奎斯特診斷 (DGX) 2013 Q3 法說會逐字稿

Welcome to the Quest Diagnostics third-quarter 2013 conference call.

At the request of the Company this call is being recorded.

The entire contents of the call, including the presentation and question-and-answer session that will follow, are the copyrighted property of Quest Diagnostics with all rights reserved.

Any redistribution, retransmission or rebroadcast of this call in any form without the express written consent of Quest Diagnostics is strictly prohibited.

Now I would like to turn the meeting over to Dan Haemmerle, Executive Director of Investor Relations for Quest Diagnostics.

Please go ahead, sir.

Thank you and good morning.

I'm here with Steve Rusckowski, our President and Chief Executive Officer, and our new Chief Financial Officer, Mark Guinan.

In addition, our Senior Vice President and Chief Medical Officer, Dr. Jon Cohen, will be joining us for Q&A.

During this call we may make forward-looking statements.

Actual results may differ materially from those projected.

Risks and uncertainties that may affect Quest Diagnostics' future results include, but are not limited to, those described in Quest Diagnostics' 2012 annual report on Form 10-K and 2013 quarterly reports on Form 10-Q and current reports on Form 8-K.

A copy of our earnings press release is available and a text of our prepared remarks will be available later today in the investor relations' quarterly update section of our website at www.QuestDiagnostics.com.

A PowerPoint presentation and spreadsheet with our results and supplemental analysis are also available on the website.

Now here is Steve Rusckowski.

Thanks, Dan, and thanks, everyone, for joining us today.

I'd like to start by taking us through the top-line performance, share our thoughts on utilization and reimbursement trends, as well as review progress against our five-point strategy.

Then Mark will provide detail on the results.

Well first, clearly our third-quarter performance was disappointing.

We recognize that we have missed expectations this year and revised our guidance more than once.

We understand it is extremely important to achieve expectations and we are focused on improving our predictability.

Our current view reflects two changes -- the impact of a softer market than we originally expected; and the fact that our strategy to restore growth is taking longer to produce results.

Before commenting further I'd like to welcome Mark Guinan, our new CFO.

Mark brings strong financial operations experience to Quest, providing us with a fresh perspective on how we can improve our performance and predictability.

Mark and I are already deeply engaged in driving shareholder value by executing our five-point strategy.

Now let's turn to the market dynamics.

All year we have been saying that we anticipated continued revenue softness in the first half of this year.

And that our efforts to restore growth were the result of gradual improvement during the back half of this year.

Although we have seen a gradual improvement in performance versus the prior year, our third-quarter performance was less than we expected.

As a result we fell short of expectations for the period by approximately $50 million.

As we all have seen from commentary from industry stakeholders including hospitals, physicians, payors, suppliers, competitors, the healthcare industry overall is facing utilization headwinds.

At the start of this year our expectation was that 2013 would have about the same level of utilization we saw in 2012.

In the first half we saw clear signs that healthcare utilization had declined versus last year and at this point it appears this trend continued.

As we reported to you last week, despite seeing some hopeful signs early in the quarter, volume softened late in the quarter.

Overall, despite the soft finish to the quarter, volumes remained in line with our previous run rate as organic volumes.

Adjusted for our business days, they were lower by 2% versus the prior year.

As I said earlier, in addition to the continued soft market, our initiatives to restore growth that we have been planning on to contribute in the quarter are taking longer to show results.

Additionally, this industry also faces considerable and ongoing pressure on reimbursement.

In 2013 reimbursement challenges have become much more pronounced.

This includes the reductions in Medicare payments of approximately 5%; the cuts to [cathology] codes on Medicare physician fee schedule; the changes to Medicare fee schedules including requirements from (inaudible) diagnostics; and finally, the effects of renewed commercial payor contracts.

These changes just this year contributed to the lower [unit of] underlying revenue per requisition by 3.3% in the third quarter compared to 2012.

We now expect underlying revenue per requisition before acquisitions to be down a similar percentage for the full year.

On a full-year basis our price erosion will be greater than $200 million in 2013.

Also our (inaudible) Trade Association has been fighting additional cuts that have been proposed or discussed.

This includes a measure to extend the fixed rate reduction of the clinical lab fee schedule through 2023 as mentioned in the President's budget proposal in April.

And CMS has proposed significant changes to the physician fee schedule and a mechanism to adjust the clinical lab fee schedule in the future, as was reported in July.

We are operating in a challenging environment; at the same time, we are making the changes to the way we operate.

Together these factors have affected our progress to restore growth.

Now let me give you an update on our efforts and the progress we're making executing our five-point business strategy.

First let me start by looking at how we are refocusing on Diagnostic Information Services.

We have made significant progress on our portfolio review.

Since last year we sold our OralDNA dental diagnostics business, HemoCue diagnostic products business, ibrutinib royalty rights, and most recently Enterix -- all generating gross proceeds of approximately $800 million, providing us flexibility to drive shareholder value.

Our portfolio review is helping us deliver disciplined capital deployment.

Our commitment is to return the majority of our free cash flow to our shareholders.

During the quarter we increased our share repurchase authorization by $1 billion.

And in September we entered into an Accelerated Share Repurchase agreement to repurchase approximately $350 million of our shares.

And then finally, year to date we have deployed nearly $1 billion into share repurchases.

In addition, our goal is to generate about 1% to 2% revenue growth per year through strategically aligned accretive acquisitions.

So far we have completed four acquisitions including the lab outreach business at the University of Massachusetts and Dignity Health, as well as Concentra's toxicology business and most recently ConVerge.

Our first three acquisitions are on track and contributed 2% to revenues in the third quarter.

In October we completed the acquisition of ConVerge, our second this year in the New England market.

Next, we are making progress driving operational excellence.

With Invigorate we are on track to realize more than $250 million savings this year and remain committed to our goal of $600 million in run rate savings next year on a path to $1 billion beyond 2014.

