奎斯特診斷 (DGX) 2016 Q3 法說會逐字稿

Good day, everyone. Welcome to the Quest Diagnostics' third-quarter 2016 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 introduce Shawn Bevec, 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. For this call, references to adjusted EPS refer to adjusted diluted EPS excluding amortization. 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' 2015 Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, and current reports on Form 8-K. The text of our prepared remarks and a PowerPoint presentation will be available later today in the Investor Relations page of our website.

Now here's Steve Rusckowski.

Thanks, Shawn, and thanks, everyone, for joining us today. This morning, I will provide you with highlights of the quarter and review progress on our strategy. Then Mark will provide more detail on the results and take you through our updated guidance.

During the third quarter, revenues were up on a reported basis and grew 2.1% on an equivalent basis. Reported EPS decreased 43%, primarily due to the gain from our 2015 contribution to the Q Squared Solutions joint venture. On an adjusted basis, EPS grew 7%. Cash from operations were $301 million, up 42%.

Now, let me discuss highlights of the progress we're making in several areas of our 5-point strategy, which is, you well know, to restore growth, drive operational excellence, simplify the organization, refocus on our Diagnostic Information Services business, and deliver disciplined capital deployment. Let's start with growth.

We continue to make progress with our expanded hospital systems relationships. In Professional Lab Services HCA began to contribute to growth in the third quarter. As we announced earlier this year we're managing an inpatient laboratory operation for six Denver area hospitals in the HealthONE system of HCA Healthcare. Revenues from this engagement will continue to increase throughout the end of the year.

Our Professional Lab Services agreement with RWJBarnabas Health in New Jersey and Clinical Laboratory Partners, the outreach lab business we acquired from Hartford HealthCare in Connecticut both contributed to perform well and grew revenue this quarter. Beyond our hospital systems relationships, we also continued to deliver solid growth in prescription drug monitoring and infectious disease testing, including Zika.

In prescription drug monitoring, we remain an industry leader with strong growth in the quarter. Providers and payers appreciate our unique ability to help manage the epidemic of prescription drug abuse with appropriate test utilization. In infectious disease, we continue to see solid growth in the fourth generation HIV testing, as well as hepatitis C testing for screening and genotyping to help doctors determine the type, dose, or duration of treatment.

Turning to Zika, we complemented are proprietary TCR test with a new antibody test license from the Center for Disease Control. Quest Diagnostics is proud to be among a group of select national reference laboratories selected by the Center for Disease Control to aid the response of the Zika emergency in the United States.

Looking forward, we are excited about our new agreement with Ancestry. Quest will become Ancestry's first CLIA-approved lab partner to provide DNA testing, enabling ancestry DNA subscribers to build their family tree based on ethnic origins. Over time, we intend to explore additional opportunities with Ancestry to guide people on building and understanding their family health tree.

We're also very excited about the recent launch of the IBM Watson Genomics from Quest Diagnostics, a new service that helps advance precision medicine by combining cognitive computing with genomic tumor sequencing. This service helps oncologists match patients with cancer therapies and clinical trials based on the tumors' unique DNA.

Quest's expertise in genomics and cancer, as well as our broad market penetration to half the country's physicians and hospitals means Watson power tumor sequencing is accessible for the time to the community of oncologists who provide 70% of the nation's cancer care. Memorial Sloan Kettering and the Broad Institute will contribute their data and research expertise to further augment the offering.

The next element of our strategy I will highlight is driving operational excellence. Our collaboration with Optum will help Quest reduce cost and complexity of our billing processes, and also increase transparency of healthcare costs for patients, physicians and employers.

Employee engagement in our Optum lines has been positive and the integration is on track. Quest employees will transition to the Optum team in mid-November. We expect to begin realizing savings from this relationship next year.

We view this agreement with Optum as the start of a long-term relationship. And it builds on our long-standing relationship with Optum's parent, UnitedHealth Group. For decades, Quest has served UnitedHealthcare plan participants to help them take action to improve their health based on insights from diagnostic testing and information services.

Also in the third quarter, we opened 12 patient service centers in five states in Safeway supermarkets. In just the first months, patients are finding it easier to access testing in a more convenient location, and we've seen volume increases in these retail settings. We remain excited about expanding patient access through retail partnerships.

We continue to execute on our last element of our strategy which is to deliver disciplined capital deployment. We completed our $250 million accelerated share repurchase program announced in May, using the proceeds of the sale of Focus Diagnostics business. Through this ASR, we repurchased approximately 3.1 million shares, additionally bought back another $50 million of Company stock, bringing the total repurchases in 2016 to $440 million through the end of the third quarter.

We look forward to sharing more detail on our market views and strategic outlook at our third Investor Day at the Intercontinental New York Barclay Hotel in Midtown on November 11. Registration information is available on our Investor Relations web page.

Now Mark will provide an overview of third-quarter financial performance and provide you with an update on our 2016 outlook. Mark?

Thanks, Steve. Starting with revenues, consolidated revenues of $1.89 billion were up 0.3% versus the prior year on a reported basis. Equivalent revenues grew 2.1% for the Company. Revenues for Diagnostic Information Services, or DIS for short, grew by 2.1%, compared to the prior year. Of this growth, approximately 1% was organic.

