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Edited Transcript of DGX earnings conference call or presentation 23-Jul-19 12:30pm GMT

Q2 2019 Quest Diagnostics Inc Earnings Call

MADISON Jul 25, 2019 (Thomson StreetEvents) -- Edited Transcript of Quest Diagnostics Inc earnings conference call or presentation Tuesday, July 23, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Mark J. Guinan

Quest Diagnostics Incorporated - Executive VP & CFO

* Shawn C. Bevec

Quest Diagnostics Incorporated - VP of Investor Relation

* Stephen H. Rusckowski

Quest Diagnostics Incorporated - Chairman, President & CEO

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Conference Call Participants

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* Adam Chase Noble

UBS Investment Bank, Research Division - Equity Research Associate of Healthcare

* Alexa Desai

Morgan Stanley, Research Division - Associate

* Ann Kathleen Hynes

Mizuho Securities USA LLC, Research Division - MD of Americas Research

* Daniel Louis Leonard

Deutsche Bank AG, Research Division - Research Analyst

* Derik De Bruin

BofA Merrill Lynch, Research Division - MD of Equity Research

* Donald Houghton Hooker

KeyBanc Capital Markets Inc., Research Division - VP and Equity Research Analyst

* Eric White Coldwell

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Jack Meehan

Barclays Bank PLC, Research Division - VP & Senior Research Analyst

* Kevin Kim Ellich

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

* Lisa Christine Gill

JP Morgan Chase & Co, Research Division - Senior Publishing Analyst

* Mark Anthony Massaro

Canaccord Genuity Corp., Research Division - Senior Analyst

* Matthew Richard Larew

William Blair & Company L.L.C., Research Division - Analyst

* Patrick B. Donnelly

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Ralph Giacobbe

Citigroup Inc, Research Division - Director

* Ross Jordan Muken

Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Healthcare Services & Technology and Fundamental Research Analyst

* Stephen C. Baxter

Wolfe Research, LLC - Senior Analyst

* William Robert Quirk

Piper Jaffray Companies, Research Division - MD and Senior Research Analyst

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Presentation

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Operator [1]

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Welcome to the Quest Diagnostics Second Quarter 2019 Conference Call. At the request of the company, this call is being recorded. The entire contents of this call, including the presentation and a 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 written consent of Quest Diagnostics is strictly prohibited.

Now I'd like to introduce Shawn Bevec, Vice President of Investor Relations for Quest Diagnostics. Please go ahead.

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Shawn C. Bevec, Quest Diagnostics Incorporated - VP of Investor Relation [2]

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Thank you, and good morning. I'm here with Steve Rusckowski, our Chairman, Chief Executive Officer and President; and Mark Guinan, our Chief Financial Officer.

During this call, we may make forward-looking statements and will discuss non-GAAP measures. We provide a reconciliation of non-GAAP measures to comparable GAAP measures in the tables to our earnings press release. 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 our most recent annual report on Form 10-K and subsequently filed quarterly reports on Form 10-Q and current reports on Form 8-K.

For this call, references to reported EPS refer to reported diluted EPS from continuing operations and references to adjusted EPS refer to adjusted diluted EPS from continuing operations, excluding amortization expense. References to adjusted operating income for all periods excludes amortization expense. Finally, growth rates associated with our long-term outlook projections, including total revenue growth, revenue growth from acquisitions, organic revenue growth and adjusted earnings growth are compound annual growth rates.

Now here is Steve Rusckowski.

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Stephen H. Rusckowski, Quest Diagnostics Incorporated - Chairman, President & CEO [3]

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Thanks, Shawn, and thanks, everyone, for joining us today. This morning, I'll discuss the second quarter and review progress on our 2-point strategy, and then Mark will provide more detail on the results.

Our volume growth accelerated in the second quarter, and we continue to build momentum through the first half of 2019. Our expanded network assets continues to accelerate volume growth, and our strategy to drive operational excellence improved efficiency. Both have helped offset the significant reimbursement pressures we are experiencing this year.

For the second quarter, we grew revenues despite significant reimbursement pressure. Reported EPS was $1.51, down about 4% from the same period of 2018. Adjusted EPS was $1.73, down about 1%.

Volume growth remained very strong at 4.4% as the expected volume continued to accelerate in the second quarter. Year-to-date, volume growth is now at 4%.

Now let me briefly update you on 3 fundamental changes in the laboratory marketplace. They are PAMA, our expanded network access, increased consumerization of healthcare. First, PAMA-driven reimbursement pressure remains a catalyst for structural change in the marketplace. Our Medicare rates in the first half of 2019 were down by 10% from the prior year, which is in line with our expectation. The next data-reporting period remains scheduled for the first quarter of next year. However, we are encouraged by the introduction of the Laboratory Access for Beneficiaries Act, or LAB Act, introduced in the House last month.

The LAB act would be a first step towards ensuring clinical laboratory service rates under PAMA are sustainable, and Medicare beneficiaries have adequate access to crucial laboratory services. By delaying the next round of PAMA data reporting by 1 year, the LAB Act would provide all applicable laboratories with additional time to report private payer data. A circuit provision in the LAB Act would require a neutral third-party to produce recommendations to Congress on how to improve the PAMA data collection rate-setting process.

The second structural change affecting our industry is our expanded network access and payers becoming more focused than ever on driving better value in their lab spend. We are partnering with UnitedHealthcare to reduce excess cost created by out-of-network labs to further value to our customers and members. On July 1, we became a UnitedHealthcare Preferred Lab Network provider and have begun an aggressive outreach campaign to physicians and UHC members.

Beginning August 1, providers referring members to out-of-network labs will need to complete an online approval process. In addition, Anthem has begun to implement its own strategy that lowers laboratory rates to hospital-based providers, aligning them better with the rates currently paid to independent laboratories. Also we continue to have conversations with other health plans on value-based care initiatives and PLN-like elements. Some of our recent contract extensions contain these features.

Finally, we continue to see increased attention on the variation in healthcare costs. Last month, the White House released the healthcare executive order designed to bring more transparency to the healthcare system. As consumers of healthcare get more information on the disparities in the cost of care, we believe this trend favors high-value providers like Quest.