This strategy, in addition to making us more efficient, will also allow us to improve our customer experience.

Now most importantly, we are building the capabilities we need to restore growth.

Our commercial reorganization is complete.

As we have said, restoring growth is a gradual process and takes time.

We have made investments in our clinical franchises and our laboratory professional services businesses.

These investments are critical to helping us restore growth.

The clinical franchises are beginning to deliver new solutions to meet customer needs and will help us grow esoteric and advanced Diagnostic Solutions.

To give you an example, we are very excited to introduce BRCAdvantage, a new choice of BRCA testing (inaudible) to significantly broaden patient and provider access to testing for BRCA gene mutations associated with increased risk of inherited breast and ovarian cancers.

Quest BRCAdvantage is based upon next gen sequencing technology and expertise in cancer genetics and women's health matched by none.

And a rich service approach to design a better healthcare experience for the patient and the clinician.

Our laboratory professional services team continues to expand its pipeline for hospitals of integrated delivery networks that are interested in working with us to improve outcomes and reduce cost.

And then finally, we also continue to simplify the organization and build a culture so we can improve our operations and grow.

We built a new organizational structure that better serves our customers by removing complexity, speeding decision-making and empowering employees.

Along with this we introduced new behaviors that will make as more agile, customer focused, transparent, collaborative and performance oriented.

This week's launch of BRCAdvantage demonstrates the power of our new organization and culture.

Our cancer clinical franchise team worked collaboratively with colleagues across our enterprise as well as externally with customers, suppliers and key opinion leaders to quickly develop and introduce this important solution.

We're looking forward to launching many more successful solutions in the future.

While we are in a difficult operating environment, we are taking the right actions to make our Company a stronger and more effective competitor.

We are making progress and recognize that there is much more to do.

Now I'd like to turn it over to Mark for a detailed analysis of the numbers.

Mark.

Thanks, Steve.

As you and I have discussed, I have several priorities for the finance function.

These include improving our predictability and supporting the business to achieve our five-point strategy, starting with improving operations and restoring growth.

I can assure the investment community that I recognize the importance of delivering on guidance and we will instill the discipline to improve our predictability.

I don't like surprises and recognize that investors like them even less than I do.

Turning to revenues, third-quarter consolidated revenues of $1.79 billion were 1.9% below the prior year.

Diagnostic Information Services revenues, which account for over 90% of total revenues, were 2.4% below the prior year.

Volume was better than the prior year by 2%.

Our first three acquisitions completed this year, UMass, Dignity Health and Concentra's toxicology business, contributed approximately 2% in the quarter to revenues and approximately 3% to volume, in line with expectations.

Volume also benefited by approximately 1% due to favorable business days.

Underlying volume, excluding business days and acquisitions, was lower by approximately 2%.

As we have shared previously, we expected this year to be a building year and we expected to build momentum and show improvement later in the year.

Revenue per requisition in Q3 was down 4.3% compared to the prior year.

The impact of our two second-quarter acquisitions, principally Concentra's toxicology business, lowered revenue per requisition by approximately 1% in the quarter, resulting in a decrease in underlying revenue per requisition of approximately 3.3%.

While under pressure all year from government and commercial payors, reimbursement was also impacted this quarter by increased denial rates and unfavorable test mix, both of which are related to molecular tests and coding changes made this year.

Q3 revenues in our Diagnostic Solutions businesses, which include risk assessment, clinical trials testing, healthcare IT and our remaining products businesses, were favorable to the prior year by 4.1%.

Adjusted operating income was 16.5% of revenues, about 260 basis points below the prior year, with the decrease principally due to lower revenues.

A significant portion of the lower revenue is being offset by continued progress with our Invigorate initiative.

However, we are operating in an environment in which we continue to make investments in advance of the revenues we expect.

For example, we are investing in clinical franchises in areas like cancer and women's health to develop and launch solutions like BRCAdvantage.

We are also making investments in our lab professional services offering, which is an important element of our long-term strategy to restore growth.

We expected volume growth in the current year to fund some of these investments.

While they have not we have not slowed down the pace of investing.

Also, keep in mind that Invigorate includes volume-based productivity improvements.

While we remain confident we will deliver $250 million or more and the current year, the volume decline we've experienced has prevented us from realizing even more of the productivity savings we had expected.

Adjusted EPS of $1.02 was $0.13 below the prior year with the decrease principally due to lower revenues partially offset with cost savings realized from Invigorate and the benefits of our share repurchase program.

As a result of the Company's ongoing efforts to drive operational excellence and simplify the organization, restructuring and integration costs of $39 million reduced reported operating income as a percentage of revenues by 2.2% and reported EPS by $0.16.

Last year's third quarter included $44 million of costs associated with restructuring and integration charges which reduced reported operating income as a percentage of revenues by 2.4% and reported EPS by $0.17.

Bad debt expense as a percentage of revenues was 3.6% or 30 basis points higher than the prior year.

The increase can be partially attributed to benefit plan design as patients shoulder an increasing portion of healthcare costs.

DSO's were 48 days, essentially unchanged from the second quarter.

Cash from operations was $186 million in the quarter compared to $395 million in the prior year.

This is principally due to the following factors -- adjusted operating income was lower by $54 million; higher cash in the prior year period due to a nonrecurring $72 million cash receipt upon termination of an interest rate swap agreement; increase in the size and timing of tax payments of $38 million in 2013; and higher restructuring and integration payments in 2013 of $15 million.

Capital expenditures were $51 million in the quarter compared to $45 million a year ago.

During the quarter we repurchased 7.2 million common shares.

So far this year we've purchased almost $1 billion of our stock.

Turning to guidance, we are updating guidance based on our performance year to date; the current operating environment, which we do not expect to materially improve; and based on updates from our business leaders.

