Welcome to the Quest Diagnostics Third Quarter 2017 Conference Call. At the request of the company, this call is being recorded. The entire contents of the call, including the presentation and question-and-answer session that will follow, are the copyrighted property of Quest Diagnostics with all rights reserved. Any redistribution, retransmission or rebroadcast of this call in any form without the written consent of Quest Diagnostics is strictly prohibited. Now, I'd like to introduce Shawn Bevec, Executive Director of Investor Relations for Quest Diagnostics. Go ahead, please.

Thank you and good morning. I am here with Steve Rusckowski, our Chairman, President and Chief Executive Officer, and Mark Guinan, our Chief Financial Officer. During this call, we may make forward-looking statements and will discuss non-GAAP measures. For this call, references to reported EPS refers to reported diluted EPS and references to adjusted EPS refers to adjusted diluted EPS excluding amortization. Actual results may differ materially from those projected. Risks and uncertainties that may affect Quest Diagnostics' future results include, but are not limited to, those described in 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. The text of our prepared remarks will be available later today in the Investor Relations page of our Website. Now here's Steve Rusckowski.

Thanks, Shawn, and thanks everyone for joining us today. This morning I'll provide you with some perspective on PAMA, highlights on the quarter and review progress on our two-point strategy, which continues to drive results. Then Mark will provide more detail and take you through updates on our 2017 guidance. Well, we delivered another strong quarter of revenue growth in spite of some weather challenges. We completed two previously announced acquisitions and agreed to purchase Shiel Medical Laboratory and then yesterday we announced a strategic relationship with Cleveland Clinic that includes the acquisition of Cleveland HeartLab. Here are some highlights from this quarter. Revenues were $1.93 billion up 2.4%, reported EPS of $1.15 was down 14% from 2016, adjusted EPS grew 150 basis points to a $1.39, which includes an increase of $0.02 over the prior year of excess tax benefit associated with stock-based compensation. Our updated guidance for our full-year 2017 primarily reflects the impact of hurricanes in the third quarter, which impacted geographies where we have a large presence as well as our recently closed acquisitions. Before I describe the progress, we have made to accelerate growth and drive operational excellence, I'd like to discuss PAMA. We continue to urge CMS to delay the implementation of PAMA to take the time to get it right. The preliminary rates that CMS released are not market-based rates as Congress indicated. Unfortunately, only 1% of all laboratories submitted data and over 99% of hospitals and physician office laboratories were prohibited from reporting their rates. Also based on data submitted through CMS, Quest alone represented nearly 40% of all the market data CMS collected. As you're aware from previous days, our estimated share of the Medicare market is less than 15%. Instead of protecting access to essential laboratory testing, this flawed approach…

Thanks Steve. Starting with revenue, consolidated revenues of $1.93 billion were up 2.4% versus the prior year. We estimate the impact of the recent hurricanes reduced our revenue growth by approximately 130 basis points in the third quarter, which is slightly lower than what we had estimated in late September. Revenues for diagnostic information services grew by 2.8% compared to the prior year with approximately 140 basis point attributed to recent acquisitions. Volume measured by the number of our acquisitions increased 1.6% versus the prior year of which about 60 basis points was organic. However, note that the impact of hurricanes presented a headwind of approximately 140 basis points to volume in the quarter. Revenue per acquisition in the third quarter grew by 1.2% compared to the prior year. As a reminder revenue per rep is not proxy for price. It includes the number of variables such as unit price variation testament and test per rep. Here price headwinds in the third quarter remain less than 100 basis points. While price fluctuations can vary from quarter to quarter, we continue to expect that unit price headwinds will remain moderate through the final quarter of 2017 and consistent with the last several quarters. Beyond unit price and the impact of growth in our PLS partnerships, other mix elements including test mix contributed to the slightly more than the positive 100 to 200 basis point trend we've observed for several quarters. Reported operating income for the quarter was $298 million or 15.5% of revenues compared to $322 million or 17.1% of revenues a year ago. Keep in mind, our reported operating income in 2016 included a gain on Escrow recovery associated with an acquisition. On an adjusted basis, operating income was $325 million or 16.8% of revenues compared to $320 million or…

Thanks Mark. We've summarized a very busy and productive quarter we turned in another strong quarter and are delivering on all five elements of our strategy to accelerate growth. Our updated guidance for our full-year 2017 reflects the impact of hurricanes in the third quarter, which impacted geographies where we have a large presence as well as the impact of recently closed acquisitions. And then finally, we remain confident in our ability to meet the long-term commitments outlined at our 2016 Investor Day. Now we'd be happy to take any of your questions, operator?

