

The acquisition of Chiltern closed on September 1st, significantly strengthening our strategic position in clinical development and accelerating revenue and profit growth within Covance.

Chiltern has add highly complementary capabilities to our offering, including scale in Asia Pacific, broader reach into the fast-growing emerging and mid-tier biopharma customer segment, enhanced FSP capabilities and expertise in medical device trials and oncology drug development.

The integration of Chiltern is off to an excellent start, and we warmly welcome our new Chiltern colleagues. Our focus on profitable growth encompasses organic investments as well as strategic acquisitions. For example, Covance’s new biopharmaceutical chemistry manufacturing and control facility is scheduled to open later this year.

This investment enhances our ability to provide comprehensive analytical capabilities for development of large-molecule therapies used in the treatment of such life-changing diseases as rheumatoid arthritis, hepatitis C, Crohn’s disease and cancer.

In the past four years alone, Covance has supported more than 1,000 biologics and more than 40 integrated new drug submission packages, including nine of the 10 biologics approved by the FDA in 2016. This investment will enhance our ability to serve this important and growing market.

We completed a consolidation of our central lab network as planned and expanded our central laboratory business by opening a European operations center in Mechelen, Belgium. The site allows faster, more cost-effective production and delivery of kits and other clinical trial supplies to our customers outside of the U.S.

Finally, our Covance LaunchPad initiative is progressing well. We are finalizing plans for longer-term projects to reengineer our drug development solutions, integrate new tools and technology, enhance the customer experience and sustainably increase our margins.

Underpinning our progress in key strategic priorities is our ongoing investment in strong leadership and top tier talent. Last month, we welcomed Dr. Brian Caveney to LabCorp as our enterprise-wide Chief Medical Officer. Dr.

Caveney is a nationally recognized clinician and health policy expert who joined us from Blue Cross and Blue Shield of North Carolina. In addition, we are pleased to promote Dr. Dorothy Adcock, one of the foremost coagulation pathologists in the United States, to the role of LabCorp Diagnostics’ Chief Medical Officer. Dr. Adcock succeeds Dr.

Mark Brecher, who announced his intention to retire after eight years of exemplary service. We are deeply grateful to Dr. Brecher for his many contributions to LabCorp. The expertise, experience and vision of our team are important differentiators for LabCorp.

To provide you with an opportunity to hear directly from our leaders, to learn more about our long-term strategy and success with key strategic initiatives, as well as to experience a demonstration of our key innovation projects, we will hold an event for analysts and investors on the morning of February 27, 2018, in New York City.

We hope to see you there. In closing, we are pleased with our performance in the quarter and optimistic about the years ahead. We continue to make substantial progress on key strategic growth initiatives, advancing innovative solutions available only from LabCorp to a wide range of customers.

Thanks to the dedication of more than 57,000 employees around the world who are motivated by our mission to improve health and improve lives, LabCorp continues to deliver significant value to patients, employees, customers, partners and shareholders. Now I’ll turn the call over to Glenn..

Thank you, Dave. I’m going to start my comments with a review of our third quarter results, followed by a discussion of our LabCorp Diagnostics and Covance Drug Development segments and conclude with an update on our 2017 guidance.

Revenue for the quarter was $2.6 billion, an increase of 9.5% over last year, as acquisitions added 6.9%, organic revenue increased 2.3% and we benefited from foreign currency translation of 30 basis points. This revenue growth was constrained by around 70 basis points due to the impact from multiple hurricanes during the quarter.

Operating income for the quarter was $341 million or 13.1% of revenue compared to 324 million or 13.7% last year.

During the quarter, we had approximately $50 million of restructuring charges and special items, primarily related to the acquisition of Chiltern, facility closures and the forgiveness of amounts owed from patients in areas heavily impacted by hurricanes.

Adjusted operating income, which excludes amortization, restructuring charges and special items, was $447 million or 17.2% of revenue compared to 404 million or 17% last year.

The increase in adjusted operating income and margin were primarily due to acquisitions, organic volume, price mix and LaunchPad savings, partially offset by higher personnel costs. In addition, adjusted operating income was negatively impacted by around $15 million due to multiple hurricanes. The tax rate for the quarter was 34.8%.

The adjusted tax rate, excluding special charges and amortization, was 33.6% compared to 32.2% last year. This increase was primarily due to the geographic mix of earnings. We continue to expect the full year tax rate to be approximately 34%, which brings the tax rate in the fourth quarter in the range of 35% to 36%.

Net earnings for the quarter were $181 million or $1.74 per diluted share. Adjusted EPS, which excludes amortization, restructuring charges and other special items, were $2.46 in the quarter, up 9.3% over last year.