We expect full year 2013 results from continuing operations before special items to be as follows -- revenues to be approximately 3.5% below 2012, prior guidance was to be about 1% to 2% below the prior year level; earnings per diluted share to be between $3.85 and $3.95, compared with prior guidance of $4.35 to $4.50; cash provided by operations to approximate $850 million, compared to prior guidance that it would approach $1 billion; and capital expenditures unchanged to approximate $250 million.

Now I will turn it back to Steve.

Thanks, Mark.

Well to summarize, 2013 is a building year for Quest.

We are focused seeing on -- implementing our five-point strategy in the challenging environment, with a particular emphasis on our strategies to restore growth.

This will require us to improve our execution.

Our recent BRCAdvantage launch demonstrates Quest's ability to empower better health with diagnostic insights.

And this illustrates a great example of how our innovation will help us restore growth.

Despite the current tough environment, we believe we operate in a very attractive market and our five-point strategy positions Quest to deliver superior shareholder value.

Now we would be happy to take your questions.

Operator.

(Operator Instructions).

Kevin Ellich, Piper Jaffray.

Steve, I guess starting off with -- one of the things that you guys called out in your press release last week was the 50 basis point impact from increased denials on the molecular test.

Will you be able to recoup the 50 basis points that was lost at some point or is that gone forever?

Yes, good question, Kevin.

Let's give you a little more clarity on what we were talking about there.

It has to do with really denials for our diagnostic-related charges that are in this molecular diagnostic category.

And as you know, there's been quite some discussion in the past about the code stacking and then also the new proposals.

And we have commented in the past we think on the price side we were okay.

And then actually we got into the quarter and we see some issues associated with getting paid.

So I'm going to turn it to Dan to give us a little more color on the specifics of what we saw and how much of that could come back to us.

Yes, sure, thanks.

Thanks, Kevin for the question.

As we think about the molecular diagnostics issue and we think about pricing in general, first let me say that we said the reimbursement pressure would be about 3% in the year from government commercial payers.

It continues to be in that zone.

So that is where we should be -- we are still in line with in terms of fee schedule erosion.

We also shared when you think about revenue per acquisition that we would see some favorable test mix and test per requisition.

And that would be offset by some unfavorable business mix issues, okay, as our wellness and toxicology business has continued to grow.

And this quarter we saw deterioration in the overall revenue per requisition, not necessarily fee schedule related, but more due to test mix as well as the molecular diagnostics issues.

And when we think about the molecular diagnostic issues and it has turned into -- resulted in a softer test mix benefit than originally anticipated.

And as we looked at those denials, some of the denials are related to some tests that we recently launched during the course of the year and have been growing.

So we will see some unfavorability there versus expectation.

And then also we do, as you know, perform reference testing for about half of the hospitals around the country.

We have had some clients that have started to see denials on their end a little bit later and, in an effort to maintain their profitability, have started to alter their ordering patterns.

And as they have altered some of those ordering patterns we've seen changes again in our -- show up in our test mix.

So denials probably on their end that resulted in softer test mix.

So, some of this -- is there an opportunity to continue to work this and get some improvement in the future?

We will be working it and hope to get some improvement.

But at this point it is early to say and we thought the prudent thing to do would be to record our revenues right where they are.

Okay, that is helpful, Dan.

But you mentioned you launched some new tests this year.

I was just wondering if some of those tests have CTP codes assigned.

Or are those the tests -- I mean how big of an issue was that?

And should we expect this kind of 50 basis point headwind to continue?

I would expect some portion of it to continue into the end of the year.

Okay, that is helpful.

And then, Steve, just going back to your prepared comments, you talked about weaker utilization this year, you saw it in the first half and in the latter part of the quarter impacting your volumes.

I was just wondering what makes you think this is an industry issue.

Obviously we -- I am on the same page; I think overall utilization is a little weaker.

But do you think there's any Company specific issues here and could you guys be losing share to some of the smaller labs or even the hospital-based labs?

Yes, good question, Kevin, so we are obviously are looking at what is happening in the marketplace and the results are starting to come in.

So, on the utilization front, as I said in my prepared remarks, and I have shared this with you before, we entered the year thinking that it would be about the same levels as we had last year and in fact it has been worse.

But we expected that Q3 would be similar to what we saw in the first two quarters.

And actually as we got into the quarter at the beginning of the quarter we actually were encouraged.

And then as we got through the midpoint of the quarter it started to slow down.

And we actually have gone back and looked at kind of our underlying business -- operationally talked about a reorganization of our sales force, we are putting more focus on operational excellence.

Yes, that is about efficiency but as importantly it is about enhancing our customer experience.

And when we look at our underlying performance we look at the key measures.

And if you go back and look at -- we do look at this -- our top 1,000 accounts and say what has happening between Q2 and Q3?

Is there anything exceptional in there?

What we see is less utilization.

Also when you go back and look at where we might be picking up accounts and where we might to be getting some defections related to possible in sourcing, it was about where we expected.

So the big change really for the quarter is related to our belief that some of the programs we put in place with our sales force, with our new products, and with our professional services business would yield more than what we delivered and that is the $50 million I comment to.

But over all if you look at the marketplace, if you look at how we compete with regional labs, how we compete with some of the national -- large national labs.

We look at our customer expense, we look at our product offering, we look at our access.

There is no notable change in that and actually we are improving as our plan has us improving throughout the year.

So that is our take on the quarter.

Obviously we are still digging into exactly what is happening in each of the regions, what is happening by each of our payor types, what is happening by product category and we will have more knowledge about it as we go forward.

But as we sit right now, that is our perspective on the quarter.

Understood.

And then one last question here, Steve.

So apparently there has been some guideline changes for women's health on the Paps.

Just wondering if you guys have had a chance to assess how much of an impact you think this will have on your women's health testing business.

Yes, the guideline changes for Pap -- this is Jon Cohen.

