奎斯特診斷 (DGX) 2014 Q3 法說會逐字稿

Thank you for standing by.

Welcome to the Quest Diagnostics third-quarter 2014 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 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 introduce Dan Haemmerle, Executive Director of Investor Relations for Quest Diagnostics.

Go ahead, please.

Thank you, and good morning.

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

During this call, we may make forward-looking statements and also discuss non-GAAP measures.

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' 2013 annual report on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K.

A copy of our earnings press release is available, and the 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's Steve Rusckowski.

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

This morning, I will provide you with highlights of the quarter.

We'll share industry trends and also review progress we're making against our five-point strategy.

Then Mark will provide more detail on the results and take you through guidance.

During the third quarter, we delivered against our expectations, continued to make progress against our strategy, and reported top and bottom line growth.

In the quarter, revenues grew 6.5% to $1.9 billion.

Adjusted EPS increased 8% to $1.10, and cash from operations was strong at $271 million.

What I would like to do is to start with some brief comments on industry trends.

We have said diagnostic information is a powerful lever for transforming healthcare, and we're determined to be paid appropriate for the value we provide.

In this respect, our trade Association has been getting the message out about the value of diagnostic information to healthcare.

We're making progress as an industry, but reimbursement dynamics continue to evolve, and there's much more to do.

To give you an example, in July, Tricare announced it had committed to restoring payment for 40 molecular codes that had previously been denied in some cases.

During the third quarter, we saw progress of payment on codes that previously had been denied.

This is a nice sign of progress we are making as an industry.

Also in April, Congress passed the so-called doc fix legislation that delayed adjustments to the clinical lab fee schedule until 2017.

We have been working with our industry trade association to participate in the rule making process.

This will define new rates based on a market-weighted median of commercial rates for a broad range of labs, which include both large and small independent labs as well as hospital outreach labs.

We remain hopeful that this will produce a representative view of market-based pricing.

Being appropriately reimbursed for the value we provide is critical to our success, and we compete on a compelling value proposition, not solely on price.

Also, we continue to work closely with our trade association on an another important issue.

And that is to oppose the FDA's proposal to regulate laboratory developed tests, referred to as LDTs.

We strongly believe that unnecessary and duplicative regulation could delay patient access to life-saving treatments and compromise America's leadership in diagnostic discovery.

Regarding the Affordable Care Act, while it's still early, we continue to see modest shifts from uninsured patient volumes in the third quarter to government and other payers.

Regarding the market dynamics, we saw additional signs of improvement in healthcare utilization through the quarter.

And then finally, we'll provide you an update on our views on the market and the competitive landscape at our Investor Day in New York City on November 5.

Now, let's look at the progress we're making in excluding our five-point strategy.

Our top priority is restoring growth, and we again made solid progress in the quarter.

The investments we've made and efforts to improve our sales effectiveness are yielding positive results.

We saw continued improvement in sequential trends in revenues, organic volume, and organic price.

If we exclude business we walked away from, organic revenues would be favorable.

Revenues showed strong growth in several product categories, driven by our clinical franchises, which included prescription drug monitoring, health and wellness, and infectious disease.

Last quarter, we told you about the partnership with Memorial Sloan-Kettering Cancer Center.

Our plans will provide annotated reports on [solid] tumor analysis based on a panel of 34 clinically actionable gene mutations.

We launched those expanded OncoVantage panels during the third quarter.

Solid tumor cancers account for about 90% of all cancers diagnosed in the United States every year.

Also, as promised, we began to offer our customers national access to Sequenom's noninvasive prenatal test.

And we continue to build our professional lab services business, and finalized yet another agreement with a medium-sized community hospital on the East Coast.

We are making good progress advancing conversations from our pipeline into proposals and new business.

These are all great examples of how we are empowering better health with diagnostic insights to make this a better world.

We're also making progress on other key areas of our strategy.

We made a number of advances in our efforts to improve our customer experience by driving operational excellence.

We opened our Lab of the Future in Marlborough, Massachusetts, which will use advanced automation technology to improve the quality and efficiency of diagnostic testing for the New England market.

The Invigorate program remains on track to deliver the expected cost savings this year.

As you know, the Company shared an initial target of $500 million in July of 2011.

Since then, we have increased that target to $600 million, delivered the original target a year earlier, and now expect to exceed the new run rate target by delivering $700 million in run rate savings as we exit 2014.

Over the past year, we've been advising you that we will update our future plans for Invigorate at Investor Day.

We intend to deliver on that commitment, and we will provide you with additional details on our plans to deliver total run rate savings in excess of $1 billion.

In addition, we made progress integrating recent acquisitions.

We told you that Solstas and Summit were expected to be dilutive for the first half of 2014 but accretive in the back half, as we work through our integration plans.

We are pleased with the progress we have made realizing the expected synergies.

I'm also happy to report that these acquisitions, as well as Steward and ConVerge, were all accretive on an adjusted basis during the quarter.

The third element of our strategy is to simplify the organization to enable our top priorities of growth and operational excellence.