Volume, measured by the number of requisitions, increased 2% versus the prior year. Approximately half came from organic growth, including our Professional Lab Services, or PLS, engagements, and the other half from recent acquisitions. Revenue per requisition in the third quarter was flat versus a year ago.

As a reminder, revenue per req is not a proxy for price. It includes a number of variables such as unit price variation, business mix, test mix and test per requisition.

Unit price headwinds moderated in the third quarter, down roughly 50 basis points compared to the 100 basis point headwind we observed in the first half. Consistent with previous quarters, our POS engagements, such as RWJBarnabas Health and HCA, carry lower revenue per requisition due to the nature of the work we are performing, and will lower the revenue-per-req calculations. In the third quarter, the impact of our POS engagements was slightly larger than the 120 basis points we highlighted in the second quarter, which is representative of the strong growth we are seeing in this business.

With HCA coming online in the third quarter and ramping up through the end of the year, we expect POS to continue to grow at a faster rate than the balance of our business in Q4. After considering the impacts of unit price and POS, other mix elements, including test and payer mix, contributed nearly 2% to revenue per req in the quarter.

Reported operating income for the quarter was $322 million or 17.1% of revenues, compared to $631 million or 33.6% of revenues a year ago. Our reported third-quarter 2015 results included a $334 million pretax gain on the contribution to our Q Squared joint venture with Quintiles. On an adjusted basis, operating income was $320 million or 17% of revenues, compared to $325 million or 17.3% of revenues last year.

The impact of our former Focus Diagnostics and Solera products businesses in the third quarter of 2015 benefited adjusted operating income by approximately $16 million or 50 basis points. Excluding this impact, margins would have grown by 20 basis points year over year.

Reported EPS was $1.34 in the quarter, compared to $2.35 a year ago. The year-over-year decline was driven primarily by the net gain on our Q Squared contribution mentioned previously. Adjusted EPS was $1.37, up from $1.28 last year.

The Company recorded special items with an after-tax benefit totaling $10 million in the quarter, representing an escrow recovery associated with an acquisition, which was partially offset by restructuring and integration charges. The net impact of these items benefited our reported EPS by $0.07.

Bad debt expense as a percentage of revenues was 4%, 20 basis points better than the previous quarter and 10 basis points higher than 2015. As a reminder, bad debt expense typically improves modestly throughout the year, as patients hit their health insurance deductibles.

Note that the year-over-year compare is negatively impacted by the fact that our products businesses had a lower associated bad debt rate. When taking this into consideration, our bad debt rate was flat year over year.

A quick comment on our new billing relationship with Optum. To reiterate, expense savings from this relationship will not begin until 2017. We expect modest savings on our billing support costs during each year of the 10-year agreement, and Optum will work with us to help lower our bad debt rate, as well as reduce our denials over time.

Income tax expense in the quarter benefited from the adoption of the new accounting standard related to stock-based compensation. The impact amounted to an EPS benefit of roughly $0.02 in Q3. The new standard also results in a change in weighted shares outstanding by increasing the effect of dilutive securities, which slightly offsets the EPS benefit.

Our DSOs were 46 days, two days higher than last year but one day better than the prior quarter. The year-over-year increase is primarily attributable to higher levels of patient responsibility.

For the first nine months of 2016, cash provided by operations was $765 million versus $549 million last year. Capital expenditures were $165 million through the third quarter, compared to $169 million a year ago.

Before moving to guidance, I would like to highlight that operations in our Southeast region were impacted by Hurricane Matthew earlier this month. Our updated guidance reflects the impact we currently know.

Additionally, I want to provide some color on a few notable items which will impact our full-year operating cash flows. The first relates to after-tax charges for the full-year 2016 of $29 million from the retirement of debt.

Second, we will incur a full-year cash tax outlay of $91 million associated with the Focus divestiture that will be recorded in our operating cash flow, while the associated $275 million from the sale is reported in our investing cash flow. We paid $68 million of this liability in Q3 with the remainder to be paid in the fourth quarter.

Third, in Q3, we realized $54 million of proceeds from the termination of interest rate swap agreements. In aggregate, these three items are adversely impacting our full-year operating cash flow by a net of $66 million.

Now, turning to guidance, based on our year-to-date results, we are narrowing are 2016 outlook as follows. Revenues to be approximately $7.51 billion, an increase of about 0.5% versus the prior year on a reported basis, and an increase of about 2.5% on an equivalent basis. This compares to previous revenue guidance of between $7.47 billion and $7.54 billion.

Reported diluted EPS to be between $4.47 and $4.52, and adjusted EPS to be between $5.07 and $5.12. This compares to previous EPS guidance of $4.18 and $4.33 on a reported basis, and $5.02 and $5.17 on an adjusted basis.

Cash provided by operations to be approximately $1 billion, which compares to previous guidance of approximately $880 million. And, finally, capital expenditures to be approximately $250 million compared to between $250 million and $300 million previously.

Now, that me turn it back to Steve.

Thanks, Mark. To summarize, we continued our success in 2016 with another good performance in the third quarter. We continue to generate strong cash from operations, and we remain on track to meet our commitments for the remainder of the year.