Guideline changes -- sorry, it's Jon.

As you know, these guideline changes did change to more than -- to less frequently than one year.

And I think in general everyone is going to see some decrease in Pap testing as a result of that as physicians, particularly OBs and primary care, begin to seriously engage with the new guidelines that we offer.

Okay.

Thanks, guys.

Thank you.

Before moving forward I would like to just ask that everyone take one question and one follow-up question as we move forward.

Thank you.

Tom Gallucci, FBR.

Good morning.

Thanks for all the color.

I guess just on the volumes for my first question, then I will ask a follow-up.

Curious about the trend that you are saying you saw there where it was a little stronger in the first part of the quarter and weaker in the second part.

Just trying to understand the magnitude of the drop off that you saw or exactly what you are relying here in terms of the trend.

Yes.

Well, we are starting to get some data back from some of the industry watchers.

And it appears that things did drop off in terms of physician visits in September, more than what we had seen in the beginning of the quarter.

So that's tracking with what we experienced.

And second is I just saw -- and we just are digesting some hospital admission data and it looks like the same happened on the hospital side too.

So it was tracking actually in the first part of the quarter, Tom, better than what we had experienced in the first half.

And then it went to a place that was lower than what we saw in the first half.

And on average is it about what we saw in the first half.

But we were hopeful in the early part of the quarter that things were actually improving somewhat versus what we had experienced in the past.

So it is our best perspective on this and we are trying to understand how much of this is the market, the environment, the utilization, what could've been the causes for that.

And also what -- as Kevin asked early, what portion of it is us versus the competition versus what we expected versus our plans.

So we are going through all of that.

But as we sit right now the biggest shortfall in the quarter is related to not executing as well as the programs that we put in place and that we had planned on in our guidance and that is the $50 million.

When we got through the quarter, you say when the dust settled, it was a little better than the first part of the quarter, less than the back part of the quarter.

Overall utilization was about, for the quarter, what we have seen in the past two quarters.

That is not it.

We actually had planned on getting more out of our restore growth initiatives.

And, as we said, they're still valid; we have the resources in place, it is just going to take more time for us to see the benefits of those.

Tom I just want to add, it is Mark.

A majority of the $50 million miss came in September.

So, I do want to make that clear.

And historically September has been a strong month for us.

So we were actually, based on where we were at, early in the quarter we were expecting some momentum in September and we saw the drop off.

Now back to Steve's point.

When you look at the quarter in total the overall health of the business, strength in utilization, was pretty consistent with the first two quarters of the year.

So while September was disappointing, when you look at it in light of the whole quarter it seemed like it just was a continuation of the year.

But early in the quarter we felt like things were turning.

The guidance, just to clarify, is more of a run rate that you saw on September or sort of the average for the quarter?

It is really looking at the quarter.

We are not building off September and assuming that is indicative of what the balance of the year will be.

Okay, my bigger picture sort of follow-up was just on use of cash.

Obviously you guys are describing a difficult environment.

You bought back a lot of stock, you have done some acquisitions.

In the environment that we are in how do you sort of think about the visibility you have on acquisitions performing or on your own business performing and the stock being a good use of cash versus doing dividends or acquisitions in different lines of business, etc.?

Just wondering how you're thinking about the use of cash in this difficult environment.

We are committed to our five-point strategy.

As we look at the acquisitions, as we mentioned in our prepared remarks, they are on track -- so the three that we have actually integrated at this point.

So we continue to feel that is a good use of cash.

And in terms of other use of cash, whether it is dividend or share buybacks, we have said we are going to return the majority of our free cash flow to our shareholders and we're going to continue along that strategy.

Okay, thank you.

Ricky Goldwasser, Morgan Stanley.

I have a couple of questions.

The first one is on the Invigorate cost savings.

So I think that the implied guidance assumes about $150 million to $170 million of incremental savings in the second half of the year.

And when we kind of like think about your business, the acquisitions, we -- doing a back of the envelope analysis, we get to Invigorate incremental savings were around $60 million to $65 million in the quarter.

So I just wanted to confirm that.

And should we -- is it reasonable to think that you are going to see another kind of like 40% of sequential uptick in the savings that you are seeing coming through in the fourth quarter?

Yes, so let me go through what we said before in my perspective on [returning] to market to round it off.

Well, first of all, what we've shared is that we have a goal of $600 million run rate savings by the end of 2014, so we are standing behind that, as I said in my prepared remarks.

We actually are encouraged by the rate of change we are making with Invigorate and we need it to offset the headwinds we have in this industry.

And as we said before, we have our foot on the accelerator to get as much out as possible.

So that continues.

What we also have shared is that last year in 2012 we were actually making about $200 million in run rate.

And we never provided a run rate for 2014 -- 2013.

But what we have said is that we would save -- delivered savings $250 million this year.

We are well on our way to save that this year, that is $250 million.

We also said, as you recall, about twice as much in the back half and the front half.

So if you go through the math, as you have done, Ricky, that would say that would be somewhere in that range that you discussed.

But it also says given the rapid pace of improvement we are making on our cost structure, there is a ramp and that ramp means that we will have a ramp going into the fourth quarter versus the third quarter.

So with that as just a -- refreshing our guidance on this I will turn it to Mark to round it off.

Sure, Ricky, as I mentioned again in my prepared remarks, some of the Invigorate savings is volume dependent.

And we were tracking actually ahead of our plan in the first half of the year and we are expecting to deliver something north of the $250 million that we communicated externally.

As volumes have softened we are expecting to still meet our commitment of over $250 million, but not quite reach the levels that we had thought and had projected and built into our expectations for the full year.

So therefore the ratio first half to second half has been impacted by two things.

One was that the overall savings are not going to be quite as high as we had hoped to achieve, but still exceed what we committed externally, the $250 million.

The second thing is that we actually were tracking ahead in the first half.