Now turning to our recent progress on our strategy to accelerate growth, which has 5 elements. Grow more than 2% per year through accretive, strategically aligned acquisitions; expand relationships with health plans and hospital health systems; offer the broadest access to diagnostic innovation; be recognized as the consumer-friendly provider of Diagnostic Information Service; and then finally, support population health and data analytics in the extended care services.

So let me take you through a few highlights of our strategy to accelerate growth in the quarter. As I said earlier, we continue to see revenue and volume growth as a result of our expanding network access. With the exception of Aetna, this growth is occurring across all of our major health plan customers.

We recently signed a new professional lab services agreement with Catholic Health Services of Long Island, a large integrated healthcare delivery system in New York. Under the agreement, Quest will provide laboratory and supply chain expertise as well as perform laboratory reference testing. We continue to believe hospitals will be increasingly more motivated to work with us under lab strategy as they feel the impact of PAMA and lower commercial reimbursement. In the area of advanced diagnostics, Quest is now participating as the designated laboratory in the National Cancer Institute's MATCH precision medicine trial. This is the largest of its kind. The trial seeks to provide better outcomes for rare cancer types for which there is no standard treatment.

Key test growth drivers in the quarter included tuberculosis testing with strength in both QuantiFERON and T-SPOT, Cardio IQ and mutual testing. Each of these test categories showed strong revenue growth.

Our QuestDirect consumer testing business continues to gain popularity. Earlier this month, we launched a new consumer initiated Lyme disease test. We also drove sequential volume growth in consumer testing each month in the second quarter.

The second part of our 2-point strategy is to drive operational excellence. We remain on track to deliver 3% cost efficiencies for 2019 by continuing to drive increases in productivity. Some examples are using digital technology to enhance the customer experience, drive growth and reduce our carbon footprint. We have begun to eliminate paper documentation for Medicare beneficiaries who have financial responsibility for non-covered services. This has reduced denials and contributed to our invigorated savings.

We're also working to help patients follow through when their physician orders a lab test. We started sending reminder emails to patients whose physicians have ordered tests for them electronically. We're now sending text messages that remind them to nearly 1/3 of our patients who scheduled an appointment online, which reduces the no-show rate. Both of these initiatives are expected to help reduce the number of lab orders that go unfulfilled.

Now let me turn it over to Mark, who will take you through the financial performance. Mark?

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Mark J. Guinan, Quest Diagnostics Incorporated - Executive VP & CFO [4]

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Thanks, Steve. In the second quarter, consolidated revenues were $1.95 billion, up 1.8% versus the prior year. Revenues for Diagnostic Information Services grew 2% compared to the prior year, driven by strong volume growth and acquisitions, partially offset by higher reimbursement pressure and patient concessions. Volume, measured by the number of requisitions, increased 4.4% versus the prior year. Excluding acquisitions, volumes grew 2.9%. As we've said before, not all volume is created equal, and we have regularly emphasized our strategy to be price-disciplined. Recently, we had a few of our capitated contracts open for renewal. These contracts, while profitable in the past, represented large volumes at very low margins. In the competitive contract renewal process, apparently one of our competitors was willing to offer lower rates that were prospectively very unprofitable for us. Therefore, rather than accept the rate cut, we walked away from the business. Walking away had very little top and bottom line impact, but did create a 70-basis-point headwind to organic volume growth and will do so throughout the balance of the year. We believe this is important for you to understand as you assess our relative volume performance.

Despite that headwind, organic volume growth accelerated in the second quarter, consistent with our expectations. Revenue per requisition declined by 2.3% versus the prior year, driven primarily by higher reimbursement pressure and patient concessions.

Unit price headwinds were approximately 2.3% in the second quarter. This includes the impact of PAMA, which amounted to a headwind of approximately 120 basis points. As a reminder, the PAMA impact includes both direct cuts to the Clinical Lab Fee Schedule as well as modest indirect price changes for Medicaid and a small number of floating rate contracts.

Reported operating income was $307 million or 15.7% of revenues compared to $305 million or 15.9% of revenues last year. On an adjusted basis, operating income was $352 million or 18% of revenues compared to $362 million or 18.9% of revenues last year. A year-over-year decline in operating margin was primarily attributable to higher reimbursement pressure and higher patient concessions, largely offset by strong volume growth and ongoing productivity improvements related to our Invigorate initiatives.

Reported EPS was $1.51 in the quarter compared to $1.57 a year ago. Adjusted EPS was $1.73, down approximately 1% from $1.75 last year.

Cash provided by operations was $596 million year-to-date versus $503 million last year.

And capital expenditures were $132 million year-to-date compared to $151 million a year ago.

Now turning to guidance, our outlook for 2019 is as follows: revenue is expected to be between $7.6 billion and $7.75 billion, an increase of approximately 1% to 3% versus the prior year. Reported EPS is expected to be greater than $5.29 and adjusted EPS to be greater than $6.40. Cash provided by operations is expected to be approximately $1.3 billion and capital expenditures are expected to be between $350 million and $400 million.

Before closing, I'd like to review a few reminders as you think about the remainder of 2019. First, we continue to expect more than $200 million of reimbursement pressure this year due to PAMA, our new in-network health plan contracts in 2019 and the modest reimbursement pressure we typically experience each year from other sources. Second, we continue to expect that volumes will gradually increase as we progress through 2019, just as they have through the first half of the year. Third, we have approximately 1 extra revenue day in the third quarter. Finally, we expect the strongest revenue in earnings growth in the fourth quarter of 2019 due to an easier comparison.

I will now turn it back to Steve.

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Stephen H. Rusckowski, Quest Diagnostics Incorporated - Chairman, President & CEO [5]

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Okay. Thanks, Mark. Well, to summarize, our volume growth accelerated in the second quarter due to our expanded network access, and we continued to build momentum through the first half of 2019. Our strong volume growth combined with our strategy to drive operational excellence enabled us to help offset the significant reimbursement pressures we're experiencing this year.

We're excited being back -- or being a new preferred lab network status with UnitedHealthcare and the opportunities to extend this approach to other players in the marketplace are with us. And then finally, we believe we're well positioned to meet our commitments in 2019.

Now we'd be happy to take any of your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Ralph Giacobbe with Citi.