With that, we'd be happy to take any of the questions. Operator?

(Operator Instructions)

Our first question is from Bill Quirk, Piper Jaffray.

Great, thanks, and good morning, everyone. The first question is just thinking about the final clinical FD schedule for 2017. We had been thinking or expecting, rather, that it was likely to be flat when the final adjustment comes out here in about less than a month now, but recently hearing some chatter that we may actually see a small inflation update to that. Any thoughts on that, guys? Thank you.

Yes, thanks, Bill. As you know, we don't really know. Last year we had a small adjustment, as well, to it. So, hopefully, your view of what you've heard is right, but at this point we have nothing to add to what you are saying.

Okay, got it. And then just as a follow-up, a bigger-picture question: Help us think a little bit about some of the health exchanges. Obviously there's been some pressure on managed care. We've seen some people pull out of this. So, how are you thinking about this over the coming couple of years here? Thanks.

I think we're all trying to understand how those lives will eventually get healthcare insurance. I think, state by state, it will sort its way out. We can't speculate at this time how those lives will be picked up.

But as you read, and you know as well as we do that the number of, particularly, national providers have decided to pull out of the exchanges. But you would have to believe that those lives that might be impacted will be dealt with in the appropriate way state by state. But it's too early to speculate on that.

Thank you. Our next question is from Ricky Goldwasser, Morgan Stanley.

Hi, good morning, this is Ashley on for Ricky. I was wondering if you could give a little bit more color into some of the partnerships you highlighted in the press release. We know that the PLS agreements are positive to volumes but headwind to price. The Optum agreement is supposed to help with curbing bad debt expense.

But could you talk a little bit about Safeway and Ancestry and IBM? Where are we with the impact of those relative to the core business?

Yes, thank you very much. First of all, we're encouraged with our continued growth that we are seeing in our Professional Lab Services business. We've highlighted two in my opening remarks. One is the relationship with HCA. The second is related to our relationship with Barnabas here in New Jersey.

They're off and running. They contributed to growth in the third quarter. We're optimistic about their prospects, and also we have a good funnel with us.

You made one comment that I would like to react to. We have been very careful to make sure that we describe how this business affects the calculation of revenue per requisition. What we've done carefully is to talk about in the script, and I am sure Mark will provide some color, is that we actually provided in the script the unit price impact this quarter to our performance. And that is, when you freeze all other characteristics of our Business what the true pricing impact is on our Business, where there is other characteristics of our Business, like business mix and payer mix that affect the calculation of revenue per req.

So, we feel very positive about the growth prospects for Professional Lab Services business. It's a great growth opportunity. It's great return on invested capital; therefore, it's great for shareholder value creation. But it does affect the calculation because it's at a lower price point. That is not to be confused with price reductions.

So, I want to make sure that's clear. I am sure when I'm done here that Mark will comment on that, as well, to make sure it's absolutely clear.

As far as partnerships, we believe that being a company that works with others in healthcare is an important part of what we do. We obviously are demonstrating we know how to do that. A number of things we talked about already have to do with us forming relationships. We talked about Professional Lab Services.

I will also mention that when we buy outreach businesses, like I referred to with the Hartford Hospital outreach business that we bought, we're working on building on that to have a strong relationship. Couple that with what we announced this fall with Optum. Optum will allow us to work with one of the leaders in healthcare analytics, leaders in healthcare services, to work on understanding what we can do to improve the billing process, and thereby, helping us with our bad debt exposure, as well as making sure we get paid for a lot of the more sophisticated testing that we do.

We think them working with us is better than us working independent, and that's a good opportunity for our shareholders going forward. So, we're optimistic about that opportunity.

But what also see in my introductory remarks, we believe this continues to build on a strong working relationship we have with UnitedHealth Group. And this new working relationship with revenue cycle management will only enhance that relationship. We have a strong collaboration and do their wellness work within Optum. We have an existing relationship with some of their physician groups that they're buying in terms of Laboratory Professional Services.

And then, finally, we continue to be a big supplier of Laboratory Professional Services for UnitedHealthcare membership today, and we believe that will continue to grow. So, we're optimistic about the prospects there.

We also announced recently the relationship with IBM. This builds on our relationship and our product that we introduced a couple of years ago with Memorial Sloan Kettering. It's in the growing new field of precision medicine, as you know. And we provide in this relationship a product called OncoVantage, which basically provides visibility to the oncologist what can be known with 34 actionable genes. From that data we will say what drugs will work, what drugs will not work, but, as importantly, what clinical trials they could potentially enroll their patients in.

This work will expand with the relationship with IBM and also Memorial Sloan. We also mentioned that this is collaborative work, once again, and the Broad Institute is involved, as well, which we are optimistic about. Because, as I said at the beginning, healthcare is really a much more collaborative game going forward. And at Quest we are all about working with others, and it comes through quite clear of the work we've done and how it's helping our Business.

Let me just stop there. Let me turn to Mark to make sure I properly addressed the question about the PLS business and how we think about revenue per requisition as a calculation. Mark?

Thanks, Steve. I think it's important. We clearly have not done enough to get everybody clear on this.

