Quest Diagnostics Inc Q3 FY2024 Earnings Call

Welcome to the Quest Diagnostics Third Quarter 2024 Conference Call. At the request of the company, this call is being recorded. The entire contents of the call, including the presentation and the question and answer session that will follow, are copyrighted property of Quest Diagnostics with all rights reserved. Any redistribution, retransmission or rebroadcast of this call in any form without the written consent of Quest Diagnostics is strictly prohibited. I’d now like to turn the call over to Shawn Bevec, Vice President of Investor Relations for Quest Diagnostics. Sir, please go ahead.

Thank you and good morning. I’m joined by Jim Davis, our Chairman, Chief Executive Officer and President, and Sam Samad, 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, and references to adjusted EPS refer to adjusted diluted EPS. Growth rates associated with our long-term outlook projections, including consolidated revenue growth, revenue growth from acquisitions, organic revenue growth, and adjusted earnings growth are compound annual growth rates. Now here is Jim Davis.

Thanks Shawn, and good morning everyone. Before we get into the details from the third quarter, I want to recognize the Quest employees who are working hard to serve our patients and customers impacted by Hurricanes Helene and Milton while also contending with the effects on their personal lives. I’m inspired by their commitment to our values, especially customer focus, collaboration and care during this very difficult time. They bring to life our purpose, working together to create a healthier world one life at a time. Now turning to our results. We delivered a strong third quarter with total revenue growth of 8.5%, including 4.2% organic growth, driven by new customer wins and expanded business with physicians and hospitals, as well as acquisitions. During the third quarter, we completed three acquisitions. We finalized our acquisition of LifeLabs, a trusted lab leader serving millions of Canadians. LifeLabs provides a strong foundation for us to expand in Canada, and we are excited about the growth opportunities serving a population that is growing and has more favorable demographics than in the U.S. We also completed our transaction with Allina Health, a leading non-profit health system serving Minnesota and western Wisconsin; and at the end of the quarter, we acquired the laboratory business of three physician groups in New York. During the quarter, we also announced plans to acquire select outreach lab assets from Ohio Health and University Hospitals, two leading non-profit health systems in Ohio. We completed the transaction with Ohio Health just last week and expect to complete the acquisition with University Hospitals later this quarter. Our recent outreach acquisitions highlight our ability to attract top health systems seeking to evolve their lab strategies to improve access and affordability. They also position us to expand in geographic areas of the U.S. where the influence of health systems had previously limited our reach. We are now on track to complete eight acquisitions this year that meet our criteria for growth, profitability and returns. Now I’ll recap our strategy and discuss highlights from the third quarter, and then Sam will provide detail on our financial results and talk about our updated financial guidance for 2024. Our strategy to drive growth is focused on delivering solutions that meet the evolving needs of our core customers: physicians, hospitals and consumers. We enable growth across our customer channels through advanced diagnostics with an intense focus on faster-growing clinical areas, including brain health, molecular genomics, and oncology. In addition, acquisitions are a key growth driver with an emphasis on accretive outreach purchases, as well as other independent labs. Our strategy also includes driving operational improvements across the business with the strategic deployment of automation and AI to improve quality, service, efficiency, and the workforce experience. Here are some updates on the progress we have made in each of these areas. In physician lab services, we delivered another quarter of high single-digit revenue growth. Our performance was driven by new customer wins and expanded business, largely due to increased utilization of our advanced diagnostics. Our acquisitions also contributed to growth within this core customer channel, and as a reminder, volumes from both hospital outreach and independent lab acquisitions originate in physician offices. We also continued to see strong volume and revenue growth within Medicare Advantage plans, where narrow network strategies direct testing to high-quality, cost-efficient options like Quest. During the quarter, we also made progress to expand into new geographies through our health plan partnerships. We renewed a large national health plan agreement with Elevance Health that will extend our reach in Virginia, Georgia, Colorado and Nevada, markets in which we