Quest Diagnostics (DGX) Earnings Report: Q Conference Call Transcript

Transcription

1 Quest Diagnostics (DGX) Earnings Report: Q Conference Transcript The following Quest Diagnostics conference call took place on October 23, 2014, 08:30 AM ET. This is a transcript of that earnings call: Company Participants Dan Haemmerle; Quest Diagnostics; Executive Director, Investor Relations Stephen Rusckowski; Quest Diagnostics; CEO and President Mark Guinan; Quest Diagnostics; CFO Other Participants Ricky Goldwasser; Morgan Stanley; Analyst Glen Santangelo; Credit Suisse; Analyst Michael Cherny; ISI Group; Analyst David Clair; Piper Jaffray; Analyst Bryan Brokmeier; Maxim Group; Analyst Darren Lehrich; Deutsche Bank; Analyst Isaac Ro; Goldman Sachs; Analyst Amanda Murphy; William Blair; Analyst Robert Willoughby; Bank of America Merrill Lynch; Analyst A.J. Rice; UBS; Analyst Gary Taylor; Citigroup; Analyst MANAGEMENT DISCUSSION SECTION Thank you for standing by. Welcome to the Quest Diagnostics Third Quarter 2014 Conference. 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 expressed written consent of Quest Diagnostics is strictly prohibited. Now I'd like to introduce Dan Haemmerle, Executive Director of Investor Relations for Quest Diagnostics. Go ahead, please. Dan Haemmerle (Executive Director, Investor Relations): 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 A PowerPoint presentation 2014 TheStreet,. All Rights Reserved Page 1 of 20

2 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'll provide you with highlights of the quarter. We'll share industry trends and also review progress we're making against our five-point strategy. And then Mark will provide more detail on the results and take you through guidance. During the third quarter, we delivered against our expectations, continue 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'd like to do is to start with some brief comments on industry trends. We have said diagnostic information is a powerful lever for transforming health care, 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 health care. We're making progress as an industry, but the 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 on 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 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 medium 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 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 health care utilization during 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 executing 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 (inaudible) reports on solid tumor analysis based on the panel of 34 clinically actionable gene mutations. We launched those 2014 TheStreet,. All Rights Reserved Page 2 of 20

3 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 mediumsized 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 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 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 of 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 the 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 2014 TheStreet,. All Rights Reserved Page 3 of 20

4 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 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, health care IT, 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 am 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 continued 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 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 the ibrutinib royalty rights, the loss on sale of the Enterix business and restructuring and integration cost. These items resulted in 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 $ 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 commitment 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 2014 TheStreet,. All Rights Reserved Page 4 of 20

5 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 to $4.10; cash provided by operations to approximate $900 million; and capital expenditures to approximate $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're 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 And then finally, I'd like to share I look forward 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? QUESTIONS & ANSWERS Operatorˆ Thank you. We will now open it up for questions. (Operator Instructions) And our first question comes from Ricky Goldwasser. Sir, your line is open. Good morning, Ricky. Good morning, Ricky. Ricky Go ldwasser (Analyst - Morgan Stanley): Thank you and good morning. Hi. I have got 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 kind of like the margins that are associated with the new business? Thanks for the question, Ricky. A couple of 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 said is if you exclude those in that volume, volume would have been up 1.5%. But nonetheless, I think the important message is that organic volume trends continue to improve. I mean we 2014 TheStreet,. All Rights Reserved Page 5 of 20

6 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's somewhat across the board by payer type. We did say there was some reduction in the uninsured. We have 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 ticking up a little bit and I think just our business gaining strength. Ricky Go ldwasser (Analyst - Morgan Stanley): Okay. And just kind of like one follow-up there. Obviously, I think, last quarter, you said that the impact on volume, once you normalize from the businesses you exit, was about 1%. It seems like it's 1.5% now. So is this a function of you exiting additional accounts, or is this just kind of like an impact of the full quarter of the same existing business that you've exited last quarter? 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 from the previous quarter, given the timing. But what you see, though, as you said it, is, as we've said consistently, we're going to move step-by-step improving our underlying business, and you see some underlying improvement in the third quarter versus Q2. So we feel good about that. Ricky Go ldwasser (Analyst - Morgan Stanley): Okay. Thank you. Thank you. And our next question comes from Glen Santangelo. Sir, your line is open. Glen Sant angelo (Analyst - Credit Suisse): Yes, thanks and good morning. Steve, I just want to follow up with you on some of the pricing comments that you made. It seems like the company also experienced a sequential improvement in organic pricing trends. And so I'm wondering if you could just 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 2014 TheStreet,. All Rights Reserved Page 6 of 20