And that ratio could have held true if we had achieved our stretch targets for the year.

But since we aren't the ratio is going to be a little bit different.

Okay, that is helpful.

And then as -- just as (technical difficulty) the code stacking kind of like reimbursement delays.

Does this relate only to Medicare or are you also seeing some of that spilling over to the commercial side?

Dan, why don't you take that?

Yes, we have seen it with other payors on the commercial side, Medicaid side.

And keep in mind as you go through this with different payors and different states even on the Medicaid side, different payors are implementing on different timelines and they are taking different approaches to this.

We still have some payors in different states that were actually billing with the old coding system.

Okay.

So we expect that some of these will continue to move, but at this point we are seeing it across multiple payors.

Okay, thank you.

Bill Bonello, Craig-Hallum.

I had a question and a follow-up.

I want to revisit something you kind of touched on earlier but maybe push you a bit more on it.

I guess I am kind of flummoxed by the degree of attention that you are placing on sort of the challenging macro environment.

I mean if I look at your performance compared to the only other national lab, it is been incredibly divergent over the last three quarters with you guys obviously performing significantly more poorly.

And a guess what I want to understand is how we can get comfortable that you are accurately assessing what problems really might be performance-based rather than macro driven and what you might be doing to address those.

And then I do have a follow-up.

All right, Bill, thanks for the question.

First of all, we only have access to our data and we see what you see in terms of our competitors and what competitor you are referring to.

As you see and what we have said is that our underlying volumes, when you do all the adjustments, just look at an organic volume for Q3, it was down by about 2%.

That is adjusting for days and adjusting for everything we adjust for with our acquisitions and that is about at the same level we have seen for the last two prior quarters.

With that said, you then look at what we had expected from each of the different categories of our operation.

We have different mixes of business and different areas of focus than some of our competitors.

And I would say that in two dimensions, one from a product perspective or a service line perspective and the second is from a geographic perspective.

And so when you look through our business and you look at our pathology business and those earlier questions about Pap smears, there is a dynamic going on with that business which we understand and we are trying to (technical difficulty) payor partners and how they are growing or not growing and that could affect our performance as well.

So you go through the whole calculus and all we can do is control what we do control.

And so what we are focused on on our strategy to restore growth is -- number one, a better commercial organization or sales organization that does a better job calling on our customers to make sure that we have the best superior experience that we can for our customers that we can.

This includes on how we sell to them, how we service them and in any light some portion of this marketplace that is growing.

So that is why we put that in place.

Second is we created an organization around clinical franchises.

This clinical franchise organization is putting more emphasis of getting more solutions to the marketplace that is much more aligned with what you see from another portion of the marketplace that is growing which is sometimes referred to as the boutique or the specialized laboratories.

Our BRCAdvantage introduction this week is a great example of the new organization that we put in place.

From the Supreme Court ruling in June to today we sped up how quickly we'd get this to the marketplace.

We are quite excited about that as an introduction and we are encouraged by that.

So again, we are controlling our own destiny, we are introducing more to the market at a faster pace than ever before.

And then finally is we're building our professional services business.

And I will share with you this is gathering traction.

It's gathering traction because many hospitals in integrated delivery networks are quite interested in what their strategy is going forward and how we can help them with that.

Some of that took the form of two acquisitions this year with hospital outreach, but you will be hearing about more laboratory management and professional service relationships with a number of systems as we go forward because our funnel is building.

So we are encouraged by that.

So you look at fundamentally how does business go from one of our competitors to the other and vis-a-vis how do we compete versus those competitors.

We think we are focused on all the right things.

We are focused on the things that are going to drive volumes.

We also understand, and you understand that we have had a significant reimbursement change this year.

Our guidance this year is about 3% change in price.

We have our fair share of the cuts in Medicare which are outlined in my remarks.

But also we had a number of commercial contracts that anniversaried and we negotiated those terms and that is in the 3%.

So if you look at the top-line and you look at price erosion for us versus some others, we had a year where we paid out, if you will, in price concessions about $200 million and we are offsetting that as well.

So we believe that we are working on the right things.

We are disappointed by Q3.

We do believe it is a difficult market with a lot of headwinds.

However, we need to work on the things we do control.

We believe our five-point strategy, if you look through the five-point strategy, is the right strategy.

If you look at the results, four of those points are tracking very well.

The one we're disappointed in is our strategy to restore growth.

We think those initiatives that I outlined are the right initiatives.

Where you look at the marketplace and look at where people are growing, what I just outlined is what is going to make a difference for us so we do restore growth.

So that is my best summary of what we have done (technical difficulty).

Just a follow-up related to that.

You have been here a couple of years now.

In light of what you believe to be an extremely difficult macro environment, and in light of the challenges that you still have in front of you trying to cut costs and make some pretty significant operational changes while also trying to restore volume growth.

Have you given any thought to -- that maybe these are things that would better be achieved as a private company?

And are you exploring strategic alternatives at all?

Any openness on the Board to a sale where there hasn't been in the past?

Okay, Bill.

So first of all, I started here May of 2012, so time does go by fast but not that fast, so not quite two years.

But related to your question, this is a tough environment.

However, we do believe we operate in a very attractive market and we do believe that our five-point strategy positions Quest very well to deliver superior shareholder value.

And with that said, we do believe we are operating in the right way (technical difficulty), we believe we are making the proper investments.

We do believe that the plan is the best value creation plan irregardless of our ownership.

So that is our focus is our five-point strategy in building shareholder value.

All right, thank you.

Gary Lieberman, Wells Fargo.

Mark, just wanted to go back to one of the things you had said, maybe just to get some clarification.

You had mentioned that the Invigorate savings were at least in part volume dependent, and so some of those soft volumes had been slowing that down.

Can you just talk a little bit more about what the exact relationship is there?

Sure.

Within our cost structure obviously there is fixed cost and variable cost, Gary.