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Ralph Giacobbe, Citigroup Inc, Research Division - Director [2]

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Maybe if you -- can you maybe help on how volume progressed through the quarter? If you're still seeing a build sort of month-to-month or if it has stabilized? And then I just wanted to kind of clarify what you said around some of the capitated contracts that you lost, is that a regional or a national contract? And then just help us on kind of the timing on when it happened and just broader thoughts. Obviously, there's a lot of discussion around the open network approach and sort of structural changes there. So this goes sort of against that tide. So maybe flush that out a bit for us.

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Mark J. Guinan, Quest Diagnostics Incorporated - Executive VP & CFO [3]

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Sure, Ralph. So because we have these artificial conventions called fiscal years, months, quarters, et cetera, there can be some noise. So if you look at our volumes throughout the quarter, they didn't accelerate each month because of the calendar. However, when you look at -- well, there's something else we look at, which is requisitions per day on an apples-to-apples basis, it did absolutely continue to grow throughout the quarter. And as I noted in my closing comments, that is our expectation for the balance of the year. So throughout each month, the beginning of the year, the first quarter, we saw accelerated volume growth. And then throughout the second quarter, when you look at an apples-and-apples comparison, absolutely we continued to strengthen despite that 70 basis point headwind. The headwind itself was actually a handful of regional capitated contracts. They were exclusively capitated. There was no (inaudible) elements in those contracts. And as I said, there were very large volumes at low margins and they started feathering in the beginning of the year, but really fully hit us largely in the second quarter.

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Operator [4]

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Our next question comes from Kevin Caliendo with UBS.

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Adam Chase Noble, UBS Investment Bank, Research Division - Equity Research Associate of Healthcare [5]

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This is Adam Noble, in for Kevin. Just wanted to see if you could size in the second quarter what the benefit to the organic volumes was from Managed Care access versus just general market growth? And do you expect to have further penetration of those contracts in the back half?

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Stephen H. Rusckowski, Quest Diagnostics Incorporated - Chairman, President & CEO [6]

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Yes. Let me start and then I'll pass it to Mark. First of all, we continue to talk about how we're always looking at the marketplace and trying to understand what's going on in the marketplace. And with all our measurements and metrics that we have, and we've talked about for many years now the same-store analysis, it still -- we still believe the market is stable. We see stable volumes, [there are efficient physician accounts] and also our hospital business seems to be stable versus the prior year. So Mark, would you like to add some color beyond that?

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Mark J. Guinan, Quest Diagnostics Incorporated - Executive VP & CFO [7]

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Yes. So it's hard to tease out specifically. I think to Steve's point, we don't think the market has been accelerating in terms of its growth. So we say market access, if you're asking specifically around United versus more generally, as we shared in the prepared remarks, other than Aetna, where obviously we had a major competitor who entered that contract, we were the sole national, and we were growing in every single major health plan. So in terms of market access, it's not just United. Obviously, it just makes us more competitive. It enables us to win the office. And so therefore, we're seeing growth across the board, not just limited to the United or Horizon.

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Adam Chase Noble, UBS Investment Bank, Research Division - Equity Research Associate of Healthcare [8]

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Got you. And if I can just sneak in one more. Just any update around the M&A pipeline? Neither you or your main competitor announced any acquisitions year-to-date. Is that a more function of an elongated conversion time line? Or are you seeing any change to the size or nature of the pipeline?

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Stephen H. Rusckowski, Quest Diagnostics Incorporated - Chairman, President & CEO [9]

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Yes. So you saw in our results that we inched up a little bit in Q2 versus Q1 in terms of the amount of our revenue from acquisitions. So we're feathering in some of the acquisitions, and they're delivering well. Second is, as we've said before and we'll continue to say it, our funnel remains strong. We have a number of that [supported ambition] to be close to 2% this year and into the future. So we keep on working on that. And just close with what I said in my remarks, the pressures that we see are now becoming real and becoming more visible. And those pressures are with PAMA cuts, some of that does extend itself, particularly for hospital outreach businesses into Medicare rates. And then the commercial changes that I talked about in my prepared remarks are clearly going to impact the hospital marketplace and the independent lab marketplace. And so because of that, we continue to have a lot of conversations around integrated delivery system lab strategies. And you again saw that we announced this new deal with Catholic Health System down in Long Island, which is another supporting proof point that we continue to advance our strategy on that front and the pipeline will be there to support the strategy as we indicated.

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Mark J. Guinan, Quest Diagnostics Incorporated - Executive VP & CFO [10]

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As Steve commented and as you noted, we didn't do any transaction in the second quarter. But Steve commented, we did get more growth from M&A. We closed a deal, a regional acquisition, Boyce and Bynum in the first quarter. So obviously, we've got the first full quarter of growth from that in Q2. And I would say there's no attitudinal change in terms of people's view around potentially getting out of outreach in our hospital customers. And certainly, some of the regional labs are feeling the PAMA pain. I think the interesting dynamic we've seen is that actually more of the conversations with hospital systems are getting broader. So it's not just about outreach but actually about doing a PLS deal, doing a reference deal and potentially selling the outreach like we did with PeaceHealth last year, and that's a positive. But on the other side, those take longer. So an outreach deal can be done much more quickly. So that dynamic has emerged a little bit over the last year or so, which is just adding a little bit to the time frame to get these transactions completed.

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Operator [11]

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Our next question comes from Ross Muken with Evercore.

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Ross Jordan Muken, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Healthcare Services & Technology and Fundamental Research Analyst [12]

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A bit on the cost side. I mean, it seemed like some pretty strong sequential OpEx management. I know you had called out in Q1 some pull forwards. But give us a little a color, it looks like restructuring ticked up a bit and your depreciation came down. So just sort of how you're tracking on your cost plan and sort of some of the realization of the main program versus some of the other timing elements that played out.

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Stephen H. Rusckowski, Quest Diagnostics Incorporated - Chairman, President & CEO [13]

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Yes. So I'll start again and Mark will follow. Just -- we continue to execute our plan for 2019. We indicated in our first quarter that we have planned for a number of restructuring efforts to start to kick in -- start to kick in, in the second quarter. That will continue in the back half of the year. So we feel good about that. And so we think we have our handles on the levers of cost in the right way. And then second, Ross, is we continue to drive our operational excellence program. I did say in my remarks, it's 3% of our cost base. And I remind everyone, that's about $200 million. And we continue to yield good results from that. We continue to see good productivity across-the-board and yes, that's in expense areas but also in cost of sales. And we will continue that into '20 and 2021. So Mark?