Our simplify strategy extends well beyond our organizational redesign to also include improving organizational capabilities, culture, and processes.

We continue to strengthen the management team and build our high performance culture.

And we have also continued to strengthen our Board.

Recently, the Board elected Dr. Jeffrey Leiden as our newest director.

He currently serves as Chairman, CEO and President of Vertex Pharmaceuticals.

Jeff is the third new Board member added this year with significant CEO experience.

Coupling this with his deep management, scientific, and clinical background in health care, this will strengthen and complement our Board's capabilities.

Finally, we continue to deliver disciplined capital deployment and refocus on our core diagnostic information services business.

We generated $271 million in cash from operations during the quarter.

We utilized that strong cash flow performance to return value to our shareholders through dividends and stock buyback program, and to repay debt associated with the Solstas transaction.

As you can see, we continue to make progress executing our five-point strategy.

Now Mark will provide an overview of our third-quarter financial performance and update you on our latest guidance details.

Mark?

Thanks, Steve.

Starting with revenues, consolidated revenues of $1.9 billion were 6.5% ahead of the prior year.

Excluding acquisitions and the divestiture of the Enterix business last year, our underlying consolidated revenues were essentially flat to prior year, reflecting another sequential step forward in our path to restoring growth.

Our diagnostic information services revenues, which account for over 90% of total revenues, grew by 7.1% compared to the prior year.

Revenue per requisition in Q3 was 60 basis points lower than the prior year.

Excluding the effect of acquisitions, revenue per requisition was slightly favorable versus the prior year and improved sequentially from the second quarter of 2014.

Compared to a year ago, price pressure continued to moderate, and we benefited from favorable test mix.

Volume for the quarter was 7.8% favorable to the prior year.

Recent acquisitions added approximately 8% to volumes.

Last quarter, I shared that we had made prudent decisions regarding pricing and, in some cases, decided to walk away from existing business.

Excluding the impact on revenue from these decisions, our underlying volumes were favorable to the prior year by approximately 1.5%, and represents another quarter of sequential improvement in year-over-year volume growth.

Q3 revenues in our Diagnostic Solutions businesses, which include risk assessment, clinical trials testing, healthcare IP, and our remaining products businesses, were lower by about 70 basis points compared to the prior year.

The divestiture of Enterix reduced revenues for our Diagnostic Solutions businesses by nearly 2%.

Excluding this impact, our Diagnostic Solutions businesses grew by approximately 1% compared to the third quarter of a year ago.

Adjusted operating income at 16% of revenues was about 50 basis points below the prior year, with the decrease due principally to the increased funding of management compensation compared to a year ago, and the initial lower margin profile on our recent acquisitions.

Earlier this year, we shared with you that we expected the Summit and Solstas acquisitions to be dilutive in the first half of the year and accretive in the back half of the year.

I'm happy to report that these acquisitions were accretive in the third quarter on an adjusted basis, as we made nice progress on those integration plans.

In addition to delivering on our integration plans, we continue to make progress on our Invigorate program.

We continue to expect to achieve approximately $200 million in realized savings during 2014, and approach approximately $700 million in run rate savings as we exit the year, with a longer-term goal of greater than $1 billion over time.

As I shared last quarter, we will provide additional details at our Investor Day in November.

Adjusted EPS of $1.10 was 7.8% better than a year ago.

As a result of the Company's ongoing efforts to restore growth, drive operational excellence, and simplify the organization, reported operating income was reduced by $48 million, principally related to restructuring and integration costs.

This reduced reported operating income as a percentage of revenues by 2.6% and reported EPS by $0.22.

Last year's third quarter reported operating income from continuing operations included the gain on the sale of ibrutinib royalty rights, the loss on sale of the Enterix business, and restructuring and integration costs.

These items resulted and a net benefit to reported operating income of $395 million or $1.64 per diluted share.

Bad debt expense as a percentage of revenues was 4%, essentially unchanged from the prior quarter, and an increase of 40 basis points from the prior year.

Our DSOs were 46 days, a one-day improvement from last quarter.

Cash from operations was $271 million in the quarter, compared to $186 million in the prior year.

Capital expenditures were $102 million in the quarter, compared to $51 million a year ago.

During the quarter, we repurchased $25 million of our common shares at an average price of $62.03.

We plan to meet our capital deployment commitments for the year by returning the majority of our free cash flow to shareholders, through a combination of dividends and share repurchases.

We also made progress against our debt repayment commitments by reducing our debt by approximately $90 million in the quarter.

Turning to guidance, we now expect full-year 2014 results from continuing operations before special items as follows -- revenues to grow approximately 3.5% compared to a year ago, versus 2.5% to 3.5% previously.

Adjusted diluted earnings per share to be between $4.03 and $4.07, compared to previous guidance of $4.00 to $4.10.

Cash provided by operations to approximate $900 million in capital expenditures to approximately $300 million.

Now I'll turn it back to Steve.

Thanks, Mark.

Well, Mark, if I recall correctly, about a year ago you joined Quest.

And actually a year ago on this call, you shared several priorities.

And those priorities included improving our predictability and supporting the business to achieve our five-point strategy.