Adjusted earnings in the quarter were reduced by approximately $0.09 per diluted share due to multiple hurricanes, which reduced our revenue and caused us to increase our bad debt reserve based upon our historical experience. Operating cash flow was $351 million in the quarter compared to $250 million a year ago.

The increase in operating cash flow was due to higher cash earnings and improved working capital management. Capital expenditures totaled $75 million or 2.9% of revenue compared to $66 million or 2.8% last year. As a result, free cash flow was $276 million in the quarter compared to $184 million last year.

At quarter end, our cash balance was $409 million, up from $300 million at the end of the second quarter. During the quarter, we invested $1.2 billion in acquisitions and repurchased $42 million of stock. As of September 30, we had $447 million of authorization remaining under our share repurchase program. Total debt at quarter end was $7.2 billion.

Following the acquisition of Chiltern, both rating agencies reaffirmed the company’s investment grade ratings. The company’s leverage was 3.5x pro forma gross debt to last 12 months’ EBITDA as of September 30. We expect to use a portion of our free cash flow in the fourth quarter to lower the company’s leverage by yearend.

Now I’ll review our segment performance, beginning with LabCorp Diagnostics. Revenue for the quarter was $1.8 billion, an increase of 9.9% over last year. The increase in revenue was driven by acquisitions; organic volume, measured by requisitions; price mix; and the benefit from currency translation of 20 basis points.

Revenue per requisition increased 2.4%, benefiting from price mix and acquisitions, including Sequenom, which annualized in September. In addition, esoteric testing grew at a faster rate than core testing. Total volume increased 7.3%, of which organic volume was 2.3%.

We achieved this result despite the negative impact on volume of approximately 1% from multiple hurricanes. Acquisition volume was 5.1%, led by the PAML and Mount Sinai transactions. LabCorp Diagnostics’ adjusted operating income for the quarter was $374 million or 20.3% of revenue compared to $342 million or 20.4% last year.

The $32 million increase in adjusted operating income was primarily due to strong organic revenue growth, acquisitions and LaunchPad savings. The 10 basis point decline in margin was due to the impact from multiple hurricanes during the quarter, which negatively impacted margins by 70 basis points.

In addition, the company achieved its three year goal to deliver net LaunchPad savings of $150 million. Although we have reached our targeted savings, the LaunchPad process will continue to drive business process improvements throughout the segment as we complete a number of projects that are underway and identify new opportunities.

Now I’ll review the performance of Covance Drug Development. Revenue for the quarter was $761 million, an increase of 8.6% from last year, due to the acquisition of Chiltern, organic growth and the benefit from 60 basis points of foreign currency translation.

Adjusted operating income was $109 million or 14.3% of revenue compared to $95 million or 13.6% last year. The increase in operating income and margin were primarily due to the acquisition of Chiltern, organic revenue growth, cost synergies and LaunchPad savings, partially offset by increased personnel costs.

During the quarter, we completed the consolidation of our central lab facilities in Europe and the U.S., achieving our three-year target to deliver $100 million in cost synergies. In addition, we’re on track to generate savings from Covance’s LaunchPad initiative of $20 million this year, which will annualize to $45 million beginning in 2018.

Our planning for the expansion of this three-year initiative is progressing well, and we will provide additional details early next year. The strategic investments that we’ve made to enhance the business’s leadership, sales force and capabilities continue to pay off, as we posted another strong improvement in net orders and book-to-bill.

For the trailing 12 months, net orders were $3.8 billion, an increase of $370 million over last quarter’s trailing 12 months, producing an improved net book-to-bill of 1.33. Backlog at the end of the quarter was $6.8 billion, of which Chiltern added $1 billion.

We expect approximately $2.7 billion of this backlog to convert into revenue over the next 12 months. Now I’ll update our 2017 guidance, which assumes foreign exchange rates as of September 30 for the remainder of 2017 and includes anticipated capital allocation.

We expect revenue growth of 8% to 8.5% after adjusting for the negative impact from approximately 10 basis points of foreign currency translation. This is an increase over our prior guidance of 5% to 6.5%. We expect LabCorp Diagnostics revenue growth of 8.5% to 9%.

This is an increase over our prior guidance of 7% to 8%, primarily due to the consolidation of a joint venture related to the acquisition of PAML. We expect Covance Drug Development revenue growth of 6% to 7.5% after adjusting for the negative impact from approximately 10 basis points of foreign currency translation.

This is an increase over our prior guidance of 1% to 3% due to the acquisition of Chiltern. Our 2017 adjusted EPS guidance is $9.40 to $9.60, an increase of 6% to 9% over 2016 and an improvement over our prior guidance of $9.30 to $9.65.

We have narrowed the range and modestly increased the midpoint of guidance, as the negative impact from multiple hurricanes during the quarter is expected to be offset by the accretion from the Chiltern acquisition.