had previously limited access. We also broadened our access in Virginia and Florida with our recently announced arrangements with Sentara Health Plans. In hospital lab services, we grew revenues mid single digits, which is above historical levels. Hospitals continue to struggle to fill specialized lab positions, including histology, cytotechnology, and microbiology. In addition, the range and scope of testing being ordered is increasing as hospitals take advantage of our expanding advanced diagnostics portfolio rather than building their own in-house capability. These dynamics contributed to strong continued demand for reference testing. Our expertise managing laboratories can help hospitals improve quality and efficiency in their core lab operations. During the quarter, we formed a professional lab services collaboration with a leading health system in New Jersey that includes reference testing as well as laboratory and supply chain management. Quest specializes in scaling diagnostic innovations to improve access, quality, and affordability. This ability enables us to help hospitals address the many challenges that they face, from workforce shortages to capital constraints to the demand for more affordable care from patients, health plans, and employers. That’s why premier health systems continue to seek us out for a range of collaborations, ranging from reference testing to professional lab management to outreach acquisitions. In consumer initiated testing, our consumer-facing platform, QuestHealth.com, grew total revenues more than 40%. Our repeat customer rate has grown to 30% from less than 10% two years ago, driven by demand for comprehensive health, chronic disease, and STI testing. During the quarter, we also introduced micronutrient blood tests to help identify vitamin and mineral deficiencies. In addition, we continued to expand our partner network with resellers and eCommerce providers. In advanced diagnostics, we drove double-digit revenue growth across several clinical areas. The growth was particularly strong in areas of brain health, especially for our AD-Detect blood-based Alzheimer’s disease testing as well as in women’s health, cardio-metabolic health, and autoimmune disorders. Our investments in advanced diagnostics enable us to deliver and scale innovative services that improve patient care and drive growth. In molecular genomics and oncology, we are pleased with the results to date from our Haystack MRD early experience program through which providers from many leading academic and community oncology centers have used our Haystack MRD blood test to assess cancer recurrence and treatment response for solid tumor cancers. We are on track to make Haystack MRD available nationally to providers in the fourth quarter. Our growth in women’s health was largely driven by prenatal and hereditary genetic testing, consistent with recent quarters. We also saw continued robust testing demand in genital tract infections, which includes several STIs. This month, we introduced a specimen self-collection option at our 2000 patient service centers that gives women a fast, convenient, and discrete way to access GTI testing. In the area of autoimmune disorders, we saw strong demand for our testing solutions which help primary care physicians comprehensively screen for autoimmune disorders in order speed diagnosis and care by specialists. Finally, we were pleased to have been selected by the CDC to be one of a handful of diagnostic service providers to support the development of laboratory tests for H5N1 avian flu and oropouche viruses. We plan to introduce an H5N1 avian flu test later this month. Now turning to operational excellence, our Invigorate program aims to deliver 3% annual cost savings and productivity improvements driven largely through the use of automation and AI to improve productivity, as well as service levels and quality. During the quarter, we completed the build-out of full end-to-end automation for our core routine tests at our Lenexa, Kansas laboratory, making it the third fully automated lab in our national network. We are now piloting automated specimen accessioning in our Clifton lab, which will help increase productivity in specimen processing and improve quality. Finally, we are pleased to extend our collaboration with Hologic to include their automated cytology solution, the Hologic Genius digital diagnostic system which utilizes AI to help analyze cervical cell samples. We expect this solution will help us improve quality and efficiency in cervical cancer screening. Now before I turn it over to Sam, I want to take a moment to recognize the decision by Congress to delay Medicare reimbursement cuts and data collection scheduled under PAMA for 2024. While we are pleased with the delay, we continue to collaborate with our trade association, ACLA, to encourage Congress to secure a permanent legislative solution that provides fair reimbursement. Now Sam will give more details on our third quarter performance and our updated guidance for 2024.