When you think about the work we do, we do tests. Now, we use requisitions as a surrogate for volume but, in fact, we do tests.

If a patient comes forward with a single test, let's say a standard routine test, and another patient comes forward and has two of those, there is going to be a different value to the requisition but it has nothing to do with price. The reason that people have, and we have, shared requisitions is there is a margin implication, to some extent, because the front end and the back end is somewhat of a fixed cost per patient engagement or requisition. So, a specimen acquisition and billing you'd say the more tests you can get on a requisition, the more efficient you can be. But, again, that's on the cost side, not the price side.

However, with PLS, as we have explained, a specimen acquisition is incredibly efficient. We don't do the draws. And from a logistics perspective, we're picking up dozens and dozens of tests at a single point in time instead of a handful as we might do in an office physician park.

So, the logistics are very efficient. We don't incur the draw cost. And then the billing is incredibly efficient because there's no third-party billing; there's no patient responsibility. It's a single bill for a large volume to a client.

So, I just want to make sure we continue to do what we need to do, that people are clear that the mix calculation is a calculation and it's not price. We actually call out price very specifically so you understand apples and apples, if there any headwinds and we are actually getting paid less per test.

Got it. That makes sense. Thank you for the color.

Our next question is from Ralph Giacobbe from Citibank.

Good morning. Just going back to the PLS, just hoping, on the two fronts, on volume and price. First on the volume side, just hoping maybe you could give a little bit of sense of what it maybe contributed, specifically HealthONE and Barnabas, to volume growth this quarter. And maybe help us -- is it in the run rate at this point? Is there some sort of ramp we should consider in the fourth quarter and in 2017? Any help there?

And then just on the pricing side, as you just explained, what I'm still grappling with is just understanding, on a test-by-test basis, is the price the same or is it lower in PLS? Because I would think you would have more tests per requisition on a hospital test than you would in the normal business. So, I'm just trying to reconcile the absolute dollar per test, and if that's lower because of a willingness to give up on that because of the benefits on the cost side that you explained.

Thanks for the questions. There were a couple there, Ralph, let me try to address them all.

First off, Barnabas is pretty much largely implemented. We may expand that relationship beyond the current set of hospitals, but at this point the initial phase of Barnabas is in a run rate. And [HCA] is the relationship that we said is ramping up.

We mentioned about of half of the volume growth in the quarter was attributable to PLS. We don't call out specific relationships, so we're not going to share Barnabas, per se, or HCA, but we are sharing what PLS is contributing in total.

And then, contrary to what you may have thought, the tests per req for PLS actually tend to be fewer, not greater. When you imagine someone going in for their annual physical, which is quite a bit of our volume -- obviously, some of it is acute conditions that people go into their primary care physician for -- but you are doing a battery of tests in your annual physical, much more than you might for an acute situation going in as an inpatient or an outpatient at a hospital. So, there's actually fewer tests.

And then, finally, on price, it is priced differently because it's not the commercial rates that we have for the core business. It's a negotiated direct rate with the hospital where we price it in a way that we can save them money, and we can make a margin ourselves. So, it is different pricing but not necessarily lower or higher, because we have pricing relationships all over the board for any given test, depending on the situation.

So, it gets a little bit complicated, but, in general, fewer tests per req. We have definitely future momentum we expect from our PLS in terms of its volume contribution, definitely from HCA, and so you should expect more of our growth coming from PLS certainly in the immediate future.

Ralph, this is Shawn. Just one point of clarification: Half of our volume was organic, of which some of that was PLS.

Okay, helpful. Then just my one follow-up, I was hoping you could give a little bit more detail on the UNH deal in terms of the economics and potential savings. Is there any way to quantify what billing and collection function costs to you guys to run, maybe some percentage of what may be saved?

And maybe help us with, if there's some level of guarantee on the other side. If bad debt expense were, for whatever reason, to actually go up as opposed to go down, are there certain protections in that contract that you have that there are guaranteed savings?

And then just any other read-through on this relationship and potential for you to get back in network on the lab side with UNH? Have you had any of those discussions at this point? Thank you.

Thanks. Let me start and then I will ask Mark to provide a little more color on the back end.

First of all, what we've committed is a continued march of making our Business better. And when we say better, we want to improve our quality of service and at the same time making it more efficient.

Our goal, as you know, for that is what we call our Invigorate program, which we have committed to an improvement of $1.3 billion by the end of 2017. And that's run rate savings, if you recall, versus a benchmark of 2011. And, as you know, we have been on a great march of showing progress on that.

What we have shown with this relationship is we're far from done. We have a lot more opportunities to improve this business, and we think this relationship with Optum, again, underscores our commitment to continue to make bold changes in this business to become better. I keep on saying better because it's both quality and cost.

So, this relationship with Optum will allow us a couple things. One is we're going to become more efficient. So, how do we become more efficient? One is definitely working together with them, our billing operation, which is part of our expense structure.

Our SG&A costs will become more efficient over time. We do have commitments around improving that together going forward. That is all part of our commitment for Invigorate. So, it allows us to achieve our goal, and also extends beyond 2017, obviously, since this is a 10-year relationship.