Finally, we expect free cash flow to be between $970 million and $1.01 billion, an increase of 8% to 13% over last year, and higher than our prior guidance of $925 million to $975 million. The improved outlook is driven by the company’s continued strong earnings and working capital management.

This concludes our formal remarks, and we’ll now take questions.

Operator?.

[Operator Instructions] Our first question comes from the line of Lisa Gill of JP Morgan. Your line is now open..

Dave, I apologize, there are three calls going on this morning, so I may have missed your specific comments on PAMA, but I just wanted to have a better understanding, we’ve heard your competitor talk about it, but is there any way to maybe think about the financial impact as we go into ‘18? It looks like at this point, we haven’t heard anything, so my expectation would be that there, the cuts are going to go forward.

So anything that you can help to frame the potential impact to earnings would be one.

And then just secondly, I just wanted to better understand if you had any comments around United and update on timing around where you are in renegotiating your relationship?.

So with respect to PAMA, what we have been saying since the beginning of the year is that we expected the reductions, starting with our clinical lab fee schedule revenue, we expected the reductions to be in the range of 6% to 8%.

Based on the preliminary rates that have been proposed, and assuming a couple of corrections of obvious errors -- so for example, the lipid panel, the general health panel, were actually proposed to be cut almost 50% in the first year, which is far in excess of the statutory limit of 10%.

Assuming those are corrected, we think at this point, that the impact will be toward the highest end -- or to the higher end of that 6% to 8% estimate that we’ve given of clinical fees -- clinical laboratory fee schedule revenue. So hopefully that helps frame what we think the financial impact is going to be.

Obviously, that’s all price, and so it largely falls through. I will say, as we’ve mentioned, there are a number of offsetting items when you think about earnings.

Obviously, the continuation of LaunchPad, the projected growth at Covance, the benefit from Chiltern, the benefit from PAML and Mount Sinai and the Covance LaunchPad process will all be offsets to the PAMA reductions.

And we also believe that as we continue to expand our patient-facing capabilities with things like the patient estimator, simplifying check-in, rolling those out to our in-office phlebotomists, that we also have some opportunity to offset some of the PAMA impacts with bad debt.

And then finally, of course, capital allocation also helps us to offset in terms of EPS, although not necessarily in terms of earnings in year one. So that’s how we think about the impact of PAMA and hope that helps frame it a little bit.

On United, we continue to have a regular and positive conversation with United, including at the most senior levels of the organization. I don’t have any update to give you other than that we’re pleased with the progress of the conversations.

And again, I would say I think it’s in our interest, and I think United believes it’s in their interest to get some clarity as soon as we can, recognizing that the contract continues through the end of 2018. And so there isn’t any obvious 2018 impact from any of the ongoing conversations..

Our next question comes from the line of Jack Meehan of Barclays. Your line is now open..

I wanted to continue on there, just in terms of your thoughts on the commercial pricing environment.

Obviously, the negotiation on the national payer contract is underway, just if you could give us an update on your philosophy as you’re negotiating on price versus value proposition versus network access in these discussion, how do you view commercial pricing in the context of PAMA as a possible offset?.

Jack, good morning. Obviously, the commercial pricing environment over the last several years has been pretty stable. And we expect it to continue to be stable.

I certainly think as we go into these conversations, we are making it known to the commercial payers that any price reduction, remember, PAMA is an ongoing process with reporting required once every three years, so any price reductions that they seek would roll through to government pricing in the future.

I think that is a constraint off, at least on our willingness to think about significant price reductions in terms of commercial contract renegotiation. Obviously, the discussions are not all about price, they are about the value proposition, they are about what else we bring to the table with Covance beyond pure laboratory services.

They are about the value proposition, about our companion diagnostics capabilities and industry leadership, and in the number of areas of esoteric testing and our centers of excellence. So I think there are multiple factors that are part of these conversations.

But realistically, there’s always a conversation around unit price and we absolutely do our best to maintain unit price stable, and we will continue to do so..

Great, that’s helpful. And then on Covance, great book-to-bill, glad to see it pivot to organic growth.

Can you give us an update on just some of the tangible data points related to the integrated offering, whether it’s net awards tied to the strategy or number of patients that have opted in for recruitment? And then finally, just with LaunchPad coming up, what the appropriate margin for this business long term is?.

Yes, I’ll make a couple of comments, and then I’ll ask John to fill in the details.

So the consented patients in the database, I believe, is up around 175,000 now, and again, as we introduce our more customer facing tools to the patient service center and through mobile devices, we’re optimistic that, that number is going to continue to increase and hopefully grow even more substantially.