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Mark J. Guinan, Quest Diagnostics Incorporated - Executive VP & CFO [14]

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Yes. Ross, thank you for reminding everyone. But really the 2 drivers, if you look at Q2 versus Q1, one was the investments that we did at the beginning of our new access in terms of some marketing, adding some commercial resources, et cetera. Certainly, we haven't stepped back on the commercial resource but we have stepped back on some of the marketing campaign information. There were also some things that were expensive because we were betting on the come, adding Patient Service Centers, adding some logistics, assuming the volume would come, making sure we were in position. Now that, that volume is coming, it just became kind of the classic typical cost of sales. So it's not incremental expense. And then the other key driver was the restructuring that we completed at the end of the first quarter, which has taken out on a run rate basis a substantial amount of expense that will continue throughout the balance of the year and going forward.

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Operator [15]

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Our next question comes from Stephen Baxter with Wolfe Research.

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Stephen C. Baxter, Wolfe Research, LLC - Senior Analyst [16]

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I wanted to try to understand the sequential improvement in the decline of revenue per requisition. Though obviously, PAMA is a known quantity at this point. So I was wondering if you could update us on some of the other moving pieces there, whether it's commercial pricing or bad debt. I guess the other potential is that maybe this capitated contract you discussed had some kind of impact. Any color you can give there would be very helpful.

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Stephen H. Rusckowski, Quest Diagnostics Incorporated - Chairman, President & CEO [17]

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Well, Mark, you want to take him through the math?

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Mark J. Guinan, Quest Diagnostics Incorporated - Executive VP & CFO [18]

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Yes. So typically -- in terms of commercial pricing, typically those contracts run on a calendar year. There's been a couple of exceptions, where we've done things in the midyear. So it really wasn't anything in terms of commercial price changes between Q1 and Q2 nor, as you noted, is there anything different than PAMA. So this was really driven by mix. Some of it was some test mix. You do have some seasonality that can drive things up or down in the rev per req. But as we've noted, that [doesn't always is] necessarily directionally aligned with profitability even though it does drive changes in rev per req. And then, of course, the -- losing some of the capitated revenue certainly is a lift from a mix perspective. And then finally, PLS is a driver as well because as we've shared in the past, those tend to be more basic requisitions on a lot of complex testing. And certainly, as the PLS grows -- business grows disproportionately to the rest of the business, it can add or put a drag on our revenue per req. And then finally, patient concessions. When you look at patient concession rate in the second quarter versus the first quarter, it was improved. And a lot of that is really the result of the efforts that we've had to really improve the collectability of a lot of the tools that we put in place at our Patient Service Centers with our real time adjudication to give people that cost upfront, ability to collect the credit card as well as really working hard with our partner, Optum, to get better information on patients, do a better job at presenting the bill and overall collect to get a higher rate.

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Operator [19]

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Our next question come from Ann Hynes with Mizuho Securities.

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Ann Kathleen Hynes, Mizuho Securities USA LLC, Research Division - MD of Americas Research [20]

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So in your prepared remarks, you did talk about all the payers' initiatives, what they're doing on the P&L side. You specifically mentioned Anthem and some recent contracts include some PLN aspects. Can you just go into more detail on what you're talking about?

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Stephen H. Rusckowski, Quest Diagnostics Incorporated - Chairman, President & CEO [21]

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Yes. Sure. Well, first of all, let's go back to the opportunity this year. The biggest opportunities, it's best to access -- health insurance access we have for over a decade. And the PLN is going to be nice to have and it will provide some more momentum in that we believe it's a nice lever for us. And yes, we talk a lot about the effect that we'll have with United. But as we talked about, we're including -- we're having a number of conversations with other payers. And then finally is some of the contract extensions that we already have signed include some of the elements that we will talk about.

United will be releasing more and more as they go and they will provide more details. As I did remark -- mentioned in my remarks, if you're out of network, it's going to require more authorization to allow that to happen. So that's one point. Second is what we've said in the past, is there clearly will be a benefit design change. So less out-of-pocket cost for consumers. And then third, there will be physician incentives. So when you think about what's going to be the big element, it's all around benefit design; less out-of-pocket, better cost for consumers; physicians being managed to drive towards the preferred lab network; and then finally is really making sure there's no leakage to out-of-network, and it will be stronger than ever with United, and we see a lot of momentum with other payers as well. So more to come on that end, but we're off and running and working this hard, and we do believe it's going to be an additional lever. But don't let it overshadow that the biggest opportunities [we invested went back into] network. And whether it's also said in my remarks, yes, we had good growth obviously from United, but all our major health plans grew with the exception of Aetna, where we actually did expect a modest decline, which we saw.

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Mark J. Guinan, Quest Diagnostics Incorporated - Executive VP & CFO [22]

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Yes. So just to add in, I think to Steve's point, that a lot of the benefits of PLN-type elements is still in front of us. So it hasn't driven the volume growth. To this point, it's an enabler to continue to drive. So what are some of those things? And it's going to be different by payer type, but these are the concepts that we've talked about and various payers have embraced some of these or all of these to a certain extent. A lot of them are rooted in us getting a additional payment or a bonus payment, what have you, as we've shown the ability to steer work to better value away from higher-cost providers. So we have gotten that in a couple of contracts recently, where we have a metric and way of showing that as they save money, as their members save money, that we get a piece of that, and so we're aligning those incentives.

Another one is around treatment of pre-authorization, which is a huge driver for denials. So in a couple of payers, we've gotten -- as has our chief competitor and some others, but the labs that have shown themselves to be high quality actually differentiated themselves [positively] from a service perspective and other things around our panels and how they conduct themselves, we've actually gotten a status where they waive the pre-authorization. So it's an advantage for us from a physician's ordering perspective that the payers, as we know, if you send the work to these following labs, that we're going to be okay with it. So therefore, you don't require a pre-auth. So that's another element that we've gotten in some of our contracts. Steve mentioned some of the 0 out-of-pocket and some of the payers are coming up with products that they are offering that obviously -- within a market and we'll see the adoption rate and then some other payers have voiced an interest in going heavily in that kind of planned benefit design. So again, it's not as if there's a one-size-fits-all. That's why we talk about these being elements in some of the other payers.