Just as we are making progress on our five-point strategy, we are also making progress on our commitment to improve our guidance and deliver on our commitments.

Well, to summarize, we delivered a second solid quarter of top line growth as we continue to build momentum.

We made good progress executing our strategy, and our Invigorate program remains firmly on track.

As a result, we delivered 8% earnings-per-share growth, and we are on track to meet our commitments for 2014.

And then finally, I'd like to share, I look for to seeing many of you at our upcoming Investor Day, where we will provide some longer-term perspective and deeper updates on our strategic plan.

Now we'd be happy to take your questions.

Operator?

Operator?

Thank you.

We will now open it up for questions.

(Operator Instructions)

Ricky Goldwasser.

Good morning.

I have a quick question on the volume number.

Mark, you talked about 1.5% organic volume figure for the quarter, which I think is the best number that you've done for a very long time.

So can you just share with us where are the volumes coming from?

Are you seeing it from exchange population, Medicaid population, or are you starting to see improvement in core business utilization?

And also just the margins that are associated with the new business?

Thanks for the question, Ricky.

A couple things.

First off, organic volume was pretty flat year-over-year.

What I had talked about is there were a couple of specific accounts that we had made a decision, based on pricing, to walk away from earlier in the year.

And what I've said is if you exclude those and that volume, volume would have been up 1.5%.

But nonetheless, I think the important message is that organic volume trends continue to improve.

And when we started in the beginning of 2013 at minus 200 basis points, since then we've crossed the threshold to less than 100 basis points of decline.

And now essentially, organic volume has been flat in the most recent quarter.

So there is an improving trend.

Where is that coming from?

I think it is somewhat across the board by [payer] type.

We did say there was some reduction in the uninsured.

We had continued to see some modest growth in Medicaid.

However, it's really in some of the growth [tests or] franchises that we've talked about before.

So PDM continues to be an area of strength.

Hepatitis C continues to be an area of strength.

Obviously we've launched our BRCA offering, which is growing.

So it's no single payer.

I couldn't certainly attribute it specifically to anything in the Affordable Care Act, although certainly, it seems like it's directionally positive.

So that's what I would say, is it's continued growth in the areas that have been growing and just utilization picking up a little bit.

And then I think just our business gaining strength.

Okay.

And just one follow-up there.

Obviously, I think, last quarter you said that the impact on volume once you normalized from the businesses you exited was about 1%.

It seems like it's 1.5% now.

So is this a function of you exiting additional accounts?

Or is it just an impact of the full quarter of the things, I think, existing business that you've exited last quarter?

No, it's the same accounts.

It's not additional accounts.

And it's really just the impact in this quarter was a little larger than the impact in the previous quarter, given the timing.

But what you see though, as you said it, is as we said consistently, we're going to move step-by-step, improving our underlying business.

And you see some underlying improvement in third-quarter versus Q2.

So we feel good about that.

Okay, thank you.

Thank you.

Glen Santangelo.

Thanks, and good morning.

Steve, just wanted to follow up with you on some of the pricing comments that you made.

It seems like the Company also experienced this sequential improvement in organic pricing trends.

And so I'm wondering if you could maybe give us a little bit more color and clarity around what you're seeing in terms of Medicaid pricing.

Any big commercial contracts coming up?

Or what's really driven that slightly better organic pricing number?

Yes, sure.

Thanks, Glen.

Well, if you go back to 2012 -- and we've been consistently talking about this -- we provided a guidance that over a three-year period, we expected real price.

And when I say real prices, really freezing other variables and just looking at unit price changes with contracts.

And Medicare, Medicaid reimbursement would be reduced by 1% to 2%.

It was higher in 2013.

And then what we also said is we believe it's going to be lower this year into 2015.

And we actually believe we're on track to achieve that guidance we provided.

In that respect, we're seeing lower year-on-year comparisons of price and sequential year-on-year comparisons in price.

Contractually, we have good visibility of this.

We don't have any major renewals coming forward.

We've already shared with you the effect of the clinical lab fee schedule [underpriced] this year, which was about 1.75% this year.

And then also, what we see overall -- and you look at revenue per [rec] is a mix in our business.

So when you go through that mix in our business, which is different than what we talked about with price, this quarter and even compared to Q2, we saw a richer mix, which generated a revenue correct which was favorable.

So, Mark, I don't know if you would like to add to any of that?

Yes.

I think Steve covered it.

We said in the first quarter price was down about 100 basis points.

In the second quarter, about 80 basis points.

And in this quarter, it was down about 30.

I think it's a combination of the timing of contracts being more disciplined.

But also, quite frankly, putting more rigor into our pricing efforts across the organization on things such as client bill negotiations and things like that.

So I think as an organization, we've really instilled a greater discipline around price.

And obviously we are also benefiting from the timing of contracts that we didn't benefit from in 2013.

And then, as Steve mentioned, the revenue per rec, when you exclude the impact of acquisition mix, as I said, revenue per rec was actually up.

And so it was some slight price decline, offset by some favorable tests and payer mix.