The data points, again, I cited a couple of them in the prepared remarks. We continue to be at the table. We don’t win every study, because there’s more to a study than data, there’s therapeutic expertise, there’s global presence, there’s a whole variety of things.

Frankly, there’s prior experience with Covance that a number of these companies have not had, but we’re getting to the table, we’re in the conversations, the data is seen as a valuable asset. And I think that’s why you see the strong net orders and the strong book-to-bill in the business.

And with that, John, any further color you’d like to provide?.

No, it’s just that now that we’ve been awarded the $0.5 billion in studies, based on that data, we understand that, that capability is highly valuable to the customers and an important component of the biopharma offering. We saw strength across the segments in terms of the 1.33.

Obviously, in order to push the 12 months up continuously we’re getting higher than the average. But from the 1.1 to the 1.15 to the 1.23 to the 1.33, so showing strength across all segments, especially the central labs..

Our next question comes from the line of Dan Leonard of Deutsche Bank. Your line is now open..

Just one question on the Covance guidance. The range of revenue guidance seems rather wide, with two months left in the year.

Can you offer a bit more color on, on what the variables are? Is it just one or two big trials or are there more factors in play?.

I think from the standpoint of now incorporating and integrating Chiltern in, has a little bit of volatility, and anytime you’re coming up the range of the organic growth from the cancellations that have impacted revenue up in the last side, now into stronger growth across the segments allows for the reason why the range is where the range is..

Yes, the only thing I’d add, too, is we do give different ranges to segments. Obviously, Diagnostics being the bigger one, we use a narrower range, and frankly, a little less volatile over historical trends anyway. But we did narrow the range as we get closer toward the end of the year..

Our next question comes from the line of Nicholas Jansen of Raymond James. Your line is now open..

First one for me is just kind of organic growth in Covance for both the quarter and for the implied 4Q, just trying to better understand the contribution from Chiltern. I think you kind of called out $550 million of total revenue in ‘17.

You have it for four months, just back of the envelope math suggests that there might be a little bit of delta versus prior expectations on organic growth, so just wanted to flesh that out?.

Yes, I’d say our organic revenue growth in the quarter was slightly below our prior expectations. But let’s keep the focus.

We had strong improvements sequentially, we had improvements in revenue growth year-on-year, and so with the book-to-bill of the 1.33 over the last 12 months, we see now that getting back to the stronger organic growth of that single to mid- to high single-digit growth in the future, and so strong quarter..

That’s very helpful. And then secondly, appreciate the comments on PAMA, Dave, just wanted to kind of better understand the mechanics for you guys.

Is your interpretation that 2019 would be worse than the 2018 level, given the differences between the NLAs and max? Just trying to flesh out if that 6% to 8% cut that you’re kind of highlighting towards the higher end of that range, is that a better guy in ‘19 or a worse guy in ‘19?.

All right, I think -- let me first say that obviously 2019 is very uncertain. The PAMA statute provides for a three-year process. In our meetings with CMS, one of the concerns that they have expressed with the statute is, normally, they do things on a one-year cycle. And if it’s not working right after a year, they have the ability to change course.

This statute does not seem to provide them with that and so one of the things we’re talking with them and Congress about is a legislative fix that this thing does not become a perpetual three-year process, but gives CMS some opportunity to adjust it. So having said that, I would assume that 2019 would be about the same as 2018.

Again, we don’t have a lot of visibility into what changes CMS may make administratively, but I think in terms of assumptions, that’s a reasonable assumption over time. .

Our next question comes from the line of Amanda Murphy of William Blair..

I was just hoping you can give us a bit of an update on BeaconLBS. I know that you had talked about that program expanding, and I think it has with United. There’s been some discussion as of late on prior auth programs, and I think United has one coming up here in November, where they’re automating prior auth.

So wanted to just see how those are going to work together and then just more broadly, how you’re looking at BeaconLBS as a growth driver, longer term?.

Yes, so we’re in the process of implementing in Florida, call it a version 2 of BeaconLBS, which responds to some of the concerns that have been expressed by customers and by United about ease of use and other factors. And so I’m pleased with the fact that we’ve developed that and we’re in the process of rolling it out.

We don’t have any plans between us and United to roll into further markets at this point, but BeaconLBS has been selected to be the tool for United’s molecular test management, which will be starting later this year.

So we see positive trajectory here, and we’ll continue to evaluate what’s the best way that BeaconLBS can become what we want it to be, which is a physician decision support and utilization tool that leads doctors to right test, right time for the right patients..

Got it. And then just switching gears to the CRO side. So you talked in the past, too, about the building database of consented patients that you’ve been, I guess, building since the acquisition, really.

So where do we stand with that? And obviously, you’ve talked about data being an important driver of decision-making for biopharma, but is that -- how important is this database? Do you view that as a differentiated asset for you at this point?.