And then finally, there is a lot of interest in kind of sharing the -- we'll call it the windfall gain from our outreach acquisitions. So when we buy a hospital outreach business, obviously those commercial rates immediately go to our negotiated rates, which is a huge savings for patience, huge savings for the payer. And the notion that, "Hey, this is good for all stakeholders, and we should share in some of that value." So those are a couple of details that certainly have gotten a lot of traction with the payers. And as Steve pointed out, that is in front of us. So when I say in front of us, we've gotten those in some of the contracts but obviously, we have to perform and we have to earn those and then those are outside going ahead.

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Operator [23]

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Our next question comes from Lisa Gill with JPMorgan.

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Lisa Christine Gill, JP Morgan Chase & Co, Research Division - Senior Publishing Analyst [24]

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I'm just wondering if you could maybe just give us an update on your consumer retail strategy. I didn't hear anything in the prepared comments this morning.

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Stephen H. Rusckowski, Quest Diagnostics Incorporated - Chairman, President & CEO [25]

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Yes. We -- it's one of our 5 strategies for growth and several parts of being what's consumer diagnostic [integration] service provider. We have talked about in the past, just to remind everyone, we have really digitized and brought our patient experience into the today world. And so when you walk into a best patient service center, it will remind everyone of the other experiences they had in their other experiences as a consumer, not as a healthcare experience. So a lot of partners there.

The second is, we continue to make progress on the tools in the access to the information. So the MyQuest app, which is our smartphone app, it has continued to expand its registration and we continue to expand the capabilities so you could schedule an appointment online. You can see wait times of Patient Service Center. You obviously get your results. And we now have over 7 million registered users, which is remarkable.

And the last piece of this, which is to your specific question, is the physical presence we think is quite important. So we have continued to manage our retail strategy and move our Patient Service Centers to a more retail setting over time. Right now we have roughly 200-ish Patient Service Centers between our Safeway relationship and Walmart. Walmart is about 70 of that, and we continue to evaluate the best-kept path forward to eventually have about 50% of our 2,200 Patient Service Centers in more retail-like settings.

Now what I'll also share is we have said that roughly 25%, let's call it 500 of our current Patient Service Centers are more retail-like, not all with retailers. But as we evolve over time with our current retail relationships and with possible others, that number will grow to be about half of our fleet of Patient Service Centers. And our experience in those is quite good. We believe that the patient obviously experience better, it's much more of a consumer experience, our employees, there's -- a lot us like it better. We can consolidate our operations into fewer sites. And the patient will exit. They walk in, they can walk around with the pager or they could do some shopping. They can eat after they've been fasting. So overall, from our perspective it's quite good, and then our relationship with the retailers is good as well because they benefit from that store traffic. So we feel positive about the response in our results so far, and we're continuing to drive it.

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Mark J. Guinan, Quest Diagnostics Incorporated - Executive VP & CFO [26]

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Yes. The only thing I would add, Lisa, is that there's always some outliers. But if you look at on average, our retail draw sites continue to increase the amount of activity. We had the highest average amount of draws in our Walmart sites in June than we've had since we started this. So we're very happy with the amount of traffic we're getting and we're feeling really good about the presence. And of course our volume is growing so there is things that are probably driving it. But part of it is awareness. People are starting to figure out we've got these draw sites in Walmart and getting comfortable going there, and we would expect that to continue over time.

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Operator [27]

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Our next question comes from Kevin Ellich with Craig-Hallum.

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Kevin Kim Ellich, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [28]

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Steve, in your prepared remarks, you commented about Anthem shifting hospital-based grades to independent lab grades. We saw something, I think, at lab economics (inaudible) that was shifted for pathology. Can you give a little bit more color? Is this for all of the tests that are being done in hospitals or just pathology? And then are you seeing other commercial payers follow this, doing something similar? And then what will that do for your hospital outreach and PLS deals?

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Stephen H. Rusckowski, Quest Diagnostics Incorporated - Chairman, President & CEO [29]

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Yes. So I would just say, as an overarching comment, and it's embedded in our introductory remarks that we have PAMA. And PAMA to some extent is independent of what's happening on the commercial side. But we now continue to see pressure from commercial payers on hospital outreach. So yes, we mentioned Anthem but I will also share that there's pressure from other payers, particularly with those that we work with, to push down the rates for all the ancillary services.

And I would -- obviously that includes labs, it includes radiology, includes other ancillary services that are provided by the hospital. And Kevin, 2 parts of this, one is, just in general to move more of the volume to most -- the highest (inaudible) provider like ourselves in the lab, but second is because of the out-of-cost to consumers. And the consumers, given the high percentage of corresponding health plans that have high deductibles and the high out-of-pocket cost for these expensive hospital-based services, the payers are looking at more aggressive strategies to normalize the rates more. So yes, recall that Anthem is proactively having a strategy. But we see this in many other places with many other commercial payers that are pushing back on what they've done in the past with ancillary services in general but specific the lab.

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Mark J. Guinan, Quest Diagnostics Incorporated - Executive VP & CFO [30]

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Yes. So Kevin, I would encourage you to ask Anthem directly. There is a -- I know they've led a couple of places with pathology, there's a publicly available document which we are referencing. And as you might imagine, before we said anything, we checked with them to make sure they were comfortable with the statement that we're attributed to. But I would -- for more detail, I would encourage you to ask Anthem about the schedule and how broadly they're doing it and so on. But there is something they've published and put out in the public domain.

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Stephen H. Rusckowski, Quest Diagnostics Incorporated - Chairman, President & CEO [31]

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Yes. And Part B of this, Kevin, I mentioned in my remarks, the movement across the country towards more price transparency.

As you know, the lag variation in our marketplace with ourselves having what we believe the best value proposition on the planet. Great quality, great service at some of the lowest prices.

And in that regard, actually there's a story today in the Journal which speaks to a number of the payers providing apps and services, if you will, to provide visibility to consumers to do a better job of shopping. And they call out Anthem, as we did, but others, including Humana and UnitedHealthcare that are working proactively as -- by way of another example, to help consumers manage their cost.

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Operator [32]

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Our next question comes from Jack Meehan with Barclays.