Thank you. We will now open it up to questions. [Operator instructions] Our first question is from Isaac Ro with Goldman Sachs. Your line is open.

Good morning, guys. Thank you.

Hey Isaac.

Hey Steve. So, both questions I had for you were longer term in nature if I may. First one had to do with market share. If we assume that you're not able to convince the regulators to push back timing of implementation, could you talk a little bit about how quickly you think the marketplace will start to react to the new pricing reality and what does that mean for your ability to start trying to take some market share in the next six to 12 months?

Yeah thanks Isaac. Well first of all we've been in the consolidation mode as far as our strategy for the past five years, a significant part of our growth strategy is to get that 1% to 2% of growth through acquisition. What you see from us this quarter is we announced two acquisitions, puts us in that range of 1% to 2% for 2017 and while we said that puts us in a very good place for 2018. So, our acquisition strategy continues to be part of our consolidation strategy. We continue to see interest in companies or laboratories looking at their strategic options and so we believe that's still a good part of our strategy. And then secondly, is we're confident that our guide proposition in the marketplace is really second to none. Our value of how we deliver our services is very strong in the marketplace from a quality and our service. You couple that with what we're doing on our consumer strategy. I mentioned in my prepared remarks about the convenience of what we're doing moving around our enablement of the whole process and are our better and better access for the consumer. Our value proposition of the marketplace is quite strong. And so, I also mentioned Isaac is that payers are taking notice to that and if you look at our assets today through our health plan relationships, it's really much stronger than what we've had in the past that will continue to build and as we get that better access we health insurance companies, we will continue to grow faster than the market place, both through acquisitions and organically. So, tracking well with our plan to accelerate growth and we believe that that is the right strategy for us going into the future. So, thanks for the question.

Okay. Thanks. And just as a follow-up on I think Mark's comment at the end around long-term guidance and if I go back to your 2015 Analyst Day you talked about EPS growth in the mid-to-high single digits, you're staying with the current outlook maybe more towards the lower end of the range. Could you articulate how much of that you think will come from M&A versus organically and just trying to understand the importance of M&A in achieving that new outlook, thank you.

Sure Isaac. So, I was qualifying that we would be in the lower end if PAMA moved forward under the currently proposed fee schedule. So obviously while the things we've shared we're trying to influence that. So, at this point we're not locked into that. What we're saying is that would be the likely outcome or the cost to be a significant or seeing in the original proposal, but we're obviously commenting on that and there is still some more work to be done to see where that settles down. So, I wouldn't say at this point we're signaling the lower end. We're just saying there is significant impact and impairment while we certainly contemplated that with that outlook in November of 2016. That's why we gave a range. This is in the high end of what we might have expected coming our CMS. So, I would not lock into that at this point. In terms of M&A other than the deal that we have already executed, do not have any earnings projections that are based on future M&A. Certainly in our revenue, we've talked about getting 1% to 2%, but we all know that it takes a period of time generally 12 to 18 months before you get to a run rate level of earnings contribution. So, in that mid to high single digits, so I am not counting on significant contributions from unexecuted M&A on the bottom line only on the revenue side.

Our next question is from Kevin Ellich with Craig-Hallum. You line is open.

Good morning. Thanks guys.

Hey Kevin.

I guess I want to go back to PAMA, in the press release you talked about exploring every option in terms of you guys and the lab industry exploring every option to make sure Medicare beneficiaries have access to lab services. What options do you have I guess on top of that more importantly, if PAMA is implemented as written, what impact you think that'll have on commercial rates going forward?

Sure. I'll take this. The first part of that question I'll give to Mark for the second part. So, we're actively working this and we've been working on it for years as we talked about. We've people engaged with the CMS on the implementation PAMA in the quarter and the principles of that we don't disagree which is market-based pricing for the refresh of the fee schedule. But while we've been helping them was but unfortunately, we think with what we've the draft rates they got wrong. We've been helping with the implementation of gathering the data to make sure the data is correct and then working through the competition of the data to establish new rates. So, we've hard at work with them three years, but I'll share with you since we got the draft rates we have provided them feedback on where we see -- where we have questions or where we see some issues with what we see so far with the draft rates and so they listen to that and that's the first part of how we're engaging in this. Second is before we saw the draft rates and now since we see the draft rates for all over our congressional leaders to make sure they understand the difference of what CMS has proposed from those rates versus what the intention was with PAMA and we feel good about the receptivity of that and also, we've been engaged with the administration on that as well. So, hitting all branches of government and that we're very active. We'll cement our formal covenants of the trade association and I'll say trade association all partners and all members of the trade association were actively engaged in that and that will go in before the deadline, which is October 23.…