Well, it’s Dave. I’ll start and then again, if John has further comments. As I mentioned, I think the database is up around 175,000 consented patients. Now to be clear, that’s only one of the ways that we can use our data to approach patients.

Because we can look at the data, as we did in the liver study that I spoke about in the prepared remarks, identify patients, and then contact them through their physicians who treat them, so that really gives us access to much broader than just the consented database.

The consented database is people who have given us consent to contact them directly, and in the ulcerative colitis study, the thing that was encouraging was when we reached out to the consented patients, we had a very high response rate of people who were interested in learning more about the opportunity to enroll in the study.

So I do think it’s a differentiator. I do think the data, particularly because it is identifiable to specific patients with specific results, is a very valuable tool. But as I mentioned earlier, and as I’m sure John will elucidate on, it’s not the only decision point for a sponsor in determining how to reward a study.

So John, any further comments?.

No, I just think from the standpoint of when you talk database, you probably need to just broaden that out to data in general.

And as Dave said, whether it’s the diagnostics data in getting the 500,000 specimen tests a day, and/or the global data that we have within the central labs, that’s identifying sites, that’s getting patient recruitment in an accelerated basis, and that’s becoming pervasive on anytime we go out on clinical trial bid defenses, et cetera.

And then as Dave stated, it also depends upon your medic, your PM, your team that you put out there. It depends on the preferred sites that we now have that is advantageous. The solutions we now bring to the table with companion diagnostics, with the actual health systems now that are becoming part of the network.

We feel like we have a differentiated solution in that regard, and that’s helping us win in general and a contributing factor to the 1.33 book-to-bill..

And Amanda, just quickly on that, because I did not mention it. We shouldn’t overlook the power of the Covance investigator database, because we have information on investigators, all the investigators who conduct trials, not only that Covance runs, but also that Covance is involved in, for example, through the central lab.

So not only can we look at patients, but we can look at investigator sites, who’s enrolled patients, who’s successfully completed trials, who’s had a higher retention rate in trials.

And that’s extremely important, because more than half of the trial sites never enroll a single patient, and to be able to eliminate those from early consideration is a very valuable asset for a sponsor..

Our next question comes from the line of Kevin Ellich of Craig-Hallum. Your line is now open..

Dave, just wanted to go back to PAMA, don’t have questions about the mechanics, but just wondering, can you remind us how much of your commercial revenue is tied to Medicare?.

So Kevin, a small portion of our commercial revenue is tied to Medicare and it mostly would fall in the managed Medicare and managed Medicaid area, but that in and of itself is not going to significantly change the impact of whatever is implemented with PAMA..

And then just one quick one for Glenn. Looking at the strong cash flow, which is really nice this quarter and the increased guidance, looking at some of the changes in working capital, it looks like accounts payable and unbilled services were sources of cash, AP to the tune of 59 million and unbilled services, 16 million.

Can you talk about the moving parts? Should that AP reverse in Q4 or what should we look at?.

Yes, overall, the improvement in the free cash flow as well as our guidance, obviously, was tied to the earnings, but also in the broader case of working capital management. We’ve seen a lot of progress that we’ve done through our LaunchPad initiative that’s been focused on order-to-cash and using tools to improve DSOs.

Each quarter, as you can imagine, there’s always going to be some timing difference between different working capital categories, whether they be receivables or payables. We did get a benefit in payables in this quarter, which was a nice contributor, and again, some of that will be timing that should go the other way.

Obviously, that would be factored into the full year guidance that we have and therefore, the implied guidance in the fourth quarter still is to generate pretty substantial free cash flow and also includes the benefit year-over-year from bad debt management..

Right.

And then can you describe the unbilled services? What is that?.

It’s effectively where we’re billing or we recognize revenues but we’ve not billed it yet, so it’s just going along the time lines of working to various milestones with our customers, so to just some extent, it’s treated like a receivable. It’s, again, we’ve recognized the revenue, which is included, but we’ve yet to bill the customer.

And therefore, we know that’s additional proceeds that will come in, or cash comes in when we ultimately bill them..

Our next question comes from the line of Erin Wright of Credit Suisse. Your line is now open..

A couple on Covance here. And sorry if you gave this, but can you speak to the nature of the new business wins and did you break out book-to-bill trend for the underlying Covance business or a comparable book-to-bill, excluding Chiltern? And any sort of commentary on RFP flow that you are seeing would be helpful..

The Chiltern new business was immaterial to the book-to-bill, and on the RFP, we saw progression first to second, second to third, so a nice trend rate in terms of proposals. I think 3Q was comparable to a little bit up from 2Q. And then in terms of the segment approach of the performance of the business, central labs was strong.