And we are not just saving on fixed costs; we are also saving on the rate on our variable cost.

So therefore the dollar figure that we have been quoting was based on a certain level of volume, revenue.

And as we have less volume obviously the dollar, not the proportional savings on our variable cost, is going to be lower.

Okay, that's -- that make sense, that's helpful.

And then, Steve, you had mentioned -- I don't know if you had put this number out there before -- sort of the $200 million in price concessions this year.

Can you characterize those to some extent or is there anything that you could have done differently maybe to not have to have had those?

And sort of where are we in terms of those anniversarying so that maybe the impact isn't quite as much on a year-over-year basis?

Yes, so, let me open it up and turn to Dan to round it off.

First of all, we have said from the beginning of this year that our price erosion would be 3%.

So if you go through the 3%, 3% in our business is greater than $200 million.

So it is consistent, we haven't shared the exact $200 million, but it is a big number for us and that is what we planned on.

As you know, we have very good line of sight in our pricing, that's a good part about this business.

Why do we have good line of sight?

We knew what was going to happen with Medicare.

We actually planned in that guidance for sequestration; it wasn't certain but we wanted to make sure we planned for the worst and hoped for the better.

And we have shared in our remarks that Medicare was about $50 million of that $200 million roughly.

Now that excludes and on top of you need to include the pathology cuts.

And the pathology cuts for us are substantial, that is 52% of technical fee and that was a considerable portion of the $200 million this year.

And the remainder is related to our price concessions with the commercial payors.

Some of that had started in 2012 and carried over into 2013.

We had a few renegotiations this year, we actually had shared in our second-quarter call that we renegotiated.

And we are very happy with our renewed contract with Cigna going forward and that is in the 3% or the $200 million for this year.

But what we also said when we were at investor day last November is that we expect over a three year period that price erosion would be about 1% to 2% over that three-year period.

And what we've also shared is that there's going to be more in 2013 than there will be in 2014 and 2015 as a percentage.

However, we still have headwinds associated with all the discussion we are having in Washington around further Medicare cuts, as I outlined in my remarks.

That is how it all fits together.

You ask, is there anything you would have done better?

Well, we are going to push as a trade association.

I would say that the effort we are mounting in Washington to offset any actions to get further cuts beyond what we have baked in is happening, so we are aggressively working on that.

I sit on the Board of ACLA; Dave King is the Chair or the Vice Chair.

We're actively working on this with members of the industry to make sure our voice is heard.

We think that this industry is [overpaid] substantially.

We are -- administrative represents about 70% of healthcare decision-making.

For Medicare we represent about 2% of cost.

In a world that you are worried about better patient outcomes and getting more data we are part of the solution to how you make that happen.

And if you look at these cuts that are being proposed going forward, not just for us and for our nearest competitor, but if you look at this marketplace with a lot of small regional players, it will be substantial for those regional players since they have a higher percentage of Medicare.

So we think we have a strong argument, our voice is being heard and we are working on that.

On the commercial side we are working actively with our commercial insurance partners.

As I said when I started in this job, I am actively engaged with many of them.

It's a key part of our business.

I see healthcare insurance as part of the transformational effort in this country.

We are making progress with them on how we bring more value to their membership.

How we work with them to narrow the networks to save them money and get us more revenues, which is an opportunity that we both enjoy so we are working that.

So overall it is about what we expected for the year.

The only change is, again, related to the earlier comments about what happened with molecular diagnostics and the coding, which is on top of, if you will, the 3% price concession guidance that we've given for the year.

So, Dan, would you like to round out my comments?

Yes, I think you touched on most of it.

The only other question I think I heard in there was around contracts anniversarying.

And so, we do have contracts that are anniversarying in the back half of the year, both third and fourth quarters.

So some of it happened in the third quarter, we will see a little more in the fourth quarter.

Okay.

And maybe you could just -- you had also mentioned that you thought it was going to take more time for the growth initiatives to kick in.

How does that sort of fit into the comments that you made?

Well, it's what was the big difference between the third-quarter expectations that we set and what we delivered.

And we have the three initiatives that we have outlined; those are priorities for this year -- more volume from a better sales organization and a commercial organization.

Second is more coming from products in our clinical franchise organization.

And then finally is our professional services business.

We have gone through the organizational change last fall; we snapped it into place in the first quarter.

We have plans and obviously part of those plans are making some modest investments in our sales force, our clinical franchises and building our professional services team.

We have actually made those investments.

We feel good about the progress, we feel good about the prospects that are building and we expected some of those to land in the third quarter, but unfortunately it did not happen.

It doesn't change our confidence.

Our confidence around what we are working on, our confidence about the market opportunities, our confidence about what we can get in this market as we continue to focus on the things we are focused on in our strategy.

And we are making progress but it will take longer.

Okay, thanks a lot.

Glen Santangelo, Credit Suisse.

I just had a couple of questions.

First was around the implied guidance for the fourth quarter.

It looks like you are using the midpoint of your range; you are looking for $0.93 in the fourth quarter, which is down almost 10% from what you reported this quarter.

And given the benefits you have from accruing from share repurchase, from some of the recent acquisitions, from some of the Invigorate savings, what are you implying I guess with respect to organic trends?

I mean, where are we going to see incremental deterioration in 4Q versus 3Q levels?

Yes, Mark?

Thanks, Glen.

Yes, Glen, I will try to answer that for you, thanks for the question.

Historically as you look at Q4, it does tend to be a softer quarter than Q3 given the seasonality.

I mean you have got the holidays.

As you look at overall billing days, etc., there's definitely a reason to suggest a softer revenue quarter even without any trend break in terms of reqs per day and revenue per req and all that.

So it is really just taking new accounts the days the fall within Q4.

No significant change in business momentum other than a little bit more lift we are building in for some of the initiatives that Steve talked about.