And maybe, if I could just follow up with one longer-term question on pricing.

Obviously, a lot of questions around 2017 and the potential changes to the clinical lab fee schedule.

And I think, Steve, you commented on some of the lobbying efforts that are going on.

Can you maybe give us some of your initial reactions with maybe how you see market pricing being defined by the regulations?

And who's included and who's excluded in that sort of market price?

And are you happy with the directions that's heading, as obviously it's going to have some impact on your business?

And I'm just curious if there's any initial comments to make at this point?

Thank you.

Glen, I appreciate that.

As I said, we're working hard as a trade association.

We're all working on this because it's very important.

First of all, we're working with CMS on the rule-making process to make sure we get it right.

And as matter of fact, a couple weeks ago, we were visiting CMS and were talking through how they'll gather the data.

You can't get a full view of the market without all the competitors in the market.

And as I said in my introductory comments, that includes large independent labs like ourselves, smaller independents, and hospital outreach.

We've been consistent on that, and we're trying to work through just how we'll collect the data from all those three pieces to get a real representative view of the market.

As you know there's wide variation in pricing.

And actually, we provided in the market -- from the trade association -- a quick snapshot on what we believe the true market base pricing would be by certain codes we did a sample on.

And we look at that -- actually, the CMS prices are not widely out of line from the median that we had sought in the market in that survey.

So we will continue to work through the rule-making process.

They'll gather the data in 2016.

And, Glen, until you gather the data, you do not know what the results are.

But if we have a thorough process, a good process, and we really gather the data to really get a market-based price, we believe that the outcome will be the outcome.

But it's not nearly as bad as what some people had intended.

But we've got some work in front of us to keep on working on this to get it right in the process and gather the data correctly and correctly represent that in the clinical lab fee schedule.

Okay.

Thank you very much.

Mike Cherny.

So I want to delve a little bit more into some of the commentary you had around the business that you walked away from.

As you think about -- I think you did this on, pretty much, a contract-by-contract basis, but what are some of the metrics, specifically?

I assume it's not just price, just margin.

How much of it is impacted by the return you [got from other business]?

Maybe walk through some other financial metrics that will cause you to say that this contract or this business is no longer for us.

Let me start, and then I'm going to turn it to Mark.

First of all, we're trying to build value, as you would expect we would.

And in building value, we're trying to make sure that we drive earnings per share growth, which you saw this quarter.

And in that regard, there's a lot of levers.

And one of which is price.

And in our portfolio of our clients and our customers -- and we have a wide range of customers and clients.

And so what we have done in executing our plans is to take a careful look at all of the business we do and to make sure we keep on getting as much value out of those accounts as possible.

So some of this, I would describe it as hygiene -- to keep on working through our portfolio of businesses.

And some of the actions we've taken have helped us improve our margins.

And you see that reflected in this quarter's results.

But, Mark, why don't you add to that?

Specifically, what have we adjusted for to get to 1.5% growth when you adjust for these decisions we've made?

Yes.

I think Mike was asking also about the decision criteria.

So, yes.

Obviously, a margin is a significant driver in the decision which, of course, is the outcome of price with some variables, depending on where the geographic location for that business is.

And therefore, what are the other cost associated with it, such as logistics and so on and so forth?

What does the book of business look like in terms of the test mix and payer mix?

So there's a number of things that go into it.

Price is the biggest driver in that margin decision.

But there are some cost variables as well that we look at.

I think the importance here, and why we decide to share it, was we wanted to send the message that not all volume is a value-creating volume.

And we're focused on value-creating volume.

And there's also some competitors in the marketplace that compete on price.

That is not us.

And to the extent that we find ourselves in situations where the price is not rational, we are going to walk away.

And we're going to stick with our strategy.

So that's really why we decided to share this.

It's not as much about, in some way, modeling an organic volume and suggesting it's different than what the actual results are.

But helping people understand that volume alone is not going to give you margin and growth, your bottom line and your cash flow.

And it's got to be value-creating volume.

Thanks.

And then just one quick question, or quick thought, on some of these hospital outsourced arrangements.

Obviously a newer opportunity for you.

Can you talk about how some of those conversations evolved?

You talked about the midsize hospital on the East Coast.

What led them to decide to work with you?

And then over time, what type of capacity do you have to add on incremental types of these contracts?

Yes.

It comes to us in a lot of different ways, Mike.

First of all, we have a sales force that's selling to about 50% of the hospitals.

So we have good presence in all the hospital systems throughout the United States with our sales force.

Second is we have very good executive access.

And when we talk about this as part of our strategy, we've garnered a lot of interest from hospital executives.

And quite often, myself and a few of the leaders on this business are spending time discussing with hospital CEOs, and typically their CFO, what their lab strategy is.

Like so much in healthcare, you see one, you see one.

And so we sit down, and we have a conversation about our lab strategy.

And we talk about the whole range of possibilities of different working relationships, where we can do reference work.

We could buy your outreach business.

We can form a joint venture.

We can run your hospital laboratory, which we call laboratory management.

It will eventually end up in a place that is tailored to what they're trying to achieve in their system.