Second is, as I said in my introductory remarks, part of the opportunities we have is to provide better transparency to patients, better transparency to patients as far as what prices are, and also what is covered, and so they can pay us more often and more quickly. And we believe by providing that with the help of Optum will serve both bad debt, our denial rate, and just generally our cash flow. So, that is part of the relationship, as well.

We don't disclose the specifics of the agreement. You wouldn't expect that we would. But it's part of what we believe we need to continue to do to continue to drive progress in this Business.

The last part of your question is, how does this affect our relationship with UnitedHealth? What I said when we announced this relationship, and I know UnitedHealth will say the same is, it can't hurt. Again, it builds on our existing relationship. We currently do a lot of work for United already. This is a substantial piece of building on that.

They are very committed to it. It's a big opportunity for them. It provides visibility of us to them in a much broader, more significant way than ever.

We're obviously going to use this to build on that relationship in wellness, I talked about earlier, what we can do around their healthcare businesses that they are building with Optum Care. We believe we can do more than help them with their analytic services. There's a lot more that we can do with them, and will do with them as we go forward, because, as you know, they are a big player in healthcare and we need to work with all the big players in healthcare.

So, we're encouraged about what we're doing so far. We're off to a good start. As we said, we're going to move the employees over in mid-November and we will start to see savings from this next year. Mark, anything you would like to add to that?

We have shared that billing is about 5% of our headcount, so it's not an insignificant portion of our cost structure. And then, just to be clear on the relationship, we're not relinquishing responsibility.

There are a number of initiatives we had already planned to work on that we think are going to improve bad debt and reduce denials. It was part of our Invigorate program. And what's really generating the incremental value there is that Optum is going to bring incremental activities and supplement what we're doing to get us to even a better place we could have gotten on our own, or certainly faster than we could have gotten on our own.

It's not as if we're just throwing it over the wall and having Optum pick up what we have been working on or what we had planned to do. We're actually going to continue to do that. A lot of that's involving our IT organization, our commercial organization, et cetera, and we're going to partner with Optum to make that even better.

Yes. And just to round that off, and once again, if you look at our 2014 deck from our Investor Day, we talked about this as being the opportunities we see within Invigorate. And, hopefully, many of you on the phone will come to our Investor Day, it's November 11, and we will provide more color beyond what we've said here about this relationship and how it helps us with our efficiency goal with Invigorate.

Thank you.

Our next question is from Jack Meehan, Barclays.

Good morning. Mark, I wanted to start with the pricing comment that you made. The unit price headwinds, they moderated 50 bps in the quarter. Were there any notable changes there, or just less of a headwind for certain codes?

What it has to do with, obviously, is the timing of any price changes. We obviously annualized either in a positive way on some price increases or annualized and got behind us some negative headwinds between the second and third quarter. So, it's really just the year-over-year compare and the timing of any price changes from our contractual negotiations.

Jack, I think it underscores what we've said for many years now, that we are being very disciplined and very thoughtful in our pricing to the market. We believe we have a great value proposition out there in the market. Our value proposition, we believe, is second to none in terms of the value-add and the price we charge for that.

And we want to continue to reinforce that going forward. And I think this quarter's performance, when you look at real unit price, a fact of 50 basis points, I think it's a good reflection of the good work we've done to apply that price discipline to our Business and the results are showing it.

Great, yes, that's helpful. And then I just had one bigger question for Optum. You obviously have a real wealth of diagnostic data that you've built up over a long period of time. What have the conversations been around trying to find ways to monetize that?

Do you think you could find ways to use it with clinical trials, like one of your peers? Or are there any other interesting ideas you had around that front? Thanks.

We have talked about in the past how we're monetizing the data we have. We see about one-third of adult Americans in the course of three years. We keep that data for about 10 years. If you go through the math, it's about 20 billion data points of laboratory data.

So, we have a nice bird's eye view of what's happening with the American population, and we're trying to use that in the most responsible and also the best way for our shareholders. We have talked about in the past of actually providing that data to a variety of third parties, including the Center for Disease Control. We've talked about them using that to understand how they can manage or monitor the performance of what's happening with hepatitis C, by way of example.

We also have sold that data to pharma companies. We're building in that relationship. We've talked about we're trying to bring to the market, and possibly with our collaboration with Quintiles, and now Quintiles has merged with IMS, we continue to have a dialogue of how we could use that data to help with the recruitment of patients for clinical trials. That's something that we'll talk about, once again, as we get into our Investor Day in November, because there's a lot of opportunities for it. It takes longer to get some traction with it but the prospects are good.

And specifically with Optum, as you know, Optum has a broad perspective on the market and they're helping many integrated delivery systems. One of the products we do provide today for integrated delivery systems is around population health, and how you can use this data to help manage that population that you are managing, and how do we try to identify those patients that are costing the risk taker the most amount each year. And by looking at performance versus laboratory results, what we can do about that to help with those gaps in care, if you will, that they have. So, a lot of opportunities -- again, come in November and we will share more with you.

Great, looking forward to it. Thanks, guys.

Isaac Ro of Goldman Sachs.