So, Kevin, so couple things. First off as we shared previously, we had very little of our commercial contracts revenue tied to floating rates. We've been cleaning that over the last couple years in anticipation for some reductions in MAA. So, it's a very small portion and we very soon not have any contracts that are in any way floating an index MAA. In terms of predicting the future, it's always hard to predict the future, but I can assure you that in the conversations with the large payers recently, they understand the significant impact of those trends in industry and certainly to us and they actually have entity for that, so versus it being an opportunity to take advantage of that and the messaging being we want to keep this ratio to Medicare. Of course, the conversation as you understand the intent of this is to incorporate commercial rates and Medicare rates. So that is an impossibility. So, at the end of the day, you're going to be basically in the same curve as the Medicare rates and given the significant impact and the fact that largely they agree with our premise that we are part of the solution on laboratory spending and pay significantly more to other providers of laboratory diagnostic and patient services. And also, were a part of the solution in terms of overall healthcare spend given the amount of influence that we have our data. Many people say one to two thirds of the other spend that we're actually all of our good guys and a good partner. So, they understand that and they you look for us to be successful and so the tenor of the discussions around price, I can assure you has not gotten worse given PAMA and certainly become neutral or got better in most cases. So, should not expect any significant commercial price erosion going forward and just to remind people, we shared before, all our labs are typically paid one and half to two times but we're paying and then hospital laboratories are often 2.5 times or more the same rate. So, I would expect some evolution in that over time as opposed to looking for credit concessions from the independent national labs.

Great. And then just really quickly, Steve any thoughts on the utilization environment and organic volume trends?

Sure. Look what we've said in the past we'll say this quarter again, we feel stable. We look at all the different indications in the marketplace and overall if you look at the amount of healthcare people are using in this country and what we see from our established accounts, we feel stable. We feel good about our organic revenue growth in the quarter. We do look at to the effect that the larger storms over the third quarter had on us and we adjust for that. We actually feel very good about the progress we're making accelerating growth. So, we're making progress in a stable marketplace to accelerate growth.

Great. Thanks guys.

Thank you.

Our next question is from Jack Meehan with Barclays. Your line is open.

Hi. Thanks. Good morning, guys.

Good morning, Jack.

Mark, I wanted to drill little bit more into your commentary on the commercial pricing environment. Obviously, there's a negotiation of national payer contracts underway. Could you just give an update on your philosophy and those negotiations on price versus value proposition, versus network access and to your comments, you just gave as a low-cost provider, do you think you could actually push on commercial prices and offset if PAMA hold?

Well, yes Jack of course that's our strategy is to push to two-way negotiation. So, at this point, I am not going to speculate our -- I promise where that could end up, but yeah, that is the position that we're taking and you already have excellent rates and there are other people whose services arguably are little better in some cases are as good as we're providing given the fact that for example we provide all of our data to the payers and quite often they don't get the data from other people to provide laboratory services within their network. So that's one argument actually to get a better product. And then some of the things that Steve walked through in terms of the consumer experience that resonates because they're understanding that the outside customer which are your members and when they compete with other health plans there is certainly some value beyond the result of laboratory tests and the services that they provide and it can positively differentiate them if they bring some partner and work with us and see some of the value that we bring and the other providers don't. So that's part of our value proposition that we're discussing with them and I can assure you that over the last couple years we have gotten rate increases with some contracts given our value proposition explanation and that comes part and parcel with what I would call it try spirit of partnership whereas I said earlier, they see what part of the solution. So, the more they can field work to us, the better from some of those higher cost providers who arguably don't have good value given the service they provide, the better they're going to be and the more they're going to solve their laboratory spend. And as I said earlier appropriately drive the use of that data for other healthcare cost. So, I feel really good about the relationships that we've been building and any time of course there is everybody wants to maximize value in their side of the equation. But I think as I said earlier, the tenure of the discussions and the lot more in the spirit of partnerships with the health plan and there are more of more seeing us as part of the solution and that's what's going to help us to defend the value of the price that we offer today and into the future.

Great. And then if PAMA holds, would you push harder on cost savings in 2018? At that point I would be curious you had any updates on regional consolidation of the footprint and then just auto adjudication rollout to payers?