7 provided guidance that over a three-year period, we expected real price. And when I say real price, it's 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 And then what we also said is we believe it's going to be lower this year and in And we actually believe we're on track to achieve that guidance we provided. In that respect, we are seeing lower year-on-year comparisons on 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 on our price this year, which was about 1.75% this year. And then also, what we see, overall, and if you look at revenue per req, is a mix in our business. So when it goes through that mix in our business, which is different than what we talk about price this quarter and even compared to Q2, we saw a richer mix, which generated revenue per req which was favorable. So, Mark, I don't know if you'd like to add anything on that. Yes. I mean 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 really instilled a greater discipline around price, and obviously, we're also benefiting from the timing of contracts that we didn't benefit from in And then as Steve mentioned revenue per req, when you exclude the impact of acquisition mix, as I said, revenue per req was actually up. And so it was some slight price decline, offset by some favorable tests and payer mix. Glen Sant angelo (Analyst - Credit Suisse): And maybe if I can just follow up with one sort of 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 pricing. I mean, are you sort of 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 comments to kind of make, initial comments to make at this point? Thank you. Glen, I appreciate that. Well, 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 a matter of fact, a couple of weeks ago, we were visiting CMS, and we're talking through how they'll gather the data. You can't get a [field] view at 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 of those three pieces to get a real representative view of the market. As you know, there's a 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-based pricing would be by certain codes we did a sample on. And when you look at that, actually, the CMS prices are not widely out of line from the median that we have sought in the market in that survey TheStreet,. All Rights Reserved Page 7 of 20

8 So we will continue to work through the rule-making process. They'll gather the data in 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, 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. And our next question comes from Mike Cherny. Sir, your line is open. Good morning, Mike. Hey, Mike. Good. Michael Cherny (Analyst - ISI Group): 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. I mean how much of it is impacted by the return you've [garnered] on the business case? Maybe walk through some of the financial metrics that will cause you to say that this contract or this business is no longer for us. Let me start and I'm going to turn it to Mark. First of all, we're trying to build value, as you would expect we would. And 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 -- there are a lot of levers, and one of which is price, and 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 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. So, Mark, why don't you add to that, specifically, what did we adjust it 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, I mean, obviously, our 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 costs 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 the payer mix TheStreet,. All Rights Reserved Page 8 of 20

9 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 decided to share it was we wanted to send the message that not all volume is value-creating volume, and we're focused on valuecreating 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 something like modeling a 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 to your bottom line and your cash flow. It's got to be value-creating volume. Michael Cherny (Analyst - ISI Group): Thanks. And then just one quick question or quick thought on some of these hospital outsourced arrangement. So obviously, a new opportunity for you. Can you talk about how some of those conversations evolved? You talked about the mid-sized hospital on the East Coast. What led them to decide to work with you? And then over time, what type of capacity 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. And like so much in health care, you see one and you see one, and so we sit down. We have a conversation with [lab trends] 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, and we'll eventually end up in a place that is tailored to what you're trying to achieve in their system. And so the contracts and engagements we have announced are very different. All are quite different. And I could 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 health care. 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 could help them with that. So that's the way we approach it. Yes, I just want to add that, 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, so it's actually running their lab for them with their people. Yes, just to add to that, we have a large hospital laboratory management deal. What we arrived at is an 2014 TheStreet,. All Rights Reserved Page 9 of 20