So we are not abandoning our belief that those investments are going to turn the tide, we just are getting a little more conservative, less aggressive in how quickly that will happen and we're basing that on what we saw in the third quarter.

Okay, that's fair.

And then maybe if I could just look forward to 2014.

I can imagine you don't want to comment on 2014 at this point, but maybe could you at least address the Affordable Care Act?

Have you done any sort of internal analysis in terms of what you think that could ultimately mean?

How much you think it could help volumes?

Any sort of high-level commentary you can give us at this point?

Sure, Glen.

Well, last quarter, as you know, we talked a fair amount about the Affordable Care Act.

And what we shared is it is taking more time to develop than we originally had expected.

We still believe that is -- that the Affordable Care Act is net positive, net positive for this industry and net positive for us.

And the simple underlying principle why that is is because there's going to be more lives with insurance and when more people have insurance they are going to need what we do.

Now as you know, with all the change that has happened this has been muted.

Only half the states have expanded their Medicaid program, which was an entry point for the lives.

We all know that the exchanges have been more problematic, but I will also share that we are negotiating with many of the commercial payors on other exchanges.

We actually feel good about that.

But as you hear and will hear from healthcare insurance companies they're being cautious about their ramp into the exchange world.

And also you know about of the issues associated with the government exchanges.

And then third is with the employer mandate being pushed out, again, this is another piece of where the growth would come from that is taking this out a year or so.

We had all expected as we entered 2013 that 2014 would be a year where we would see some of the benefits, that is more lives into the system; when more lives are in the system we would benefit from that and that has clearly been pushed out.

However, we still believe that the train has left the station.

We still believe that more lives will be insured with a variety of products.

And we still believe in the end when people have insurance and have access to the healthcare system they will be net positive for this industry, a net positive for us.

So, Dan, anything you would to do to round that off?

No, I think you touched on most of it.

Again, I think the exchange piece, as we said, we have been negotiating with a number of commercial payors.

We are pleased with how those have progressed so far and we have a number of contracts that we have signed.

A lot of this will depend on which contracts -- who the big winners and losers are in the exchanges in different markets.

And how many lives are signing up in terms of how it impacts the business.

But overall the rates we're seeing are generally in line with some of the commercial rates that we've seen in our existing contracts to this point.

Okay, thank you.

A.J. Rice, UBS.

Maybe just following up and talking about fourth-quarter expectations.

I appreciate on the -- income statement wise it looks pretty -- even maybe a little conservative.

But your cash flow assumption, you are going to need a pretty big pick up in cash flow in the fourth quarter to hit your target for the year.

And I just wondered is there some items that are going to swing in the fourth quarter that are going to drive -- I think you need more than $400 million to hit your target.

Just what is the thinking there and any impact on capital deployment decisions given a little lower cash flow expectation?

Yes, good morning, A.J.; I am going to turn that to Mark.

Yes.

No, we haven't changed any of our capital deployment plans.

And in terms of what is going to give us some uplift in Q4, it is really the -- it is the DSOs to a certain extent are a contributor.

We have had a delay in getting our Medicare provider number and for some of our acquisitions.

And so, we are highly confident that that is going to take place and we're going to get paid.

But at this point that's really been the driver and the spike in our DSOs in Q2 and Q3 and we expect that to be resolved in Q4.

Okay.

On the commentary about expecting sort of pricing pressure 1% to 2% annually for the next few years.

Maybe just to put it in perspective to sort of maintain margin or even start to talk about expanding margin what kind of -- give us a sense of what kind of volume growth you need in light of that pricing environment to sort of hold margin constant or even begin to expand it a little?

Yes, I appreciate that, A.J. Well, you go through the facts that we had in 2013, which was a substantially larger year than what we anticipate in 2014 and 2015.

So we will have less headwinds from pricing in 2014 than we clearly saw in 2013, that is number one.

Number two is we continue to talk about the acceleration and improvements that we are making on our cost structure with Invigorate.

It continues to build, it hasn't stopped.

We exited 2012 at $200 million; we talk about $600 million in 2014 as the exit.

And we are tracking to exiting at a higher rate than 2012 and we are going to be on a path to get to the 2014 number that we have committed to.

So that is tracking nicely.

Third is we have a little bit of headwind, as you would expect, on our wage bill.

We have to be competitive with our workforce.

And so we have to dial that into our expectations.

And we continue to build our 1% to 2% top-line opportunities with acquisitions, which is part of our disciplined capital deployment.

As you see in the back half of this year, A.J., we actually are now in the third quarter at 2% of the top-line, so we are getting to the higher end of the range.

And as you know, we do these acquisitions with a large part of those acquisitions based upon cost synergies.

As we work through the integration plans, and some of those integration plans are short, as short as six months, and some are as large as two years when it is more complicated.

It builds our profitability from those acquisitions.

So we have that flowing through in 2014.

So I can't give you the specific color of 2014 and we won't do it at this call.

But we are still tracking where we think our five-point strategy will allow us to build shareholder value.

And we do believe it is still compelling as we keep on working through this.

As you know, it is always more difficult to get the results with the headwinds in the challenging environment that we see.

And if that improves we are not planning on a significantly sunnier day, if you will, in the short-term.

But the challenging environment is making it more difficult and the challenging environment will improve.

And with the Affordable Care Act and more lives in the system, because we do believe there will be more lives in the system and that this marketplace is growing, we do believe we are an attractive marketplace.

And we do believe that our five-point strategy will give us lift as we go forward in 2014 and 2015 with our earnings and also with the opportunity to build shareholder value.

So we will keep you posted on when we will provide insight into 2014, but that is as much color as we can provide at this time.

Sure, that's great.

Okay, thanks a lot.

Amanda Murphy, William Blair.

I had a couple of follow-up questions on the volume.

Just a couple questions on the volume side.

I know we've talked a lot about it.