Yeah. So, we continue to drive on an invigorate despite PAMA and what we've shared and this has been our philosophy for filing out years that we need to continue to get better in what we do and better probably the both in quality and the service as well as efficiency. And as you see in our results we continue to get more efficient and we feel about tracking to that $1.3 billion goal. And if you recall in 2016 Investor Day, we said we're not done yet. So, we got a lot more in front of us. We provided some visibility in color to that in 2016. So, we see more beyond the $1.3 billion and so we were anticipating that there might be some more price pressure going into '18 and '19. So, what you see implied in our guidance is the continuation of invigorate test what we'll do this year and into 2018 along with just driving productivity in general. And when you go through the math based upon what we have said, obviously we feel strong. We've had the convenience of the outlook that we provided in our Investor Day in 2016 because we've been working so hard for years. It's not a new program we're going to the continuation of the existing program and we have more efficiency to get out of this organization.

Great. Thank you.

Our next question is from Nicholas Jansen with Raymond James and Associates. Your line is open.

Hey Nick.

Hey guys. Good morning. Just two questions for me. First just wanted to dig a little bit deeper into margin trends and expectations as we think about PAMA being rolled out over the next two years. Certainly, you're showcasing very nice progress in 2017 on margins, I think up 50 basis points in the most recent quarter ex hurricane. So just wanted to get your sense is 2017 peak margin year and how we think about if you analyze the next three years, how much does margin degrade associated with PAMA, thanks?

Yeah Nick, so thanks for the question. The outlook that we gave is a CAGR. So that will be put as a CAGR. So, it's not year-to-year, we're not until we see some variability especially depending the way some of the PAMA cuts get rolled out. But with that said what we've committed to is growing earnings faster than revenues. So, by definition that we says that we expect to expand margins. So, then it may not be every quarter, it may not be every single year in the period year-over-year, but over the next several years we're looking for continued margin expansion because we're committed to growing our earnings faster now.

And just a clarification on that regarding the structure of PAMA, does that mean -- my understanding is that 2019 would be a worse year than 2018 as we think about the size of the headwind. Is that the right understanding?

The honest answer this point is I don't know because there are still so many things up in the air regarding how they're going to imply some of their rules and in pricing practices and without getting into too much detail because it's very complicated. But just in summary a lot of the billings to Medicare are panels and the way Medicare pays panel is very, very complicated and the more analyzing the panels, the more it impacts the overall price and it's not the positive fashion. So, they already have historically deviated from what people who are close to the industry might not understand which is you don't get in a way for every single analyze unless you start putting things together in a panel. So, the question we have is how our panels get paid and how we price which is the course to market because in many cases there is not a comparable code within the commercial world with a very, very complicated issue that we're trying to sort through and that's why even if at this point we were in a position to know and really interested in sharing the estimate by year, I don't have that answer. So still more to come. So, I would say at this point, do not assume that '19 is worse than '18 and vice versa. We will tell you as soon as we have people understanding to provide you some reliable information.

That's very helpful and then just one quick -- just a numbers question. I understand the tax dynamics the stock-based compensation benefit you're seeing this year. Any way you can just share what we should be plugging in for '18? Is it kind of the 35 to 37 range, just wanted to get a sense of how we should be modeling tax specifically in '18, thanks.

Yeah so, I am sure you understand that, what drives that is a couple of factors. As long as the share price is higher than it was at the time of the brand of the equity and that you're going to seek in some value. So certainly, when you see a year like 2017 where we had significant stock appreciation that was versus previous years that was driving a lot of this benefit. The other thing is option exercises, which of course we can't predict. So, we're investing performance shares investing that will drive some level of benefit consistently assuming that the stock price continues to appreciate to some degree, but we can't predict the timing of the option exercises, which is a huge variable. So, what I will say is the sixth sense that we shared when we say the base level assuming that the stock is stable and continues to go up to some degree that is pretty reliable but that's kind of be there, but the large swing is beyond that will be highly dependent on appreciation of the stock movement and the amount of option exercises and that's what we can't predict. So, I would say sixth sense and we'll continue to update if that change is kind of a base level you should consistently expect and anything beyond that is dependent on those other factors.

Thanks for all the detail guys.

Our next question is from Bill Quirk with Piper Jaffray. Your line is open.

Good morning, everybody.

Hey Bill. Good morning.

So, you addressed the commercial rate in Medicare relationship with respect to Kevin's question. I was hoping you could comment on the percent of Medicaid business that's tied into Medicare rates and how you're thinking that -- thinking about that rather over the next couple of years assuming that PAMA goes into effect?