Good morning, guys. Thank you. I wanted to start with just a minute on guidance. I'm hoping you can put a little more color around the underlying assumption you're making around the utilization and volume backdrop in 4Q relative to what you guys expect to show in your own growth.

We don't assume a change in utilization from quarter to quarter. When we look at the guidance we put out there, we want guidance that's reasonable but very achievable. And, as we mentioned, we did take into account the impact of Matthew, which happened in October, so it's a fourth-quarter event.

With that said, we basically have not changed the mid-point of our earnings guidance and we haven't changed the mid-point of our revenue guidance, despite Matthew. We're not assuming any significant changes or anything in the marketplace. We're really basing it on what we've seen pretty steadily for the first nine months of the year and then our historical experience in Q4.

Great. And then just maybe a second question on margins. You guys have spent a lot of time talking about all the work you've done with PLS and then with outreach deals. Curious, as you put those initiatives together in context with profitability, is there a timeline you could share or a path to when we should expect those programs to be accretive to the overall corporate margins? Thank you.

When you're talking about margins, I want to make sure whether you are asking dollars or percentages, so I will address both. Typically, what we've said is an outreach purchase, it takes 12 to 18 months to get to its going rate on profitability of when we can get all the synergies achieved. And the outreach businesses are typically at our corporate margin percentage. So, we usually get some margin dollars pretty quickly on those outreach, but get to our going percentage of ratio profitability takes 12 to 18 months.

For PLS, it's somewhat similar to an outreach in that there is a transition period of time. A lot of the savings is driven around moving the test menu partially off the hospital's site to ours. It doesn't happen the first day. The second piece is really the procurement savings. It's either changing out the platform or burning through their reagents, which typically are at higher cost than ours, so it takes a little while before we get to that going profitability.

But I'd say the same thing, probably a little closer to 12 than the 18, when we get to the going rate of profitability for PLS within the first year to 1.5 years. Those margins are going to be lower than the corporate average slightly, but, as I said before, still an excellent return on invested capital and they're still double-digit margins.

Got it. That's helpful color. Thank you, guys.

Our next question is from Nick Jansen, Raymond James & Associates. Your line is open.

Good morning. Two questions -- first on operating income growth, I know when you adjust for some headwinds last year tied to Celera, you're talking about 3.5% or so equivalent operating income growth based on the disclosure that you gave on the call. I'm just trying to get a better sense of how that can accelerate, absent M&A? It feels like, I felt that your analyst event two years ago you were talking about 8% to 10% operational EPS growth.

So, there's a pretty sizable delta between that operating income and that operational EPS aspiration. So, I just wanted to flush out how do we think about -- I know there's no chance for 2017 guidance yet, but what are some of the drivers that might help accelerate that organic operating income growth as we think about the next 6 to 8 quarters? Thanks.

Nick, any given quarter, it may bounce around. The outlook that we provided in 2014 and we're planning, and I'll do it personally, to update you on that at our Investor Day on November 11, and show a look back at how we have done and give you a general idea of what you can expect going forward.

It is really an annual basis or a CAGR basis. It's not necessarily what you're going to see in any given quarter.

So, the things that are going to contribute to growing earnings faster than our revenue are unchanged. It's really going to be as we have returned to organic growth that has a high drop-through, and then we have the Invigorate program, which certainly is large enough in this period of time to offset price and our cost pay-fors, which is our annual merit inflation and things like that, and still have enough to expand margin.

As you look at some of the PLS relationships that we have talked about, those have really started up this year. And as I mentioned earlier to the question, how long does it take PLS to get up and going in its profitability, it's generally 12 to 18 months, so you would expect those deals to be contributing more to the bottom line and helping to expand our margin more than they did this year.

So, it really gets down to the fundamentals, which is the growth and the high drop-through we get there, our Invigorate program, which continues to drive efficiency, and then all of those things more are on an annual or a CAGR basis as opposed to any given quarter. And year to date, we're up 5.4%. That's a higher number than the third quarter.

And, again, the other thing is, as you're well aware, we're accelerating organic growth, and we couple that with our acquisitions of 1% to 2% growth. That allows us, as they feather through our numbers, to also get some lift in operating income going forward.

That's very helpful perspective. My follow-up would be on the M&A front. It does feel like you might be a little bit light relative to the 1% to 2% contribution hopeful in every given year. I just wanted to get your thoughts on the broader deal pipeline as we think about your appetite, given your leverage profile today is certainly capable to do more. Thanks.

We have actually contributed about 1%, so at the low end but we are still within the 1% to 2%. And in terms of our appetite, it hasn't changed. But we're very diligent about the deals that we move forward with.

As we've shared, we walk away from more deals than we execute. It's not as if it's not an interest, it's not as if we're not investing a lot of time in evaluating assets and potential outreach deals, but we do have a lot of rigor around our financial metrics, and we don't execute a deal if we don't see a path towards value creation, importantly.

So, really, it comes down to our capital allocation strategy, which is, once you get beyond the 50% that we guarantee, of our free cash flow, to our shareholders, it comes mostly through the dividend but also through some share repurchases, and then the decision is what's the best value creation strategy? And we have to feel very comfortable that we're going to create more value through M&A than we will through share repurchases. Therefore, it's really situational.