Thanks Jim. In the third quarter, consolidated revenues were $2.49 billion, up 8.5% versus the prior year. Consolidated organic revenues grew by 4.2%. Revenues for diagnostic information services were up 9% compared to the prior year, reflecting strong growth in our key physician and hospital channels as well as the contribution from recently closed acquisitions. As a reminder, our acquisition of LifeLabs closed towards the end of August, and our outreach acquisition from Allina Health closed in September. Total volume measured by the number of requisitions increased 5.5% versus the third quarter of 2023, with acquisitions contributing 5% to total volume. The impact of weather and the Crowdstrike global IT outage in July negatively impacted volume by approximately 40 basis points in the quarter. Total revenue per requisition was up 3.3% versus the prior year, driven primarily by an increase in the number of tests per requisition and favorable test mix driven by advanced diagnostics demand, partially offset by the impact of the recent LifeLabs acquisition which carries a lower revenue per requisition than our typical average. Unit price reimbursement was stable, consistent with our expectations. Reported operating income in the third quarter was $330 million or 13.3% of revenues compared to $342 million or 14.9% of revenues last year. On an adjusted basis, operating income was $385 million or 15.5% of revenues compared to $380 million or 16.6% of revenues last year. The increase in adjusted operating income was due to strong organic revenue growth and the impact of recent acquisitions, partially offset by the impact of weather and the Crowdstrike outage, as well as wage increases and higher performance-based compensation. We estimate the impact of weather and the IT outage on operating margins to be approximately 50 basis points. LifeLabs had a negligible impact on operating margin rates in the quarter. Reported EPS was $1.99 in the quarter compared to $1.96 a year ago. Adjusted EPS was $2.30 versus $2.22 the prior year. We estimate the EPS impact of weather and the IT outage to be approximately $0.08 in the quarter. Cash from operations was $870 million year-to-date through the third quarter versus $745 million in the prior year. In the third quarter, we issued $1.85 billion of senior notes with an average coupon of approximately 4.8%. Turning now to our updated full year 2024 guidance, revenues are expected to be between $9.8 billion and $9.85 billion. Reported EPS is expected to be in a range of $7.55 to $7.65 and adjusted EPS to be in a range of $8.85 to $8.95. Cash from operations is expected to be approximately $1.3 billion and capital expenditures are expected to be approximately $420 million. The following are key assumptions underlying our updated guidance for you to consider. The increase in our updated revenue guidance is related to recently announced and closed acquisitions, with the majority being from LifeLabs. As a reminder, new acquisitions are typically breakeven to slightly profitable initially with profitability expanding over several quarters, therefore we are not expecting a material contribution to earnings from these acquisitions in 2024 but do expect increasing profitability next year. We are projecting the disruption from Hurricane Milton to negatively impact revenues by approximately $15 million and EPS by approximately $0.08 in the fourth quarter. Operating margin is expected to be down versus the prior year due to the integration of LifeLabs and the combined impact of weather and Crowdstrike headwinds. Excluding the impact of these items, full year operating margin is expected to be up. Net interest expense is expected to be approximately $200 million, weighted average share count to be flat compared to the end of 2023. We have narrowed our adjusted EPS guidance and maintain the midpoint of $8.90 despite the impact of Hurricane Milton in the fourth quarter. While we aren’t prepared to provide 2025 guidance today, I’d like to share some initial considerations as you think about next year. We are reaffirming our long-term outlook from 2023 through 2026, which assumes a mid single-digit revenue CAGR with at least 1% to 2% growth from acquisitions, and a high single-digit earnings CAGR with approximately 75 to 150 basis points of margin expansion over the three-year period. Given the eight acquisitions we expect to complete in 2024, we will exceed our 1% to 2% revenue growth targets from acquisitions next year. Excluding LifeLabs, we already expect to be towards the high end of this range due to the carryover contribution from the other acquisitions that will be completed this year. Interest expense is expected to increase next year as a result of our recent debt issuance. As I noted previously, we raised $1.85 billion of senior notes with an average coupon of approximately 4.8% in August, and in March of 2025 we plan to retire $600 million of senior notes with a coupon of 3.5%. Finally, as we consider all the moving pieces heading into 2025, we expect to deliver earnings growth consistent with our long-term outlook in the high single digits. With that, I will now turn it back to Jim.

Thanks Sam. To summarize, our business delivered strong total and organic revenue growth driven by new customers wins and expanded business with physicians and hospitals, as well as acquisitions. We are now on track to complete eight acquisitions by year’s end that meet our criteria for profitability, growth, and returns. Our growing advanced diagnostics offering and increasing health plan access positions us to drive new customer business next year. Given the strength of our business and revenue from acquisitions, we are well positioned to drive accelerated revenue growth and earnings growth in 2025. With that, we’d be happy to take your questions.