And so the contracts and engagements we've announced all are very different -- all are quite different.

And I can tell you that some are small community hospitals.

And some discussions that we're having are large, very large integrated delivery systems that are substantially reengineering what they're doing in healthcare.

And as part of that, they're thinking about where they put their resources and what's the best approach to laboratory services in that respect.

We're generally thought of as a trusted partner, and we can help them with that.

So that's the way we approach it.

I just want to add, Mike, just to be clear.

When you ask about capacity, certainly a lot of these deals come with reference work.

So we may have been doing the reference work, or we may be getting the reference work.

But in many cases, we're actually managing their workforce.

So the -- it's not additional strain on our lab capacity.

It's actually our capabilities to help them run their lab better, together with our procurement leverage, is really where the value creation comes from.

So it's not bringing all their in-house testing into the walls of our laboratory.

It's actually running their lab for them, with their people.

That's very helpful.

Yes.

Just to add to that.

We have a large hospital laboratory management deal.

What we arrived at is an opportunity for them to save somewhere in the neighborhood of 10% to 15% on their hospital-based laboratory cost.

And one potential strategy we deploy to get there is we take a portion of their menu, and we actually move it to our geographic laboratory.

And this is the more high-volume oriented portion of their menu where we could still respond in an active way to meet the requirements of earning their hospital.

So it's good for us because, as you know, most of our laboratories are really in full force, starting at midnight to 8:00 in the morning.

So during the day, we actually have a lot of capacity idle.

So it's an opportunity for us to use that capacity to help with this portion of our business.

Great.

Thanks for all the details, guys.

Thank you.

David Clair.

Good morning.

Thanks for taking the questions.

I guess the first one for me -- just wondering -- you spoke about the FDA regulation of LDTs.

So just curious what your exposure there is.

And what do you think the cost would be to push these through for approval?

Well, first of all, as you all know, we're already regulated.

So we already meet the requirements of CLIA.

So we already have oversight.

And so the question that we all have as an industry is, why do we need more?

And some portion of this would be redundant with what we're already meeting.

So there's a concern about how these two get reconciled as we go forward.

And frankly, the proposal in the language has been silent on that topic.

Second is, in essence, what the language would say is that LDTs are devices -- medical devices.

And when you meet the regs of medical devices, there are substantial changes in getting regulatory approval for new products and also having a quality system to meet those regs.

We haven't provided the size of that for labs like ourselves, but it's not insignificant.

And there's two parts again.

It's, one, getting a new product to the marketplace -- a new solution to the marketplace.

And then second is running our operation on a day-to-day basis.

Our concern, particularly when new innovation comes into the marketplace, is what it would take for us to bring new innovation, particularly in the case where some laboratory developer tests may require a PMA for approval.

And that's a lengthy, drawn-out process, where today, we believe we can -- with good data -- support that our LDTs we introduce to the marketplace are safe and efficacious and, therefore, do not require what a device manufacturer would need.

And that's our position on it.

So we haven't sized it.

We haven't provided it, but it is substantial.

There is concern about the redundancy that we would have in this industry.

And what we'd like to do is to understand what we can do to bring these points forward as a trade association and we're doing that.

Okay.

Thanks for that.

And then I was just hoping we could get a quick update on some of the women's health products.

So specifically, Pap volumes, BRACAvantage, and IPT?

Sure.

Mark mentioned where we're getting some of our growth.

Well, BRCA continues to grow.

We're seeing nice, sequential pickup in our offering in the marketplace.

As you know, that's a big market and a market that's still growing.

And we're starting to gain some share.

So we feel good about progress made there.

In noninvasive prenatal testing, we talked about our introduction of Sequenom's solution in the marketplace.

So we're seeing nice growth in that market.

And as far as Pap is concerned, we continue to see the slowdown of volumes, quarter-on-quarter, until we get to some normal steady state of volumes, given the new clinical guidelines that are out there in the marketplace.

So we still haven't quite bottomed out there yet.

Thank you.

Bryan Brokmeier.

Hi.

Good morning.

Steve, you said that you saw a richer mix of business.

Was any of that mix one-time in nature?

Was it a trend of higher-priced tests that you expect to continue?

I assume the BRCA test is one positive factor there that should continue, but are there are others?

Yes.

So if you look at some of the growth we talked about, most of the products we're introducing in our clinical franchises are new solutions that have higher prices.

So therefore, if you look at the mix going forward, you should see some effect for that on a continual basis.

So that's some of it.

Second is, we did say that the acquisitions that we brought in did affect our revenue per rec.

And if you adjust for that, we actually saw an improvement year-on-year.

But there's nothing here that was one big one-off -- if you will, if that's what you're asking -- that won't continue going forward.

Mark, would you like to add to that?

Yes.

Just to add to that.

Steve talked about the fact that we have some Tricare payments, but as we've said before and I'll confirm, it's not material.

So it's good to see.

That's a positive sign, but that was not an extraordinary catch up.

It's not significant in terms of overall revenue, but still nice to see.

So, absolutely not.

This is really where the business is trending.

There is nothing unusual.