But obviously you have mentioned some of the underlying utilization trends, but one question I had was you've made some changes on the management side as well.

I'm curious -- did that have an effect on the business in terms of volume trends?

Yes, that's a good question and obviously we are going through territory by territory understanding where we see the effects can we explain it.

We've taken out a sizable portion of management throughout the entire Company.

As I shared with you, we had to do it.

One is we had a very complicated organizational structure; it was not aligned with our two highest priorities, which are operational excellence as well as restoring growth.

We now have an organizational structure that is leaner and is much more focused on those two priorities.

And in doing that we've taken out three management layers.

And actually we did this because we spent a lot of time inside talking to ourselves.

And one of our behavior changes that we are driving is to get more external.

And so, if you take out three management layers, which we have done, we're spending less time talking to ourselves and more time talking to customers.

And it starts with me and my entire management team and throughout the organization.

So when you referred to management, I actually think our management changes have actually improved our ability to get outside and our management today is much more externally focused than before, number one.

Number two though, as you go through a reorganization of the sales force, and these are at the sales rep level, we had to change our sales force organization to put an organizational structure that will be more aligned with the way our customers are organizing.

As you know, Amanda, customers organize around integrated delivery networks, they include hospitals, they include physicians, they include ancillary services.

And so, we now have a geographic organization, we made those changes.

We did have some account assignments in the first quarter that we had to change to get a more effective organization and we feel good about that.

We did incent our sales force to make sure any changes between the accounts between sales reps would be handled properly.

We don't see substantial defections or losses in accounts because of that.

We do track our customer experience and we think we're actually improving how we experience -- or our customers experience us.

So when we go through all the data we think we've made all the right changes.

We believe that when you get down to the granular level they're actually moving in the right directions.

But we haven't seen anything come out of some of the positive sides of these.

We do expect more productivity from our sales reps; we expect our sales reps to be able to sell more.

We expect them to be able to get more from our new products.

And that is what we planned for in the $50 million expectation that we set.

So that is the disappointing side of Q3.

This is a lot of change.

We believe we are making the right changes and we are doing the right things, but it will take longer.

So that is my best perspective I can give you on what we've done and how it has affected our business.

Okay, got it.

And just a broader question.

Obviously the space has been -- and just healthcare in general have been challenged by lower utilization rates for quite a while now.

So at what point do you say maybe this is the new normal?

And if that is true then I guess longer-term when you talk to M&A, helping you supplement that growth, but how long is that runway?

Well, as you know, first of all, we are not planning on the environment changing abruptly or getting better quickly.

You see that in our guidance for Q4 and that is what we should plan for and we believe that is being prudent.

Second is if we are feeling pressure this whole industry is feeling pressure.

If you look at the most broadly defined market, ourselves and our nearest competitor represent about 20% of the market, 20% of that overall market and that has hospital outreach included in that.

The reason why we are encouraged by our professional services business, many of the hospital clients we are now selling into are thinking about their lab strategy, which includes potentially selling their outreach business.

The list continues to grow.

They are also looking at us of helping them manage some of their inpatient laboratories or helping them with their outreach activities as well and we are encouraged by that.

And then finally is if you look at the smaller players, the regional players in this marketplace, they have a much higher percentage of the business for Medicare.

So with these cuts that we've seen this year and the potential cuts going forward, we think there is an opportunity for the strongest player, the leader in this industry to continue to consolidate and gain share.

And our plan, our five-point strategy addresses that.

So we are moving forward on this strategy that we have to use some portion of our capital to get 1% to 2% top-line for acquisitions.

As I mentioned, we actually moved to the two side of that range in the third quarter.

We are encouraged by that in the third quarter for the fourth quarter and we continue to build our funnel.

And there is a growing level of interest of parties that might consider selling.

And also, we want to make sure that these are strategically aligned and accretive acquisitions as we go forward that helps build shareholder value.

So that is my perspective.

Mark, would you like to round that off?

Just one thing I would add, Amanda, is I think we are seeing a rebasing of utilization driven by a lot of the changes that we are all familiar with.

One could argue maybe there was over consumption of healthcare and we are rebasing it.

But at some point you are rebased and then we should be growing along demographic lines.

When that point is, I'm not sure.

In addition to that, when you think about the desire to move from treatments to early detection or prevention, it is our belief that diagnostics is a great part of that solution.

So that is -- Steve said it in his remarks, we believe this is a great space.

Those are really the drivers.

While we certainly have had a couple of tough years here and it's not looking like it's going to be over in the immediate term, we do think that long-term this is a good space to be in.

And also, as Steve said, one that is likely to migrate to the highest quality low-cost providers and we certainly expect ourselves to be there within this marketplace.

Yes, so, this is a tough environment, we all know that.

But we also, to Mark's point, believe this is a very attractive market.

There is the routine work that we do, but most importantly we are investing in the advanced and esoteric work.

And I think our example this week of our launch of BRCAdvantage is a great example where we will be entering a market that is growing and enters in a market where clearly more information and more insight is helpful to helping healthcare overall.

And that is one of the areas of focus for us is to make sure we introduce more innovative solutions to the market.

And as we have talked, it is not just the diagnostic, it is the information, it's the services.

And that to us will fuel new growth as we go forward.

And we look at those prospects; we believe this is a very attractive market despite the difficult environment we are operating in today.

Okay.

Thanks for much, guys.

Thank you for participating in the Quest Diagnostics third-quarter conference call.

A transcript of prepared remarks on this call will be posted later today on Quest Diagnostics' website at www.QuestDiagnostics.com.

A replay of the call will be accessed online at www.QuestDiagnostics.com/investor or by phone at 888-566-0076 for domestic callers or 402-998-1224 for international callers.

Telephone replays will be available from 10.30 AM Eastern Time on October 17 until midnight Eastern Time on November 16, 2013.

Thank you and goodbye.