So, the best of our understanding, Medicaid rates are not largely tied in terms of being an index in terms of a mechanistic fashion. Certainly, they look at Medicare rates to make sense and the states set those rates. But it doesn’t look like there is a formulaic relationship in most cases again to the best of our understanding and we've looked at this pretty deeply and will automatically trigger changes in Medicaid. So that's going to be pretty much up to the states. And again, reminding you only about 2% or 3% of our revenues are paid by traditional Medicaid fee for service. A lot of the Medicaid are removed to management and the one thing that it won't say is that there are rules around the fact that Medicaid cannot pay more than Medicare. So, in any case where there is a state Medicaid rate where the fee for service is close to Medicaid and there is a Medicare reduction, you will see a reduction to ensure that Medicaid is not higher than Medicare. But beyond that at this point still more to learn, but I would not expect this will trigger significant reductions in state Medicaid rate and again given the small portion of our revenue that comes from 3% Medicaid, I wouldn't expect it to be a major headwind for us.

Okay. No, I appreciate the color around that, thank you. And then just separately can you guys comment on I guess the consumer outreach programs that you have with Safeway and Walmart and help us think a little bit about the relative profitability of those as compared to say your traditional draw station and traditional diagnostics business, thanks?

Yeah Bill thanks. It's our consumer strategy and I outlined the five elements of our growth strategy one of which is to be most consumer oriented laboratory and there are multiple facets as far as that is concerned. One is we're putting a lot of work and e-enabling our whole consumer process and we're talking about e-check-in. So, moving really our experience that we have our consumers to contemporary experiences that people experience in the consumer world. Making a lot of progress there. The feedback is great. It helps patients. It helps our employees and as I mentioned, our healthcare insurance partners feel great about their experience as well because they're working on that. The second is around information. We got MyQuest, we have 4.5 million users, which is a phenomenal number given that we only brought this to the marketplace in a little over two years. So, it's just picking up the volume of users that we have and we put more and more content around that and also want people to navigate into our whole experience through MyQuest, which is a nice consumer touch if you will. The third is around products. We see a lot more from us and we have direct to consumer testing. We mentioned we tested this in our marketplace last year. We're bringing this into Missouri and Colorado. We're actually are encouraged by some of the early returns that consumers are interested in paying out of pocket from their own ordered diagnostic test. It could be cholesterol, it could be hemoglobin, glucose or such are transmitted, but there is a market there and so we're going at that market. And the last place we're investing in which is what you -- and that is a bit part of your questions is what we're…

Our next question is from Ralph Jacoby with Citi. Your line is open.

Thanks. Good morning.

Good morning, Ralph.

Hi, just wanted to understand and clarify the jumping off point for 2017, the midpoint of guide I guess is $5.65, we’ve got the $0.10 from the hurricane, so it’s $5.75. We take out the $0.20 for the tax benefit we're at $5.55 and then ex panel we essentially grow that mid to high single digits, is that -- just want to make sure if that’s right?

Yeah, so the jumping off point shouldn’t be adjusted for the hurricane, but you may argue that the year-over-year growth compare is easier given the fact that we had hurricanes in 2017. So, the jumping off point you're right takes the midpoint of our guidance and take out the $0.20 and that's out of the way we are thinking our starting point given that at this point we would project only $0.06 of excess tax benefits from stock-based compensation. And that’s how we would build our initial plan for 2018 and certainly taking into account that the hurricane impact this year, that can give us an easier compare to next year.

Okay. That’s fair and then the -- that’s in the same context as the $6 to $7 number by 2020 right. So that's off that baseline that’s how we should be thinking about $6 to $7 for 2020?

Exactly. Not off the guidance that’s includes the $0.20 excess with stock-based comp around.

Okay. All right that’s helpful. And then I guess any help you can give on sort of based on your current mix. Can you give us the impact of the PAMA cuts for 2018, 2019 and 2020?

No as I said earlier – maybe wasn’t as clear as I intended to be given that there are so many things that have to be sorted out. So many unanswered questions we're still trying to figure out obviously looked at it deeply and we have a huge range of potential outcomes depending on the answers to some of those questions. So, it would not be helpful at this point to share that information as I said in a minute we expect to get more clarity in the not too distant future as soon as we're in a position to share something we’ll certainly do so.