And actually, we would expect to see more growth in those higher-value, hence, higher-priced areas and favorable mix going forward.

The one exception is, we've talked about our laboratory professional services does have a lower revenue ForEx.

So obviously, depending on the timing of some of those deals, that could have a mix impact that goes the other direction.

But as we've also stated that despite the lower margins, those are very attractive from a return-on-invested-capital perspective.

So still very value creating.

Great.

And on the unprofitable business that you walked away from, where these contracts that you had to terminate, were you able to renegotiate terms on similar agreements that you ended up not terminating?

And are there more of these that you may walk away from in the current quarter or into 2015?

Yes.

What I would say, as Steve mentioned, we did some hygiene work.

So we looked across our portfolio, and we looked at some specific books of business that we didn't think were creating acceptable value.

We engaged with those parties around some pricing discussions, weren't able to come to a reasonable outcome in our opinion, and that was a discrete exercise, which I would call a portfolio rationalization.

As we go forward, we're going to have the same discipline in any new offerings, any renegotiations, et cetera.

So there always could be, for the same reason, an account that we walk away from.

Because we say, hey, given your pricing position and the competitive price environment, this just doesn't make sense for us.

However, I don't want anyone to think that there's going to be a regular rhythm of exiting accounts.

This was really a refresh of our portfolio.

And that's why we've taken the time to talk about it.

Okay, thanks a lot.

Darren Lehrich.

Good morning, everybody.

So I just wanted to come back to the margin topic.

It sounds like you clearly exited some unprofitable business.

That accelerated in the third quarter.

Then, Mark, you're describing a little bit of a pickup from Tricare.

And I think you said in your prepared remarks that the deals were accretive in the second half, versus dilutive.

So when we look at margin down year-over-year and a stable pricing environment and some of the things you're describing, what are some of the other factors at play with margin?

Is it a mix of your hospital management business?

Maybe just help us think about the margin decline year-over-year, despite, I guess, some of the things you've described in the exited businesses, which were a drag.

So obviously, Darren, margin is our total enterprise.

And when you look at, despite the fact that the acquisitions were accretive, they're not yet to the margins of the ongoing organic business.

So from a mix perspective year-over-year, since we didn't have those books of business, there was some negative mix impact.

We also referenced the fact that -- we talked several times about the fact that management incentive comp would be headwind this year because last year, we didn't pay out anywhere near the target.

And we're still accruing and hoping, expecting to pay out more to that target.

So that's a headwind as well.

And then we talked about inflation.

But with the $200 million we're getting from Invigorate, largely, those two things -- the inflation and the management comp -- should be offset.

So really what you're looking at here, largely, is a combination of the mix impact of the new book of business we have.

And then bad debt was up 40 basis points year-over-year.

And I'd really say those are really the contributors to that decline.

So we feel good about the margin going forward -- the margin profile.

Certainly, also as you mentioned, some of these laboratory professional services which we're really just wanted to ramp up -- initially, just like an acquisition, those margins are not where they're going to be in the long run.

Because there's things to do to get those operationally to their long-term margin.

So it's a lot of different pieces.

But we feel good about, generally, where our margin is heading.

Okay.

That's helpful.

And just remind us again, the management incentive comp -- the year-over-year impact on margin from that?

We haven't quantified it.

Typically, we said, hey -- previously -- we had about $200 million of Invigorate savings.

When you add merit inflation and, I guess, SWB inflation and the management comp, that a big chunk of that was going to be taken up for both those items.

So it's not insignificant.

Okay.

Then my follow-up here is just, as it relates to molecular pathology, you mentioned some modest success with Tricare.

We've been hearing that still a lot of the state Medicaid programs are challenging, in terms of getting paid for molecular pathology.

So how much is still out there, in terms of what was denied?

And can you just give us a brief update on how you're seeing the progress with some of the state programs?

Dan, why don't you take that one?

Yes.

Darren, we said in the past the total molecular coding impact for us, when you look at it, the umbrella of tests we're looking at, represented about 5% of consolidated revenues.

So that puts an umbrella over the entire amount.

When you look at this -- and that's 5% across all payers.

Okay?

Commercial payers, government payers, et cetera.

We continue to work through this with all the payers -- the commercial payers as well as government.

And on the Medicaid programs, it's state-by-state, and it's code-by-code.

So we're engaging in different discussions in different states, and there's different levels of success.

We spoke to one state last year that had overturned their position and started to reimburse on the particular code late in last year.

So there was a positive sign there.

Other states have been more challenged to move the bar with those.

But it's something we continue to work on.

And we look at the state we referenced last year.

We looked at the Tricare scenario here that we talked about earlier today as two good proof points.

And we'll continue to work the issue one payer at a time.

Okay.

Thanks a lot.

Isaac Ro.

Good morning, guys.

Thank you.

Just wanted to ask a question about fourth-quarter seasonality.

We've seen an uptick in healthcare utilization across the board, I think, in the fourth quarter for at least the last few years.

I'm wondering if your guidance for the rest of year assumes that that trend will continue or, perhaps, increase this fourth-quarter?