Obviously, the clinical business integrating in Chiltern in terms of after the September 1 completion and then on the early development a nice momentum on the order rates. So that’s a little bit of description in terms of the individual silos..

And on the preclinical segment, ROA development segment, I guess, how big is that business for you now? And what’s your commitment, I guess, to that business over the longer term within your Covance asset?.

It’s a great business. We don’t break out the segment results, it’s strong. Obviously, we’re in the number one, number two position, depending on which area of the segmentation within the preclinical, both the chemistry and the non-chemistry side of the business.

And with that leadership position, we feel like we can now really broaden out even some of the areas of service and the menu of science that we bring to the table.

And as Dave even stated, our commitment in terms of investing in areas of the business, whether that’s the BioCMC or the BioA or in the base infrastructure and large molecule, et cetera, is evidenced by the capital allocation that we’re putting to the business unit..

Our next question comes from the line of Bill Quirk of Piper Jaffray. Your line is now open..

Couple of questions here. So Dave, I guess, first question. Help us think a little bit about capital allocation in general.

And I guess, specifically, has this changed at all in light of PAMA? I would presumably suggest that, I suppose, some lab acquisitions may be a little cheaper now than they were, say, a couple of months ago?.

Well, I think, Bill, if you look at our history of acquisition activity, we always start with it has to be strategic.

And so you look at two significant transactions that we’ve done this year on the lab side, PAML and Mount Sinai, highly strategic, health-system integrated, New York City market, Pacific Northwest market, multiple joint ventures underneath the PAML structure, just great transactions for us in terms of long term positioning of the business and growth.

There is a quite robust pipeline of potential acquisitions, there has been for some time. Again, we are very selective in terms of what we acquire from strategic fit, from geographic fit, from therapeutic fit. And I feel optimistic that we’re going to see some good opportunities. I don’t know that PAMA has changed it that much.

It may be that once PAMA is implemented, we’ll see some greater activity around the smaller assets. But we continue to look at all of these assets as do they fit our strategic model, and if they do, then are the valuations reasonable..

Okay, got it. And then appreciate the comments around PAMA and the potential effect on private pay business and your comments there. Just a word maybe, Dave, on the traditional fee-for-service Medicaid business. How much of that is tied to Medicare pricing? And then just remind us how should we be thinking about potential exposure..

Well, traditional fee-for-service Medicaid is a very small part of our book. It’s probably about 2% of the book. It is not tied to Medicare per se, but fee-for-service Medicaid is not allowed to pay more than the Medicare National Limitation Amount, the NLA.

So if the Medicare NLA is reduced and now the Medicaid NLA is above it, that -- I’m sorry, the Medicaid payment rate is above it, then the Medicaid rate will be reduced, it’s required by law. The reality is that many state Medicaids already pay well below the current Medicare NLA.

So I do not think there is going to be a significant impact from fee-for-service Medicaid in terms of the PAMA pricing..

And our next question comes from the line of Ricky Goldwasser of Morgan Stanley..

I have a couple of follow-up questions. First of all, obviously, a lot of discussion around PAMA and a lot of moving parts on next year.

But if the proposed rates cuts do hold, do you think that you can keep margins flat for the lab segment next year?.

Ricky, it’s Dave. I think it’s too early to make a prediction about what will happen with margins. Obviously, PAMA is a -- will be a headwind. We do have the tailwinds that I mentioned earlier, and I’m not going to run through them all again.

And we also have the potential to deploy capital toward acquisitions that could -- that could be incremental to margins as well. So instinctively, it’s going to be difficult to keep margins flat, but I’m not prepared to say that we won’t be able to at this point without knowing what’s really going to happen..

Okay, that’s fair. And then on the M&A point. Volumes in the quarter, both organically, but from acquisitions, were strong.

On the M&A, were there any additional acquisitions that you didn’t announce that benefited and it drove that 5% contribution to volume, or should we just account for everything that you announced last quarter and not assume anything new?.

Yes, Ricky, nothing, if you will. For the quarter, we did three acquisitions, obviously, Chiltern for the drug development being the largest and we did two small tuck-ins there. But the acquisition number is not just for the last quarter, but will be for any acquisitions that we would have done over the -- essentially, the last 11 months.

So anything that hasn’t annualized would be a factor that shows up into what the contribution from M&A is. And then each quarter, new acquisitions coming in and then those that annualize off will change. So in the case of Diagnostics, we commented that Sequenom annualized in September, so obviously, it wasn’t for a period of the quarter.

This time next quarter, Sequenom will now be a part of our organic growth..

But on a sequential basis, to your point, there were in the Diagnostics business, though there were a couple of acquisitions that were not there in the second quarter?.

Right, very, very small, wouldn’t move the numbers, but we continue to be acquisitive and again, they were not meaningful at all..