Okay. And then just…

With that said we obviously have reconfirmed our views on outlook and the view outlook took into consideration what we saw in the draft rates. And so, our feedback to CMS is that there is a lot of areas that we think they got wrong and therefore we think the rates are too low. So, we think as we contemplate what we just shared with you this morning we are confident we feel with those outlook despite what might happen or not happen given our dialogue with CMS.

Okay. All right. That's helpful. And then just last one, can you give us a sense of multiples you’re paying for deals and maybe how you approach a purchase price just given what likely maybe a lower future earnings stream from whatever you’re acquiring given PAMA? Thanks.

Sure. We've shared that we have very robust specific metrics around evaluating our deals that involves a return to invested capital metric where it would be accretive by the third year relative to our plan of record and we have a plan of record based on our performance shares. So, every year we put forward our forecast for our return on invested capital for the base business and half of our performance shares our based on that. So, we need to do deal that are accretive to do that by the third year. And we have also have an MPV metric and obviously the MPV level that needs to be exceeded before you will consummate a deal. So, the multiple question is a tough one because their P&L generally has no relationship to our P&L as I shared at the Investor Day. I went through actually Strawman example and in most cases, it’s not all of their revenues are higher than ours. When the business becomes part question, we get paid at the rates at which we negotiated, but the cost structure is so dramatically different than despite that revenue and synergies, we still significantly make more margin typically then the individual. So, taking a multiple of their P&L really does not make any sense as we shared the revenue multiple look like -- they look a great deal based on when it was in their hands and the earnings multiples, or EBITDA multiples look like we way overpaid it, but it's really not meaningful. If you look at our pro forma, you would see multiples that are the opposite, which says based on the earnings it was good and based on the revenue maybe you paid a little bit too much, but we cannot pay significantly more than our current enterprise multiple because by definition the math doesn’t work and then we’re not able to hit that rolling target. So, when we actually use return on invested capital, not our cost of capital, which some other companies use to evaluate deals so in fact we have a risk premium built into our MPV and built into our return expectations that we think make sense that's good for our shareholders.

Okay. That’s helpful. Thank you.

Our next question is from Amanda Murphy with William Blair. Your line is open.

Hey Amanda.

Hey. How are you good morning?

Good.

Just a quick question on the long-term outlook and obviously there has been discussion around contract renewals repair perspective and I think you gave some perspective there just in terms of pricing over the long-term but I just wanted to clarify in terms of the long-term outlook how you're thinking about some of the major contract changes are you including any assumptions there. And then also just thinking about capital deployment in terms of share buybacks can just help us think about how you're thinking about that over the long-term specially given PAMA? Thanks.

Yes, so let me start the contracting. We obviously want to have the best access as possible and I said in my earlier comments that we should really good about our growing access and it’s helping us accelerate in growth and that continues to be our strategy going forward as you are aware one of the nationals that we don't have our preferred relationship is united what we shared in the past we know that contract expires in 2018 with our nearest competitor. And as we said we would like to be on contract with United and our relationship continues to be strong in building so we did contemplate in our outlook is growing capability for us to have many of your insurances also on network then what we currently enjoy. And so that is contemplated in outlook and Mark second part of the question.

So, Amanda we’re going to stick with our capital deployment strategy in terms of earnings growth being low to actually mid to high single-digit that is earnings that’s not earnings per share so does contemplate significant buybacks two step earnings-per-share as well as earnings from cash And so, we will continue our strategy which says in the near-term accretive opportunities that used of that cash to do M&A that will be a priority once we satisfy that majority of free cash flow back to our shareholders as we’ve talked about before the dividend gets a long way towards that objective and use of supplemental share buybacks to get at least to 50%. Our free cash flow again with the other 50% of our free cash flow will be opportunity dependent if we have M&A that will be the preference and if we don't have M&A then that is a better use of cash and we will buy back more shares. But at this point the outlook does not include a reduction in our way so to get to higher levels of earnings. The growth rate that I share at the CAGR is real earnings.

Got it. And then just one quick follow-up, I think Jack has done some good work in terms of looking at the regional dynamics of PAMA in the first year just given that we're going to switch from a regional to more of a national schedule. So, I don't know if you've been able to look at that yet and if there is any mitigation there for you guys and based on your mix I know early in terms of the data but just looking for some insights into maybe what the first share might look like relative to the reported rate for you?