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Jack Meehan, Barclays Bank PLC, Research Division - VP & Senior Research Analyst [33]

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Just given some of the recent progress in terms of the commercial contracting that you talked about, I was wondering if you could give us some line of sight into how you think commercial unit pricing is shaking out for 2020? And just how that compares to the long-term guidance that you laid out at the Investor Day last year?

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Stephen H. Rusckowski, Quest Diagnostics Incorporated - Chairman, President & CEO [34]

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Mark?

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Mark J. Guinan, Quest Diagnostics Incorporated - Executive VP & CFO [35]

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Yes. So I'm sure you appreciate, Jack, I'm not going to speak to 2020. We're in very good shape in terms of where we stand with the commercial payers and the need to extend contracts. So there's no surprises that anyone should expect. We're in great shape. And around the pricing, I mean, obviously those prices are already set in those contracts. But really some of the incentive payments that I referenced, those have to be determined as we perform. So those could be some upside. However, if you recall, I gave you a pretty broad range on the revenue CAGR. So what I would tell you is that within those scenarios between the low end and the high end, we've contemplated all the different kind of outcomes that might happen, including obviously how quickly we gain our fair share of some of the new network access contracts and then how quickly and to what extent we earn some of those potential incentive payments. So I would say everything within the multiyear outlook that I provided has been reasonably contemplated and that's why we give a broad range.

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Operator [36]

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Our next question comes from Dan Leonard with Deutsche Bank.

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Daniel Louis Leonard, Deutsche Bank AG, Research Division - Research Analyst [37]

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Question for Mark. Just wanted to clarify your organic volume growth expectations in the second half of the year. So you said that volume should gradually increase as you progress throughout the year. The comps do get tougher. So are you expecting organic volume growth in the back half of the year to be higher than this kind of rounding to 3-ish percent you've delivered in the first half of the year?

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Mark J. Guinan, Quest Diagnostics Incorporated - Executive VP & CFO [38]

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Yes. So we absolutely expect the revenue despite any sort of comps -- I'm sorry, the volume to increase on an organic basis. So it may not happen every week, it may not happen every day, every month. But when you look at Q3 and Q4, we expect to continue to see improvements versus the second quarter in our year-over-year organic volume.

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Operator [39]

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Our next question comes from Donald Hooker with KeyBanc.

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Donald Houghton Hooker, KeyBanc Capital Markets Inc., Research Division - VP and Equity Research Analyst [40]

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So I just wanted to ask maybe a question on the PLS business. I think in the past, you guys have targeted some good -- some optimistic outlook, an optimistic outlook for this is, I think, you've talked about 50 basis points of revenue growth in going forward or something -- or revenue growth tailwind going forward from just PLS deals. Are you on track with that with these deals or -- looks like there's been a couple, I'm not sure if there have been others that you haven't announced. But in terms of trying to sort of size these deals and sort of put you on a trajectory with PLS, can you kind of reiterate that or discuss that?

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Stephen H. Rusckowski, Quest Diagnostics Incorporated - Chairman, President & CEO [41]

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Yes. So as we've shared with you our [prior] strategies, one of which is to proactively have conversations with integrated delivery systems on their lab strategy. And also the access is helpful there as well to be within geographies where we had issues with not having good access with some of their patients. So this continues to be a nice growth driver for us. We announced the Catholic Health Systems deal in Long Island. We did announce some other relationships last year and they [got studded] in and built throughout 2019. And I'll just close with saying the funnel continues to build. In the past, we've shared when we'll go in and we have a conversation with the lab strategy, it starts with how we can make them more efficient and this is what we call Professional Lab Services or PLS. And this is their inpatient hospital lab and it's a cost center. So we could save them anywhere from 10% to 20% of their cost. So that's an opportunity.

Second, as we get into that, then we work with them to rationalize and to become more efficient in their sophisticated reference testing that we sent out, that's another opportunity. And then the third piece, it's very unusual not to have this conversation. We didn't have a conversation about their outreach. Whether in a commercial marketplace with us, it doesn't make sense for us to -- them to continue to be in it or should we buy their business. So that just -- those discussions continue to progress. We have a bigger funnel than ever. We've backed up the United States. We know all the integrated delivery systems with big outreach businesses. We know those that have substantial number of beds in their cost centers. And that -- it continues to be a nice growth driver for us.

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Operator [42]

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Our next question comes from Patrick Donnelly with Goldman Sachs.

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Patrick B. Donnelly, Goldman Sachs Group Inc., Research Division - Equity Analyst [43]

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Steve, maybe just on the contracts you walked away from. Can you just provide some more color there? It's a bit surprising to hear competitors are once again being aggressive on price. It felt like there had been a bit of a lull there. Given the PAMA backdrop, the industry seems to realize price discipline was the best way to fend that off. So maybe just some more context around what you're seeing, what would lead these other labs to be price competitive given this backdrop?

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Stephen H. Rusckowski, Quest Diagnostics Incorporated - Chairman, President & CEO [44]

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Want to take this one, Mark?

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Mark J. Guinan, Quest Diagnostics Incorporated - Executive VP & CFO [45]

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A great question for you to ask our competitors. So it's not something we can speak to. Obviously, we control our own view towards pricing. We've been pretty vocal and consistent that -- and we feel our price is already really good. There's an awful lot of competitors in this marketplace that have prices that are multiple of our price, and we are an excellent value. There is no need for Quest to offer a lower price. So in terms of other people's motivation to drop price further in some instances, that's a question you would need to put to them.

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Operator [46]

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Our next question come from Ricky Goldwasser with Morgan Stanley.

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Alexa Desai, Morgan Stanley, Research Division - Associate [47]

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This is Alexa on for Ricky. Can you hear me?

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Stephen H. Rusckowski, Quest Diagnostics Incorporated - Chairman, President & CEO [48]

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Yes.

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Mark J. Guinan, Quest Diagnostics Incorporated - Executive VP & CFO [49]

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Yes. We can.

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Alexa Desai, Morgan Stanley, Research Division - Associate [50]

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Great. I wanted to come back to your expectations for the second half of the year. You beat the quarter but maintained guidance, which sort of implies a lower second half earnings growth than what The Street is currently modeling. Are there any headwinds you feel The Street isn't factoring in for the back half of the year? I guess, can you just give us a sense of the puts and takes here? And what the sources of upside to the guide could be?