Mark, why don't you talk and take us through the seasonality we see in Q4, typically.

Obviously, when we model any given quarter, we model the year, we take into account historical performance.

So any sort of seasonality we may or may not have seen would be one of the bases for our forecast.

So I don't think we're expecting any significant deviation from our quarterly pattern.

So really, what's driving Q4 is where we see the business trending, both in terms of some of the growth areas -- some of the areas that may be a little drag like Paps -- and then things like potential for laboratory professional service and [sells] and so on and so forth.

So we're expecting -- as we get into this time of year -- an average weather month.

So we certainly have built in, based on history, some sort of weather impact.

But nothing extraordinarily good or nothing extraordinarily bad at this point.

If I could just press you a little bit there.

What is different this year?

Of course, the enrollment for ACA and all that is changing deductibles and [cost burdens] and so forth.

So there's plenty of reason that people might be deferring utilization to the end of the year and all that.

So I'm just curious, as you think about forecasting, if that was a meaningful change to your process.

That certainly, I think, could be within the trends we've already seen for the third quarter.

Some of that will, maybe, be more pronounced in Q4, given, hey, I got a procedure.

Better I do it in December than January.

Is it material enough at this point?

Is it materially different enough from what it's been historically?

Don't know.

We've not, certainly, built anything that's a major shift change.

So, yes.

I think that dynamic has always existed with people that have high deductible plans.

And certainly, the trend has been more and more private plans as well have a high deductible feature.

So we've not assumed any major impact from the Affordable Care Act that will skew fourth-quarter.

And if it's upside, we'll be pleasantly pleased as much as anybody else.

Great.

Thanks so much, guys.

Amanda Murphy.

Good morning.

I just had a follow-up on the [PMA] discussion.

So in terms of the inclusion or exclusion of hospitals, do you have a sense of how CMS is looking at some of the new bundling legislation that they propose for 2015 as part of [HOPS].

Does that meaningfully impact who, from a hospital perspective, may or may not be included in who's providing data for the 2017 pricing?

That's a good question, Amanda.

Bundled payments and hospital inpatient, obviously, is a cost for hospitals.

And therefore when you think about their revenues -- as a matter of fact, if you look at the language that was in the bill, it says the majority of their Medicare revenues are from the clinical lab fee schedule.

And if you're running a hospital outreach, that's the majority of your lab revenues to Medicare.

Therefore, they should be included.

So the bundle side and the inpatient DRG side of hospital inpatient laboratories is part of the cost of doing business of running that hospital.

And really, what we're looking at is that outreach portion.

That should be included because that is the market, as we all know.

And is that still, roughly, about a third of the hospital market?

I think that's what the data suggested, historically -- in terms of just outreach?

It depends on what -- if you look at the market, it's roughly about 40% of the total market is hospital outreach.

The total market and the rest is independent laboratories, big and small.

Got it.

And then on the molecular -- the Tricare and the low Pap pricing situation.

I don't know if I'm -- maybe this is a bit of wishful thinking -- but have you guys got any sense of whether you might get anything from a retroactive perspective at this point?

Mark, you want to take that?

Yes.

I don't -- I think we've been pretty consistent that we don't expect any major windfalls from retroactive reimbursements.

So even on Tricare, we mentioned that we were getting paid for a portion of Tricare all along for the active military personnel.

Many of these were covered.

It was really for the retirees and the family members.

So it's not as if we're getting paid nothing.

So once in a while, you may get a windfall.

Like in 2013, we mentioned, there was one state that started reimbursing for cystic fibrosis.

And it went retroactively back to the beginning of the year.

But still, you're talking about small millions, not anything in the tens of millions or anything that would be materially significant.

Got it.

Okay.

Thanks very much.

Robert Willoughby.

Steve and Mark, just two quick ones.

Can you comment at all on the Solstas revenue retention rate?

And possibly, could you size the fuel opportunity year-over-year?

What kind of benefit might you see there?

Yes.

First of all, we're pleased with the integration of Solstas.

We said that in our introductory comments.

We're working nicely through our integration work, which we feel good about.

As we mentioned, many of these acquisitions, we justify the business case based upon cost synergies.

And we're integrating Solstas nicely into our operation and feel good about that.

As we make the transition, we've integrated two separate sales forces into one.

We feel good that that has happened in an orderly way.

And in general, we're tracking to what our business plan was for that business so far.

And as we said, it's accretive along with other acquisitions this quarter.

So we feel good about that.

And also in the back half, we expect that to continue.

So, Mark, anything you would like to add?

No.

As Steve mentioned, we're tracking, pretty much, on our business case.

And as we've shared in the past, when we model these kind of acquisitions for conservatism, we do build in some level of attrition into each of these deals.

Because despite our best efforts to not lose any of those accounts, history has demonstrated that there are various reasons why you will get some attrition.

I'd say right now, Bob, like Steve shared, we're pretty much on track to our business case.

Okay.

And the fuel?

You mean fuel for growth in 2015?

No.

I'm sorry.

Just gasoline prices being down.

It's not a huge opportunity but --

Yes.