10 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 can still respond in an active way to meet the requirements of running their hospital. And 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. And so during the day, we actually have a lot of capacity idle. And so it's an opportunity for us to use that capacity to help at this portion of our business. Michael Cherny (Analyst - ISI Group): Great. Thanks for all the details, guys. Thank you. And our next question comes from David Clair. David Clair (Analyst - Piper Jaffray): Hi, good morning. Good morning. David Clair (Analyst - Piper Jaffray): Thanks for taking the questions, it s 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 needing. And 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 that meets those regs. We haven't provided that 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, new solution to the marketplace, and then second is running our operation on a day-to-day basis. Our concern, particularly with 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, which [are our] marketplace are safe and efficacious and therefore do not require what a device manufacturer would need, and that's our position on it TheStreet,. All Rights Reserved Page 10 of 20

11 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. David Clair (Analyst - Piper Jaffray): Okay. Thanks for that. And then I was just hoping that we could get a quick update on some of the women's health products, so specifically, Pap volumes, BRCAvantage, and NIPT? 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. 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. David Clair (Analyst - Piper Jaffray): Thank you. Thank you. Thank you. And our next question comes from Bryan Brokmeier. Sir, your line is open. Bryan Bro kmeier (Analyst - Maxim Group): Hi, good morning. Steve, you said that you saw a richer mix of business. Was any of that mix onetime in nature? Was it a trend of higher-priced tests that you expect to continue? I assume the other bracket test is one positive factor there that should continue. But are there others? Yes. So if you look at some of the growth we talked about, most of the products we're introducing in our clinical franchise is our new solutions that have higher prices. And so, therefore, if you look at the mix, going forward, you should see some effect for that in 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 req. 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, do 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 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 it. So absolutely not. This is really where the business is trending. There's nothing unusual, and actually, we will expect to see 2014 TheStreet,. All Rights Reserved Page 11 of 20

12 more growth in those higher-value and 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 per req. So obviously, depending on the timing of some of those deals, that could have a mixed 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]. Bryan Bro kmeier (Analyst - Maxim Group): All right. And on the unprofitable business that you walked away from, were these contracts that you had to terminate, were you able to renegotiate terms in 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 is, 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. We weren't able to come to a reasonable outcome in our opinion, and that was kind of 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, 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 in 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 kind of a refresh of our portfolio, and that's why we've taken the time to talk about it. Bryan Bro kmeier (Analyst - Maxim Group): Okay. Thanks a lot. Thank you. And our next question comes from Darren Lehrich. Sir, your line is open. Good morning, Darren. Good morning, Darren. Darren Lehrich (Analyst - Deutsche Bank): Okay, thanks. Good morning, everybody. Yes, so I just wanted to come back to the margin topic. It sounds like you've clearly exited some unprofitable business that accelerated in the third quarter. And 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 in sort of 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 the 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 TheStreet,. All Rights Reserved Page 12 of 20

13 Yes. 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 is some negative mix impact. We also referenced the fact that we've talked several times about the fact that management incentive comp would be a headwind this year because last year we didn't pay out anywhere near the target, and we're still accruing and hoping and expecting to pay out more to that target, so that's a headwind as well, and then we've 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 were really just starting 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, the long-term margin. So it's a lot of different pieces, but we feel good about generally where our margin is headed. Darren Lehrich (Analyst - Deutsche Bank): Okay, no, that's helpful. And then just remind us, again, the management incentive comp, the year-over-year impact on margin from that? Yes, we haven't quantified it. I mean but, typically, we said, hey -- and 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 of those items. So it's not insignificant. Darren Lehrich (Analyst - Deutsche Bank): Okay. And then my follow-up here is just as it relates to like your 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? Dan Haemmerle (Executive Director, Investor Relations): Yes. Darren, we've said in the past the total molecular coding impact for us, when you look at 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 5% across all payers, okay, commercial payers, government payers, et cetera, we continue to work through this with all the payers that -- commercial payers as well as government. And on the Medicaid program, 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 a 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 would look 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 TheStreet,. All Rights Reserved Page 13 of 20