You're correct. That is a mitigation and any sort of price declines from the NOA because there are some reasons that we're already paying less than NOA. So, by definition there's less of a decrease at least in the first year depending on what the overall cuts might be over a multiyear period. And actually, on that note that is the issue with the panel. So, in the case of any of the panels, if you added up the individual components in there NOA, we've not been getting paid that total amount. So that would also be a mitigation assuming that they don't change into some sort of other methodology. So that's what makes it a little bit complicated, but I did want to acknowledge that if you just look at the fee schedule and tried to say okay if the Medicare revenues are X and it looks like and this isn’t the case. Every code was reduced by 10% if I can do the math. Now it's a lot more complicated than that because in most cases, we're not getting paid NOA for the work that we do for Medicare.

Got it. Thanks very much.

Our next question is from Ann Hynes with Mizuho Securities. Your line is open.

Good morning, Ann.

Good morning. So, I don't want to beat the dead horse. So, I am just going to go back to that $6 to $7 answer to 2020. So, I just want to clarify what's included and what's not. So, it includes the proposed rates for PAMA as stated in the rule and it includes only 1% to 2% M&A annually. It includes an increase in your cost entry program, and if it does can you tell us exactly how much just for modeling purposes? It includes some share revolve but not a lot and then whether UNH contract if you're not let in it, I mean I'm assuming that if it's in you have some type of visibility and if it's not, can you let us know the downside risk, thanks?

So, let me clarify so on the efficiency program, I wouldn't model in a significant change from what we've been doing. I think Steve said that there is more to be done and then certainly we'll continue to deliver significant efficiencies, so that's part and parcel with the outlook that we gave. Now with that said of course depending on the PAMA outcome, the timing of it and how severe it is, we're going to do what we need to do. So, we're going to get to that outlook. We have enough levers to pull that we're very comfortable and we're not reaffirming the outlook if weren’t confident that we have the ability to do that despite where PAMA might come out. And certainly, in this case, where we have the plan and it contemplates the worst-case scenario which is what they proposed. And then in terms about the share buybacks. So, there will be some share buybacks, but I think a lot of that is really just to prevent dilution given our equity program. So, I wouldn't assume that any reduction in ways. So that is not in my outlook for this point. As I said again that growth is in earnings. And therefore, at this point given all other factors you should assume that earnings per share for both earnings and then depending on that's where to create value that could vary because we get more M&A and because we do more share buybacks. And yes, the 1% to 2% is what we're counting on, but while we're signaling back to it's original question is we think although we've been doing consolidation, this could be a trigger for acceleration in the consolidation. So, we are just knowing that there could be an opportunity for an acceleration and for more M&A but I'm not modeling that in the outlook at this point.

Okay. And then the UNH question, so I'm assuming if you include in the guidance you have some type of visibility, and if you don't, can you just maybe give us some visibility what the downside will be?

Ann, my commentary was that we're working on it, but it's the current status quo is whether it stayed that way or not. We still feel confident with our outlook. Okay. So that's the way you should think about it is your current access is getting stronger. We are working to get it even stronger but our outlook contemplates staying where we are as well.

Okay. And then with PAMA in Washington, I appreciate all the efforts that you guys have done that you talking to Congressional people. You're commenting to CMS, but I feel like all of that was done beforehand. What do you think can change? Do you think CMS just wanted the common period? Do they need that to make a change? So, I am just trying to figure out like what would change in two months?

The big change let me give you a little color around this. So, when we went off around and talked to our members of Congress and Southerners and the administration, we explained our concern but it was a concern without a lot of facts and a lot of our stakeholders said well, I understand, but let's see what the data says. And so many of them were waiting for these draft rates. And so, the good news is the draft rates are out and the draft rates are severely flawed with the amount of data that was collected a very small percentage that is 1% with a lot of the data coming from ourselves, so the majority of the rates are based upon the large nationals and that was not the congressional intent. So, the data being out there and is helping us now get more momentum with our stakeholders to say well okay what these guys have been talking about before we have addressed, they were right, they really got along and their message around taking time to get it right we now understand. Now the question is what do we do about that. So strange way the draft rates have been helpful to move the dialogue along.

And one example, Ann, is the OIG in some of the reports over a month ago have said based on the definition of the applicable lab they were expecting about 5% of the labs, but close to 70% of the volume to be reflected. As you heard us say today only 1% of the labs actually ended up submitting for various reasons. So back to Steve's point around okay, I get your concerns, but we'll see where it comes out, certainly those kind of facts are weighing in the conversations we're having right now.