Certainly, that's better news than we would have thought six months ago or so.

We're still in the process, Bob.

Obviously, I'm not going to talk about any guidance or anything else for 2015.

We're still in the process of putting our plan together for 2015.

But certainly, that's a good tailwind, at least for now, since we have a large fleet.

And certainly, that should be helpful.

We're talking pennies though, not dimes, correct?

Yes.

Yes.

Right.

Thank you.

Thank you.

A.J. Rice.

Thanks.

Hi, everybody.

First, just maybe quick to ask you about your thoughts with respect to share repurchases.

Obviously, last year was the year where you took in a lot of proceeds from asset sales and licensing agreements.

And this year has been one more characterized by acquisitions.

Within the context of that, do you have any sort of way to articulate your view on -- update your view on share repurchases and how they fall out in the capital deployment mix?

Yes.

Well, our capital deployment commitment is the same.

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

We've been standing by that.

That will continue.

You saw our purchases this quarter.

Mark will give you an update on what we've done year-to-date.

Also, as you know, if you look at share repurchases, we're heavier in 2012 and 2013.

And acquisitions were heavier in 2013.

If you look at the two together, it's pretty consistent -- pretty good weight, based upon the two little heavier acquisitions where we took out the debt.

But we stand behind our commitment of returning a majority of our free cash flow.

And we're tracking well against that.

And you saw a good cash flow this quarter to support that.

Mark?

AJ, for this year, I talked about the need to delever post the Solstas acquisition.

As we mentioned, we paid down $90 million in the most recent quarter.

So we do have a commitment to get down closer to the 2.5% rate from a spike of up to 3% that we were at post Summit acquisition.

So we have been making it a priority to pay down debt.

In terms of what we're going to be doing going forward, at the Investor Day, I'm going to talk a little bit about the philosophy and some potential outcomes in terms of paying down further debt or getting to that leverage ratio.

And then obviously, when we give guidance for 2015, I'll get specifically around what our intents would be and --

Okay.

I guess, at this point in the call, I'll take the bait and ask you the obligatory question about Theranos.

Is there any update that you're seeing in their posture in the marketplace that you'd want to share?

And I know you've said from time to time you'd be open to talking to them if they had any interest in talking to you about what they have and how you might work to collaborate.

Any update in any of those areas?

No, A.J. No new news on what they're doing in the marketplace.

Essentially, they're running some pilots in a couple locations as a laboratory.

Again, what they have presented in the past to the market is some disruptive approach to some routinely provided diagnostics.

If, in fact, they have a disruptive technology, we're all for listening about that.

And one would hope that a company that had something like that would like to talk to one of the largest providers of diagnostic information services.

But no news to share on that, other than what you have probably heard and what we have said so far.

Okay, thanks a lot.

Gary Taylor.

Thanks, guys.

Most of my questions answered, so I'll do just one quick one here, and let you go.

I wanted to talk about restructuring charges for a second and $48 million this quarter over $100 million year-to-date.

I guess, presumably, the fourth quarter has some assumption about $20 million, $30 million perhaps of excluded charges.

I just wanted to understand, what's the glide path over the next couple years as your cost saving programs mature and come to fruition?

Are we still looking at hundreds of millions of dollars of one-timers to get to that?

Or is there a glide path for that diminishes, maybe, more quickly than that?

So, Gary, I appreciate the question.

Really not in position to comment on the future at this moment.

At the Investor Day, we're going to talk about the next phase for Invigorate.

And as part of that, we will lay out not just the benefits, but also the required investment -- both capital and expense.

I do want to mention that the adjustments this quarter were not all restructuring.

Certainly there was a significant integration.

And you can imagine, with an acquisition the size of Solstas, that over the -- as we mentioned, it typically takes 18 months to complete that integration.

And you might imagine that the first six to nine months is where you have a significant amount of those integration one-time expenses.

We did just open up our lab in Marlborough, Massachusetts.

And with that, we're moving out of some other facilities.

We did have some one-timers there to get into that new facility.

And then finally, we did have some legal expenses -- one-time legal expenses in those adjustments as well.

So they're not all restructuring, per se.

I want to be clear.

And there's not, certainly -- you should not look at this quarter as being a consistent representation of the kind of expenses that we'll be adjusting out, going forward.

It really depends on all those different factors and what's going on in the business.

Okay.

That's fair.

I guess I'll hear more in a couple weeks on that.

Yes.

Okay.

Thanks.

Any other questions?

Okay.

If not, as I said in my introductory comments, we had our second solid quarter of top-line growth.

And we continue to build momentum.

We're doing a good job executing against our strategy, and we look forward to seeing many of you at our Investor Day on November 5 in New York City.

Thank you all, and talk to you soon.

Thank you for participating in the Quest Diagnostics third-quarter 2014 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 may be accessed online at www.questdiagnostics.com/investor or by phone at (888) 566-0486 for domestic callers or (203) 369-3611 for international callers.

Telephone replays will be available from 10.30 AM Eastern time today until midnight Eastern time on November 23, 2014.

Thank you and goodbye.