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Stephen H. Rusckowski, Quest Diagnostics Incorporated - Chairman, President & CEO [51]

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Let me to just start and then Mark will get in the details. What we showed in the first half is, we've delivered on what we -- separate expectations that we wanted to show momentum built throughout the first half of 2019 and we did. So we're pleased with the results in the first half. Second is we're midway through the year. And we thought it was prudent at this point to maintain our outlook, not get ahead of ourselves, but what Mark said earlier is -- and what we've said about this year but also in general about the growth opportunities in front of it, it will continue to build throughout 2019. But this is not just a build for 2019, it will include a build in 2020 and 2021. So Mark, a little more color around the rest of the year?

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Mark J. Guinan, Quest Diagnostics Incorporated - Executive VP & CFO [52]

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Yes. So we are not in any way influenced by what The Street's view is in the back half. What we're -- what we do when we give guidance is really what we think our shareholders and stakeholders should understand from our perspective. So when you look at the first half, we're very pleased with our results, we feel like we're on track. It's still halfway through the year. Of course, in the back half, we have things that sometimes happen that are beyond our control, like hurricanes and snow and December and so on. And so at this point, we just felt that there wasn't any need since we've given a floor and not given any sort of a range. So there's nothing negative in terms of our signaling for the back half. We are on track to do what we expected, which is to do at least $6.40. We're obviously feeling good, I think, as many others with what we've done in the first. But we'd rather just continue to perform and then obviously cross our fingers around any sort of weather events and other things that might impact the back half. But certainly nothing operational that we're signaling or that anyone should be concerned.

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Operator [53]

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Our next question comes from Bill Quirk with Piper Jaffray.

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William Robert Quirk, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [54]

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So kind of multipart question here, guys. First, I think the answer is no. But is there any negative effects from Anthem? Second piece is, with respect to the capitated contract loss, was that contemplated in the original guidance? And then lastly, just any comment with respect to consumer genomics business given that the principal supplier into that industry had obviously cited some challenges in that space a couple of weeks ago?

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Mark J. Guinan, Quest Diagnostics Incorporated - Executive VP & CFO [55]

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So I'm sorry. I didn't catch your question, Bill, on Anthem.

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Stephen H. Rusckowski, Quest Diagnostics Incorporated - Chairman, President & CEO [56]

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Yes. The first part.

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William Robert Quirk, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [57]

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The first part of the Anthem question was just, I think the impact here is predominantly for hospitals. I just want to confirm, guys, that you're not seeing any negative effect from some of the Anthem reimbursement changes that they're implementing?

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Mark J. Guinan, Quest Diagnostics Incorporated - Executive VP & CFO [58]

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No. We have a contract, multiple contracts with Anthem actually. We contract with them regionally that we have a negotiated price and so on. And certainly, we are not in the ZIP Code of the hospitals that they are now starting to say need to be rationalized. So this is really a movement to get everyone. It's not targeting anyone specifically except for the outliers to be more -- at a more consistent rate. So we feel we're already in that ZIP Code and certainly, there's going to be no changes in the current time frame because we have contracts with Anthem.

On the capitated, we really don't give guidance on volume. So was this a possibility that we contemplated? Yes, certainly. But as I've pointed out in my prepared remarks, it has minimal impact to our revenue, and certainly no impact to our bottom line. So really, it's more of a volume effect. And we've tried to encourage our stakeholders to not pay quite as much attention to volume for this very reason. So we thought given the magnitude of this change, we're going to make sure that you understood there was a big volume shift from us to others or to an another direct headwind, but really no financial or economic negativity to us, just volume.

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Stephen H. Rusckowski, Quest Diagnostics Incorporated - Chairman, President & CEO [59]

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And the last part, Bill, I had a hard time hearing that as well.

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William Robert Quirk, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [60]

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Just a comment, Steve, on your outlook for the consumer genomics business given what are the principal outliers a couple of weeks ago?

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Stephen H. Rusckowski, Quest Diagnostics Incorporated - Chairman, President & CEO [61]

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Yes. Got you. And as you know, we have a relationship with Ancestry. It's a good relationship, it continues to build. No material effect on our growth, plus or minus. So I would just say, in general, really stable. Second is, I did remark about our consumer testing business, which affords us a nice platform that is growing nicely, and we're very pleased with the pickup around our general diagnostic testing. And I mentioned that we just introduced a new line with these tests, but we're going to use that as well as a platform for consumer genetics in the future. And so more to come. But overall, stable environment as we see it. As you know, we're not the only provider to Ancestry at this time and it's not a big piece of our revenue. So a stable business for us at this point and still good opportunity in front of us.

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Operator [62]

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Our next question comes from Derik De Bruin with Bank of America Merrill Lynch.

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Derik De Bruin, BofA Merrill Lynch, Research Division - MD of Equity Research [63]

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Could you talk a little bit about the esoteric testing business? And just sort of volume and mix trends within that and sort of how that's impacting the overall revenue per acquisition? Just -- is pricing getting better, reimbursing stable in that? Just any additional color would be great.

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Stephen H. Rusckowski, Quest Diagnostics Incorporated - Chairman, President & CEO [64]

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Yes. Well, first of all, the term esoteric is an industry term. We have defined our genetic and molecular business as being what we call advanced diagnostics, and we don't break out specifically that business and provide color. But in general, what we've said in the past, it's a business and an opportunity that's been growing mid-single digits, and we wanted -- continued to accelerate it and it's an active part of our strategy. And within the quarter, we felt good about the progress we've made in that business on a number of fronts. We have some good growth in some portions of women's health. And then in addition to that, we define esoteric. It typically includes a toxicology presence. Prescription drug monitoring continues to be a nice, big, growing business for us. We're pleased with the progress in the quarter as well. And just in general, I think our esoteric or more sophisticated testing, we had good year-on-year comparisons, better than last year in the hospital presence. That's not all esoteric, but in general, a lot of it is. And then as we pull more growth in our general diagnostics business, it typically will also pull some advanced diagnostics or esoteric business as well. So overall, as we raise the tide, it's going to help all the boats in the harbor, including advanced or esoteric as well as general diagnostics.

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Operator [65]

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Our next question comes from Matt Larew with William Blair.