And our next question comes from the line of Tim Evans of Wells Fargo Securities. .

I wanted to come back to the Covance revenue growth guidance. If I’m doing my math correctly, using the full year guidance, and if we assume that Chiltern is on track to do the $550 million that you have guided to already, it looks like the organic constant currency revenue for Covance would be about $50 million lower on a full year basis.

Am I looking at that correctly? And if not, where might the delta be?.

All right, I’d say the comment that you take the annualized number that we’ve provided, obviously for Chiltern, and take the four months, will give you a good proxy for the contribution that will come from the acquisition.

We’ve given you as well the impact from currency, so we do expect organic growth year-over-year within the, call it, the legacy Covance prior to Chiltern. So similar comment within the third quarter. We’ve enjoyed good sequential growth off of the base business organically, as well as year-over-year.

And the trends, given the strength of the bookings and our existing backlog and what will convert, again, gives us a lot of confidence, as John commented earlier, that we’ll continue to see good revenue growth within Covance going forward, based on all those attributes..

And I think John did say that organic growth was maybe a little bit less than you were expecting this quarter.

Can you talk about why that might be? Was it preclinical, central lab, clinical, anything in particular there that you can help us characterize that?.

I think, from the standpoint of the segments, just slightly less in terms of the early development and clinical, but still having aggregate growth year-on-year in terms of the Covance organic and then sequential growth in all of those segments..

Our next question comes from the line of Mark Massaro of Canaccord Genuity. Your line is now open..

A two-parter, if I can.

I guess, given that a number of tests are facing high single-digit or even 10% cuts per year, Dave, can you speak to how you’re thinking about potentially walking away from providing access to certain lower-margin tests, assuming PAMA goes through? And then the second part of that is now that the draft rates have been out for some time now, can you just -- and there’s been some broad support joining ACLA, can you just speak to the receptivity maybe you’ve been hearing in some of the comments and maybe some of the momentum you think that might be communicated through to CMS?.

First of all, I certainly have never said or meant to imply that it was our intention to walk away from providing any particular test or any particular service to our patients. We’re here for the patients, first and foremost, and so that would not be something in our thinking.

That said, obviously, we and everybody else in the industry will be looking at our infrastructure, looking at access points, looking at size of the business. We have about 1,800 patient service centers. We have phlebotomists in doctors’ offices; we have to look at whether we’re right-sized, given the changes if PAMA gets implemented.

I think of more concern in terms of beneficiary access is rural areas where the impact of PAMA will be most demonstrably felt, and yet, fewer than 2% of the data points were from rural laboratories or rural hospitals.

Nursing homes, which is a very unique service provided largely by local providers, it’s a completely different model from our model, which largely is focused on ambulatory patients. These are -- typically, they’re patients who are, obviously, they’re in a nursing facility, many of them are in a bed.

Someone has to go out there and draw them and I won’t go into all the detail, but it’s a very different business model.

Our concern as an industry is that’s where the access will be lost and those are the people who actually most critically need laboratory services, which again, 3% of total Medicare spend and if you look at the OIG reports, the spending trend has been flat over the last three years.

So the impact of these cuts is completely out of proportion to what Congress ever intended.

Now in terms of the receptivity, the industry collectively, and I want to compliment my CEO and executive colleagues from around the industry, we’ve had a tremendous amount of activity on Capitol Hill and otherwise, the ACLA, the 21 other health care groups that joined the letter from ACLA urging a delay in the PAMA rates, there’s a very strong consensus, including the American Medical Association, the American Hospital Association, the College of American Pathology, that these rates are not right and that CMS should wait to get them right and should do the appropriate thing here.

As we said, this is a first foray into market based pricing for Medicare, and it’s a bad start to what Congress is trying to accomplish.

So there is receptivity to thinking about both a near-term and long-term solution, but obviously, the challenge is going to be in the details of how do you get that done, given that we’ve just filed comments, CMS proposes to finalize the rates. It’s the end of October and these rates are supposed to go into effect in two months..

And our next question comes from the line of Ralph Giacobbe of Citi. Your line is now open..

Just the revenue impact from the hurricane, it looks like about 18 million EBITDA, about 13 million -- I’m assuming that’s just the sort of leverage of lack of volume.

I’m assuming I’m thinking about that right and is that a good proxy of understanding margin of incremental volume as well?.

Yes, Ralph, couple of things that come into play. One, the impact from the reduced volumes. But also we did build up our bad debt reserve during the quarter for the potential challenges of collections in those affected areas, again, based upon what our historical experience. So you have kind of the drop-down on the impact of volume.