Thank you. We will now open it up to questions. Our first question will come from Ann Hynes of Mizuho Securities. Your line is open.

Good morning. Thank you. Thanks for all the details on 2025. When you think about next year, how do you think the organic growth profile of the business will do? And within that, can you remind us with Haystack, is there any change in your assumptions now that you’ve had the asset for over a year on how you think it will do in 2025? Thanks.

Yes. So good morning, Ann. We just came off a very strong quarter of organic growth of 4.2%, driven by good volume growth and really nice improvements in revenue per requisition, those improvements in revenue per requisition coming with basically price being about flat, price per test, but really nice increases in tests per requisition and test mix. So as we enter into 2025, we would put out there at this point approximately 3%, I mean, it’s hard to judge what’s going to go on with utilization, but by all means and based on some of the payor report-outs earlier in the week and last week, it appears that utilization remains strong. So I think an assumption of roughly 3% is solid. In terms of Haystack, we’ve said the dilution this year is approximately $0.20. We said the dilution going into next year would be less, and we’re still on track to achieve that.

Yes, with regards to Haystack, Ann, the incremental dilution this year is $0.20, so it’s a total of $0.35 to $0.40 dilution, and it will improve next year. And we are preparing to launch the assay in the next few months here and expect to get reimbursement as we go forward as well.

The next question is from Michael Cherny of Leerink Partners. Your line is open.

Thanks so much for taking the questions. Maybe if I can go back to just some of your commentary about the marketplace and your positioning, if I heard correctly, I think you had some incremental share gains from Elevance, obviously, you have a combination of inorganic growth. As you think about building on Ann’s question a bit relative to the organic side, how much do you feel like the growth profile is within your control relative to that share pick-up, relative to what you’re doing on the pricing side versus market-driven? If there’s any we can break that down, that’d be great.

Yes. So first, thanks for the question, Mike. With respect to Elevance, none of those changes take effect until the first of the year in 2025, and those changes, which are allowing us to be in network in the states of Colorado and Nevada, with expanded access in Georgia and Virginia. But again none of those changes have any impact on our third quarter results, but we expect those to help fuel organic growth going into next year.

In terms of pricing and market share, we anticipate reimbursement dynamics to remain stable or improve slightly. This outlook is consistent with what we observed this year, indicating a positive trend in reimbursement. Additionally, reflecting on the increased access that Jim mentioned, we are experiencing market share gains from our hospital outreach acquisitions, which have resulted in a shift in market share recently.

The next question will come from Patrick Donnelly of Citi. Your line is open.

Hey, guys, thank you for taking the questions. Sam, maybe one on LifeLabs, nice to see that close early. Can you just talk a little about both the margin impact that you see near term there, I know obviously accretive to earnings, but just the margin impact; and then the progression on the earnings accretion as we get into next year? I know there’s some accounting stuff that maybe holds it back a little bit and then it should step up, but it would be helpful just to talk through that profile. And then lastly just Jim, on the M&A side, since we’re on the topic. What does the pipeline look like? Should we expect continued smaller deals versus something like LifeLabs, being a much larger one, and what you’re seeing there? Thank you, again.

Good morning, Patrick. I will briefly discuss operating margins first and then address how LifeLabs affected our results in the third quarter and our outlook moving forward. In the third quarter, our operating margins stood at 15.5%, which adjusted for weather would be closer to 16%. Both weather-related factors and CrowdStrike had an impact of about 50 basis points. There was also a slight negative contribution from LifeLabs during the quarter since we had approximately five weeks of LifeLabs revenue included. The profitability from this deal is on the rise, though initial adjustments, including some accounting changes, are still in play. We anticipate an increase in the margin profile from this deal over time. We previously mentioned a potential earnings per share increase of $0.10 to $0.15 in the first year, based on the assumption that the deal would close at the end of the year, allowing a full year for 2025. Since the deal closed a bit earlier, we will provide more details in our fourth-quarter call regarding expectations for 2025. Overall, I want to emphasize that while the operating margin at the start will be lower than our overall enterprise margin and will dilute margin rates, it will positively impact operating margin dollars and earnings per share. Over the next two to three years, we expect it to align with Quest's operating margins, but this will take time. Therefore, I recommend focusing on the increase in operating margin dollars and earnings per share from the deal, rather than short-term operating margin rates.