So, it's not a change in strategy; it's not a change in appetite. And certainly there's been a number of assets we have been evaluating. There's a lot of things we're looking at. And we are still having success with 1% growth from M&A, within the range. And, really, nothing has changed other than we're at the low end of the 1% to 2%.

Nick, as you recall, we announced our 5-point strategy back in 2012. Part of that in terms of restoring growth was to accelerate our organic growth, which we're doing, and then second is to couple that with acquisitions.

And if you look at 2013, 2014, 2015, and now 2016, we have been achieving that 1% to 2% growth through acquisitions. So, we've developed a credible track record of being able to do that in the past. And, as Mark said, prospectively our views haven't changed.

And then you couple that with our strong cash position. We feel good about the cash we generated this quarter, and are using that cash wisely with our capital deployment plan. So, going forward we think we have a solid strategy to continue to build shareholder value, and the growth prospects both organically and through acquisitions remain encouraging.

Thanks for the color. See you guys in a few weeks.

Thank you. Our next question is from Brian Tanquilut, Jefferies.

Hey, guys, this is Jason Plagman on for Brian. Just a quick question: Can you provide any update on the progress with the Q Squared partnership and how that's progressing?

Sure, it's doing well. We've lapped it already, one-year anniversary in July. The initial work for both companies is to put both of our laboratory clinical trials business together, and then operationally integrate those.

By integrating those, we will benefit from that in our equity earnings. We get 40% since we own 40% of the joint venture. So, we believe we've made some excellent progress and there is more opportunities in front of us in terms of the yield we'll see from that joint venture, because it takes some time to get the integration completed. But we're starting to see some of that already this year.

Great, thanks.

Our next question is from Bill Bonello, Craig-Hallum.

Good morning, guys. I'm wondering if you might be able to give a little bit more color on the collaboration with IBM Watson. Obviously in the press release and in the call today you talked about what it is you're trying to do. But I'm just curious in terms of things like indications.

Is the thought that this service would be broadly utilized? Or is it limited to patients where maybe first- or second-line therapies have failed? What type of clinical data you're going to be publishing to support the validity of the information you're providing, maybe the regulatory and reimbursement considerations. And then, finally, whether you're building out some kind of a service or database where you can connect patients to clinical trials based on what you learn.

Thanks, Bill, for the question. First of all, as I said, we're excited about the opportunity. It's an embryonic field, it's building, it's evolving. The field of precision medicine or personalized healthcare is very new, and it continues to provide opportunities. But it also takes time to develop.

We believe, once again, that we, in this field, need to work together with others. Two years ago we announced the relationship with Memorial Sloan Kettering. We brought a product to the market called OncoVantage.

The opportunity we're going after, Bill, is to get to those community oncologists, which, as I said in my remarks, about 70% of cancer care is there. What we realized is that Memorial Sloan is very strong and we have a strong presence in the United States. But by working together with some others, once again, we can even enhance what we've done already. The IBM opportunity allows us to use their platform and also their data capabilities in a much broader way.

Second is, as you know, IBM is building out their go-to-market plan for IBM Watson in general, IBM Watson Health, and IBM Watson Genomics. We're hopeful that sales force, coupled with our sales force, will drive some additional demand as people become more aware of this.

The other part of this, Bill, is we believe there is an opportunity for patients to become more aware of what they should gain access to in assessing what they need to do with their cancer care. And IBM is a very powerful marketing machine, and we're hopeful that their work and their visibility around cognitive computing, particularly in healthcare, will help us with this effort.

Now, as far as future products, we have the existing products today. We're offering that. There is plans for us to expand that capability with a number of actionable genes. And then also an expanded panel, which will touch close to 400 genes that we will look at.

Yes, we do believe that this will help us in terms of companion diagnostics with those cancer drugs, to rule in and rule out patients it can affect. And also making sure that we can support in the right way connecting patients to the right clinical trials through their oncologist with this information.

So, this is -- work's in progress. A lot will be introduced in time. And it is a good example of the evolving nature of this whole effort across the world.

But we are lining up with some of the best, Memorial Sloan Kettering, IBM. We talked about the Broad Institute and obviously their relationship they have with MIT and Harvard. So, we have a good team working on this and we feel very encouraged about the prospects here.

Excellent. Thanks a lot.

Mark Massaro, Canaccord Genuity.

Hey, guys, thanks for the question. I wanted to ask more about the hospital side. You mentioned that HCA started to contribute in Q3. When do you think we'll know to the extent that you can help HCA manage their lab operations in terms of cost benefit to HCA?

What I'm getting at is, how many quarters do you think it'll take before you think you might be able to expand that within HCA? And then related to that, can you just discuss how active you have been talking to other hospital systems?

First of all, one step at a time. We announced this relationship with HCA with their Denver-based division. They have six inpatient laboratories that we will manage for them. When we do this, we make them more efficient.

If you understand how they work, and I would argue a lot of hospital systems work or for-profit corporations, they're going to see how it goes. And we expect to deliver. So, we're hopeful when we deliver, that we can then expand that discussion to say -- can we help you in some other areas?