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Matthew Richard Larew, William Blair & Company L.L.C., Research Division - Analyst [66]

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Obviously, PAMA was an initial catalyst for hospitals and health systems thinking about the future of their lab business. But it sounds like the preferred lab network was specifically with United and then more broadly as payers are being more aggressive with the way they think about laboratory testing may actually be perhaps a more dramatic catalyst. I wonder if you could just discuss the conversations you're having with hospitals and health systems, be it for outright M&A or PLS arrangements and how payer behavior has started to change those conversations?

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Stephen H. Rusckowski, Quest Diagnostics Incorporated - Chairman, President & CEO [67]

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Yes, sure. First of all, if you recall, we've been talking about 3 changes in the marketplace, the PAMA effect, and one could argue it really just got started in 2018. And because of some of the nuances of how the payment works, it was somewhat muted related to some of the offsets to the P reductions, we grew about 10%. So the first year, '19 is the second year, it's a full year. No muting of any of the effects and then we could have another effect in 2020.

So that is starting to become more visible and the hospital outreach businesses and administration of hospitals are becoming more aware of that. And then the second part of that is it will spill over, even has already spilled over to Medicaid. Typically Medicaid in all states is slower than Medicare. And then finally, as I talked earlier, a lot of the commercial payers are pushing back on the [widened] discrepancy of health care cost slipping in our space. So laboratory-wide variations where hospital rates could be to the 10x higher than our rates. And the last piece is, the reason why they're pushing on this is because consumers are paying for more and more health care every day, employers are asking questions about it and it's getting visibility in Washington. So those 3 changes in the marketplace are getting a lot of visibility for -- from administration of any integrated delivery system. And then second is small retail operators clearly see a different environment going forward.

But sometimes we're asked a question what inning we're in. Okay, in anything we do. I would say in this front, with those 3 sort of structural changes, we're still in early innings, but it's building momentum as we get into the middle of the game. So I think we're now beyond the start and we're starting to get a lot more visibility to it and there's going to be a lot more change in 2020, and that's going to be attracting decisions of whether hospitals stay in the business or whether regionals continue to operate as the operator consider their options and considering selling the business. And it is part of our strategy to be a consolidator in a smart place since we are the leader.

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Operator [68]

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Our next question comes from Eric Coldwell with Baird.

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Eric White Coldwell, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [69]

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Most of my topics were covered, but on these capitated contracts, we know from past filings that they were in total representing about 11% of volume and 3% of your revenue. Were the contracts that you specifically walked away from the low end of a capitated contract because you're seeing absolutely no impact on revenue? So I'm just trying to understand -- typically, capitated contract is 1/4 of your average profitability. So were these the low end of that range, or is there perhaps some slight impact from this change?

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Mark J. Guinan, Quest Diagnostics Incorporated - Executive VP & CFO [70]

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Yes. So they were definitely low margin as I referenced. We're -- we've actually maintained some of the work at a higher rate. So there's an offset to the lost OM because in the particular state that this took place, they're obligated to pay us for a subset of tests even if we're not in contract, and they're obligated to pay us at a rate that's much higher. So therefore, you can get detail in the prepared remarks, but that's why there's really very little if any OM impact. That's a partial offset to the revenue, not 100% because it's lower volume, less revenue. We even [go] at a higher rep, much higher rep for req, but not enough to compensate in total. So it's within the -- certainly rounding our overall annual revenue, it's not a huge number with that offset. And on an OM basis, it's really had no impact because we continue to get paid for some of the work that we've maintained.

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Operator [71]

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Our last question comes from Mark Massaro with Canaccord Genuity.

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Mark Anthony Massaro, Canaccord Genuity Corp., Research Division - Senior Analyst [72]

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I wanted to ask about in regards to your consumer initiatives, QuestDirect is certainly one of the initiatives. I know it seems fairly early, and other lab providers are doing similar pilots, but can you just speak to any traction you're getting there? Maybe can you help us think about whether or not that has moved the needle in terms of actual orders coming from new types of individuals? And then my second question is on the Clinical Trials Connect program. Also seems like it's early days, but can you speak to any wins there that gives you confidence that this can grow in the future?

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Stephen H. Rusckowski, Quest Diagnostics Incorporated - Chairman, President & CEO [73]

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Okay. So first of all in -- on direct to consumer, we've been at this for a while. We've actually started to test the water. We built a business with a relationship with the New York Football Giants and we call it Sports Diagnostics and really we're a toe in the water of understanding a very specific segment. How we can market our products directly to consumers. How we can fulfill that order because it's a different order fulfillment change -- resulted. So we had to build some capability years ago to do that. And then second is we actually tested the waters on our general diagnostics business. In the state of Arizona several years ago, we have a joint venture partner with Banner Health. And as you recall, one of our competitors, given -- in that state, they passed legislation where consumers no longer needed a physician order to order a laboratory test. And so we actually priced out about 100 tests and found out, in fact, in Arizona, there was a market. And so we took that success and we moved it to Missouri and to Colorado. And then this past fall, we actually expanded it to 48 continental states. And so about 22 of those states who no longer need a physician order and that's what we've also done in the other 26 states is we lit up a (inaudible) network with PWN to provide an order for consumers if they need it. So we're deeply engaged in this. We've worked out some of the kinks operationally from years ago with all those experiences and we're off and running. And as I said in my prepared remarks, we're very pleased with the sequential improvement and sequentially, actually month upon month, we're seeing some nice volume growth. And there is a segment. Now this is all private pay, and we price it accordingly for private pay, and there is a segment where people rather could get some of these tests done without engaging their health care insurance company. So off and running, and we're pleased with its initial results. The second part of the question had to do with -- Mark, could you remind me of the second question?

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Mark J. Guinan, Quest Diagnostics Incorporated - Executive VP & CFO [74]

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Mark, you still there? No.

All right. Operator, we'll end it from there.

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Stephen H. Rusckowski, Quest Diagnostics Incorporated - Chairman, President & CEO [75]

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We'll take it from there. Well, thanks everyone for joining us today. We appreciate your support, and have a great day.

Thank you.

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Operator [76]

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Thank you for participating in the Quest Diagnostics Second Quarter 2019 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 (800) 871-1320 for domestic callers, or (402) 280-1688 for international callers. Telephone replays will be available for approximately 10:30 a.m. Eastern time on July 23, 2019, until midnight Eastern time on August 6, 2019.

Goodbye.