And the vast majority of the data they're looking after these drafts from the large laboratories and we know from Medicare data that roughly 50% of what they buy is laboratory services from hospital at which laboratories as well as physician office labs. And from the two large nationals, it's only 20% of their purchases roughly. So, the sampling is flawed and they need to take the time to get it right and the whole philosophy of PAMA is to make sure that they look at this different cost of served issue in this industry to make sure they're paying market based rates and those market base rates are not the rates of large nationals that generally have the density of large centers.

Okay. Great. Thank you.

Thank you, Ann.

Our last question is from Lisa Gill with JPMC. Your line is open.

Thanks very much for taking my question. I just had a question, Steve, you talked a little bit about United and potentially opening that out from the preferred relationship they have today. Would you anticipate that the same would happen with your Aetna relationship that time? Do you think that as you think about the world if you know that may believe preferred relationships don't work quite the way that they were intended back when they were assigned in the mid-2000s? Just how do we think about that dynamic one? And then two, if United has opened up, my assumption would be that you're probably getting some rates today that were non-network rates and so they would potentially be higher. Are you thinking that the volumes help to offset that when you're thinking about this, the equation of getting to that $6 to $7 in 2020?

Well first of all, in Aetna our relationship continues to be strong. Yes, we have preferred national relationship and we haven’t commented where we'll continue or not, but we do have one extended contract, which we feel good about and we've secured. And second, as far as our philosophy with all of your insurance companies, we do believe that it is good to have a smaller network and frankly given our value proposition, we actually like those contracts where we are on contract with other nationals, where we have the opportunity to compete for the business because when we do compete for the business, we do quite well. So philosophically and strategically that's the position we've taken and as you see three out of the five nationals do have both their competitor on par and we feel good about those relationships as there is a different approach. We feel great about that relationship and we're working with United. All of those supplies have different relationships and I'll remind you we spend a lot of time talking multinationals but a large part of our business is not with the nationals. We have a lot of regionals. We have hundreds of contracts and those contracts continue to provide great access for us as well. So, Lisa just to clear, yes, our network rates are higher and in some cases significantly higher than the network rates, but there is also some supplies that don't have that network benefit, typically they're falling short. So, we don't get paid quite the premium being out of network that some people might think because there's some work we receive that we do basically for free because we don't get paid for those full insurance. So, if we get any network in a plan where we're on a network, there is countervailing forces. One is the network rate obviously typically is lower than the other network rates but then for the supplies that didn't have that benefits we actually get paid. So, there will be certainly some pricing headwind offset by what we will consider to be significant volume increase for any time we get into a network where we were previously out of network, but it's not as large a price headwind that some people might come to surface.

Okay. And then Mark, if I could just ask one question, I know everything said about the future is not about the quarter, but I just want to understand two things, one would be around the pricing environment obviously pricing coming in a little stronger. Is that just a mix element or is there something else going on there would be first and then just second on the nonclinical down 4%, we expect it will be down around 2%. Is there anything else there that's worth calling out from a quarter perspective?

Sure. So, as I shared in the prepared remarks, pricing continues to be less and on a apples-and-apples price and then we've also shared in the past that there was any mix element that suppresses revenue correct from our PLS business. So really when you look at the revenue per rep, it's the positive mix that we've experienced pretty consistently for several quarters, which is around the tax mix and then also then to the acquisitions where we tend to consistently have been growing our test per rep ratio. So those are the drivers. The other mix elements have been favorable more of our advanced diagnostic testing and then more test per acquisition have all set the negative mix impact of PLS on revenue per rep. When you look at the diagnostic services business, it's largely our risk assessment businesses. There is a couple of other things in there, but that's a big driver. That is the work we do for individuals who are looking to secure life insurance policies and in front of that is how independent on the industry itself and the number of policies that are being written and recently that's a little softer. So, it has nothing to do with the competitive environment per se losing the competition really have to do with the market and the market has slowed in full recently.

Okay. Great. Thank you.

Okay. So, thanks again for joining us today. As we've said, we had another strong quarter in the third quarter 2017. We look forward to make our commitments and executing our two-point strategy of accelerating growth and driving operational excellence. We thank you for your continued support and have a great day.

Thank you for participating in the Quest Diagnostics' third quarter 2017 conference call. A transcript of prepared remarks on this call will be posted later today on Quest Diagnostics website at www.questdiagnostics.com. A replay of the call may be accessed online at www.questdiagnostics.com/investor or by phone at 888-667-5784 for domestic callers or 402-220-6427 for international callers. Telephone replays will be available from approximately 10:30 AM Eastern Time on October 19, 2017 until midnight Eastern Time on November 2, 2017. Goodbye.