The first piece of business right now is to do what we said we're going to do in Denver, and do that well. And then we will grow the account, as you grow any account, going forward.

I would also say that this discussion around hospital interest in what we're doing is building. What we find is that the C suite of integrated delivery systems, and hospital CEOs and CFOs, are quite interested in anything anyone could do to make them more efficient.

I personally get engaged in this in a very active way. And I can tell you that when we go in and have a conversation with a CEO and a CFO, and share with them that we can save them 15% to 20% of their hospital inpatient laboratory cost, our batting average, if you will, of getting to the next conversation to start sharing some data is quite good. Very few times do they say we are not interested. Most times they say -- interesting, we should take a look at this, and we understand how you can help us, and let's see if the numbers work.

When we go in there, we also talk about their lab strategy. Usually when we have a discussion around their inpatient laboratory costs, we then have a conversation around their reference testing, their most advanced testing that we provide to about 50% of hospitals. We talk about us being able to provide more of that for them.

And then the third leg of the stool is they then start to question, if they are in an outreach business, essentially competing with us, do they want to remain in that business. The best end state for us is to become their lab partner -- where it is Quest inside. So, we do all three.

We're helping them with their inpatient labs, making them more efficient. We're providing the most advanced testing for their hospital operations. And then, third, is where their laboratory for their non-hospital portion of the care they are providing within their geographic area.

We have a number of examples of that, and probably some of the best examples is where we've actually formed joint ventures. And we have a number of longstanding joint ventures -- University of Pittsburgh Medical Center, probably the most recent large one is University of Massachusetts. We have a joint venture up in Massachusetts around that. And there's others, too, that we have built.

So, I would argue that this is a growing trend. It's a trend that we're ahead on. It takes a while to build a services business. We've built the capabilities. We're now executing and we're now starting to see the results in our growth.

Excellent. And then quickly on capital deployment, you've repurchased almost $0.5 billion of stock for the year. Where are you on the authorization? And should we think about a similar run rate next year?

The year to year on what you should expect, I can't give you anything specific. Obviously we're not giving guidance for next year. But you should expect us to adhere to our capital allocation policy, which is basically half of our free cash flow is committed to shareholders. And then above and beyond that depends on M&A and/or additional share repurchase. In terms of our authorization --

$532 million left on the current authorization.

Great. Thanks so much.

Our last question is from Amanda Murphy of William Blair. Your line is open.

This is [Arco] in for Amanda. I was wondering if you could give me some color on the relationship between esoteric testing and routine testing growth? And then the pricing in esoteric, what trends have you seen? And then I have a follow-up question after that.

First of all, last year, at the end of the year, we said that our advanced diagnostics grew by about 5%. It's a sizable portion of our portfolio, about $1.8 billion. We do not share quarterly performance related to that portion of our Business, but it continues to grow.

Some of the mentions I had in my introductory comments show that we continue to get good growth of some of the more advanced testing. And particularly our last question around our work with IBM, and work in genetics, that field continues to provide nice growth prospects for us. So, we're continuing to get growth, and, once again, we'll share the growth from that business in due course as we announce our results.

As far as pricing, it's already in that 50 basis points headwind, if you will. We don't share specifics on what's happening with commercial contracts or what's happening per test, but it's implied in the 50 basis points. So, it's very manageable, we believe.

There's always going to be some ups and downs in our portfolio tests. We're bringing new products to the marketplace, as well, which have new price points. So it's in that overall aggregate measure that we provide.

Got it. And then as esoteric testing continues to grow, I was wondering if you had any updated thoughts on the sales force? What do you have now and do you think you are the right size to service the market more broadly, particularly as esoteric becomes a bigger portion of the pie?

We continue to build our sales and marketing capabilities. The way we've addressed the market is really to make sure that we capture the right level of focus around accounts. And with 65% of physicians now working for hospital systems, we believe it's important to have a geographic orientation to our sales force.

So, we have about 108 sales districts and they have full responsibility for the whole portfolio of Quest into the market. Because it's hard to separate hospital business from physician business, given where healthcare is today and how it's organized.

At the same time, we all know that healthcare is very specialized, so we also, in addition to the geographic orientation to our sales force, have dedicated specialized sales forces. We have a specialized sales force for our neurology business, we have a specialized sales force for our anatomic pathology business, a specialized sales force for our women's health business. And we believe we appropriately staff that for the opportunities in the marketplace.

We're always trying to optimize our investment in our go-to-market plan with the opportunities we see in the marketplace. And we think we've struck the right balance to deliver on our goals of growth in 2016, and we believe we'll do so, also, as we go forward with accelerating growth, as well, in the future.

Thank you.

Thank you. At this time, speakers, we don't have any other questions on the phone. I would like to hand the call back to you.

Thanks again for joining the call today. As you can see, we're making good progress on executing our strategy. We look forward to seeing many of you at our Investor Day in New York City on November 11. Thank you very much, and have a great day.

Thank you for participating in the Quest Diagnostics third-quarter 2016 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 866-435-1319 for domestic callers, or 203-369-1017 for international callers. Telephone replays will be available from 10:30 AM Eastern time today until midnight Eastern time on November 19, 2016. Goodbye.