14 Darren Lehrich (Analyst - Deutsche Bank): Okay. Thanks a lot. Thank you. And the next question comes from Isaac Ro. Sir, your line is open. Isaac Ro (Analyst - Goldman Sachs): Good morning, guys. Thank you. Hey, good morning, Isaac. Good morning. Isaac Ro (Analyst - Goldman Sachs): Yes, just I want to ask a question about fourth quarter seasonality. We've seen an uptick in health care utilization across the board, I think, in the fourth quarter for [at least] the last few years. And I'm wondering if your guidance for the rest of the year assumes that, that if that trend will continue or perhaps increase this fourth quarter? Hey, Mark, why don't you take us through the seasonality we see in Q4 typically? Yes. 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 we may have not 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 there maybe a little drag, like Paps, and then things like potential for laboratory professional service and fields and so on and so forth. So we're expecting, I think as we get into this time of year, 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. Isaac Ro (Analyst - Goldman Sachs): Well, if I can just stretch you a little bit there, I mean what is different this year and, of course, the enrollment for ACA and all that is changing, deductibles and cost burdens and so forth? So there's plenty of reason to think that people might be deferring utilization until the end of the year and all that. So I'm just curious, as you think about forecasting, that was a meaningful change to your process. Yes, that certainly, I think, could be within the trends we've already seen for the third quarter, some of that, while maybe 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 TheStreet,. All Rights Reserved Page 14 of 20

15 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 kind of skew fourth quarter. And if it's upside, we'll be pleasantly pleased as much as anybody else. Isaac Ro (Analyst - Goldman Sachs): Great. Thanks a bunch, guys. Thank you. Thank you. Thank you. And our next question comes from Amanda Murphy. Ma am, your line is open. Hey, Amanda. Amanda Murphy (Analyst - William Blair): Hi, good morning. I just had a follow-up on the PAMA 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 proposed 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 2017 pricing? Yes, that's a good question, Amanda. I mean bundle payments and hospital inpatient, obviously, there's a cost for hospitals. And therefore, when you think about their revenues, as 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 [over in 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. Amanda Murphy (Analyst - William Blair): And is that still roughly about 1/3 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 -- Amanda Murphy (Analyst - William Blair): 2014 TheStreet,. All Rights Reserved Page 15 of 20

16 Okay. -- of the total market, and the rest is independent laboratories, big and small. Amanda Murphy (Analyst - William Blair): Got it. And then on the molecular, the TRICARE and [the middle 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, do you want to take that? Yes, I don't -- I think we've been pretty consistent, and 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 of the family members. So it's not as if we're getting paid nothing. And so once in a while, you may get a windfall. Like in 2013, we mentioned there was one state that are reimbursing for cystic fibrosis, and it went retroactively back to 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. Amanda Murphy (Analyst - William Blair): Got it. Okay, thanks very much. Thank you. Thanks. Thank you. And our next question comes from Robert Willoughby. Sir, your line is open. Hey, Bob. Ro bert Willo ughby (Analyst - Bank of America Merrill Lynch): Hey, 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, so 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 2014 TheStreet,. All Rights Reserved Page 16 of 20

17 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'd like to add? No, I mean, 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 in 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. So I'd say, right now, Bob, like Steve shared, we're pretty much on track to our business case. Ro bert Willo ughby (Analyst - Bank of America Merrill Lynch): Okay. And the fuel? You mean fuel for growth in 2015? Ro bert Willo ughby (Analyst - Bank of America Merrill Lynch): No, I'm sorry, just gasoline prices being down, it's not a huge opportunity, but Yes. I mean certainly that's better news than we would have thought six months ago or so. So, yes, we're still in the process, Bob. And obviously, I'm not going to talk about any guidance or anything else for We're still in the process of putting our plans 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. Ro bert Willo ughby (Analyst - Bank of America Merrill Lynch): We're talking pennies, though, not dimes, correct? Yes, yes. Ro bert Willo ughby (Analyst - Bank of America Merrill Lynch): All right. Thank you. Thank you. Thank you. And our next question comes from A.J. Rice. Sir, your line is open. A.J. Rice (Analyst - UBS): 2014 TheStreet,. All Rights Reserved Page 17 of 20