Obviously, incremental volume for us is very profitable, so that comes down, plus the increase in the bad debt expense, if you will, as a result. So the two of those caused around a $15 million negative impact on our operating income and to your point, around 17 millionish impact on the revenue line..

Okay, that’s helpful.

And then, Medicare Advantage, just want to confirm that, that’s in the commercial bucket, is that right? And if you could maybe just give us a sense of how much is current MA revenue and is that rate closer to commercial or closer to Medicare?.

Ralph, it’s Dave. It is in the commercial bucket, I think it’s broken out as part of managed care revenue. We don’t break out specifically how much is Medicare Advantage, and typically, those rates would tend to be commercially negotiated as opposed to set by the Medicare fee schedule.

So we’re five past the hour, everybody, and we have three more people in the queue. I just ask you to make sure that the question you’re asking has not already been answered. Please, we’ll try to get to everyone..

Our next question comes from the line of Dave Windley of Jefferies. Your line is now open..

Focused on Covance, I’m wondering if you could comment on first, the pricing environment across the segments, particularly clinical and preclinical pricing environment, and then opportunities for growth, apart from the traditional target areas.

So for example, Asia Pac that you’ve talked about, Phase IV, real-world, late-phase type areas as examples..

Dave, in terms of the pricing, it’s pretty stable. Obviously, all of pharma is looking for efficiencies and more effective approaches to trials and we need to continue then to develop our own efficiencies in-house. So there’s always going to be that dynamic, but it’s a pretty stable environment.

And then from the standpoint of the opportunities, we consider, when I look across the spectrum, number one, the Chiltern acquisition now opens up a much more broader infrastructure, much more broader base to now attack the faster R&D growth environment of the small, medium, emerging, because their dollars are growing more in the high singles than the large pharma.

We do see opportunities in terms of the real-world areas. Asia Pacific, we just added now another 700-plus employee base, they can go attack the Asia Pac environment.

We see early clinical and in terms of a very positive opportunity base, but even some of our base businesses, Dave, in terms of whether it’s on the safety assessment, the metabolic lead optimization, the central labs, building upon your strength, building upon the significant technical resources that you have, we see that the base is growing.

So appropriate question, we’re all looking for those adjacent opportunities and we see Covance primed to take advantage of that..

And our next question comes from the line of Isaac Ro of Goldman Sachs. Your line is now open..

Question for you as it relates to M&A. If we look at the PAMA situation here as it relates to your competitors, mostly the smaller ones, how do you expect this to precipitate potentially a broader opportunity set for M&A? As some of these smaller labs look to sort of make strategic decisions here as to whether they want to stay independent.

I’m just curious, if considering that plays out, whether or not you think that’ll take a few months to start accelerating or could it take a lot longer than that?.

Yes, it’s Dave, as I said in response to this question when Bill Quirk asked it, I think that the M&A environment and the pipeline has been pretty robust. I think it’s going to continue to be robust.

I’m not sure what the impact will be on the smaller labs, whether it will be M&A, whether it will be that they’ll try to throw in their lot with the hospitals, it’s just very unclear. But we like the acquisition pipeline and we will continue to be selective in the deals that we choose to do..

Maybe more specifically, then, sorry, I didn’t ask it properly. Is it fair to say that you’re not seeing a change in behavior from those other labs at this point, because it’s early.

I’m just trying to get a sense of what the reaction has been?.

Yes, that’s an accurate statement..

And our next question comes from the line of Rohan Abrol of KeyBanc Capital..

Yes, just a quick one from me.

I just wanted to know if you are seeing any particular trends you’d like to point out with respect to the FSP and full-service elements of the CRO business?.

Well, I see that continuing. I haven’t seen the shift from programmatic to FSPs. I’ve just seen a continuing penetration of the FSPs. We’ve seen a couple of companies actually go more balanced from just an FSP strategy to more of a, as an example, programmatic in the oncology versus FSP on all other.

But with that in mind, we then, with Chiltern, now add a greater talent base, where they are focused on the FSP business was more in that data management stack, programming, to now bring forward an enterprise offering with Covance having the FSP CoSource business with respect to the monitoring.

So now being an enterprise offering that encompasses all the different segments, and now trying to take advantage of that broader-based service offering..

And I’m showing no further questions at this time. I’d like to hand the call back over to Mr. Dave King for any closing remarks..

Thank you very much. In closing, I just want to, again, thank all of the 57,000 colleagues for a really terrific performance in the quarter.

Again, recognize the efforts on behalf of patients and the community in response to these very impactful storms and reiterate the -- we are very, very pleased with our very strong performance in the quarter and we’re extremely optimistic about the future of our business in the years ahead of. Thank you, and good day..

Ladies and gentlemen, thank you for participating in today’s conference. That does conclude today’s program, and you may all disconnect. Everyone, have a great day..