Yes, Patrick, regarding your question about the funnel and the M&A pipeline, it remains strong with numerous discussions happening with various health systems across the country. Currently, we are in a phase of integrating and digesting the deals we have recently completed, including the lab assets from PathAI, Allina Health System, Ohio Health, University Hospitals, the three physician office labs in New York, and LifeLabs. We are diligently working on integrating these assets to achieve the margin accretion we have previously discussed. Our interest in small outreach deals remains, and we are always on the lookout for those opportunities.

The next question will come from Pito Chickering of Deutsche Bank. Your line is open.

Hey, good morning guys. Can I go back to the questions on Elevance and Sentara Health, on those contracts you talked about earlier? I guess, why weren’t you in those contracts previously? Did you have to give any pricing concessions in any states in order to go in those markets, or did you give pricing concessions to enter the states? Who was previously servicing those patients? It’s just been a long time since we’ve seen such large managed care contract wins for you guys, so just curious whether other central labs servicing these guys or is it simply payors pushing large labs, who take share from hospital-based labs? Thanks so much.

Yes, so with respect to Elevance, we’ve been in their network broadly on a national basis, except for the markets that I indicated - Colorado and Nevada, we were completely out of their network. Georgia, we had limited access to some products but not all, and the same with Virginia. This is just an opening up, like many of the other large national labs, that provide access to all the independent labs, so we feel great on that. Sentara, we were previously not serving - it was being served by other laboratories, and they made the decision to put us in their network. It’s a great health plan, a great health system that was in Virginia, but the health plan actually goes down well below Virginia into the Carolinas and Florida, so we feel really, really good about that. Look, I think it represents just a commitment on behalf of these health plans to include independent labs that offer great quality. It starts with great quality, great service, and really competitive pricing.

Next question, please?

Good morning guys, and congrats on the quarter. This is Meghan Holtz on for Brian. Just going back to guidance, core EPS guidance is up slightly, right? If I just check my math, the midpoint stays at $8.90 but you have to add back the $0.08 from Milton, while LifeLabs should be a little less, so can you just kind of break down that EPS guidance?

Sure. Regarding EPS guidance, I want to touch on revenue as well. We increased revenue by $285 million at the midpoint, predominantly due to acquisitions, particularly LifeLabs. Essentially, the majority of that increase stems from M&A, which typically doesn't contribute significantly to profitability in the initial period. As for EPS, we narrowed the range by five cents on either side, while keeping the midpoint steady at $8.90. We are facing an $0.08 headwind from Milton in Q4, so you're right that EPS, excluding Milton's impact, would have risen, driven by the strength of our organic business. In Q3, we observed impressive revenue per requisition at 3.3%, with organic revenue per requisition even exceeding that. Good utilization is helping to offset some of the negative impact from Milton, but overall, the midpoint EPS remains unchanged.

The next question will come from David Westenberg of Piper Sandler.

Hi, thanks for taking the question, and congrats on a good quarter. I believe turnover rates reduced pretty meaningfully. I think you’re still seeing wage inflation here above historical norms, so can you just talk about some of the pushes and pulls in terms of historically low unemployment rate? Are there actually maybe some tailwinds you’re seeing with insurance and other things, maybe even price increases that could help offset that, and can you talk about maybe some of the headwinds in terms of wage pressures, how long they’re expected to continue, and if we did continue to see some of those wage pressures, are there any other ways you can get operating leverage, say AI, automation, etc.? Thank you.

Dave, just real quick, you broke up there in the very beginning. What did you start with?

Yes, so as we indicated in the script, our turnover rates have come down here in 2024, so last year they were in the low 20s, and we’re now below 20%, in the 18% to 19% range. Some of this still depends on job category, but overall we’ve seen really nice improvement. Now, the wage inflation of 3% to 4%, I’d say it’s slightly less than last year, but in terms of historical norms, if you want to go back to 2012 to 2019, kind of pre-COVID, I would tell you it was in the 2% to 3% range, so it’s 100 basis points higher than it historically was. As we walk into next year, it might be a bit early to tell, but I would still think it’s going to hang closer to 3%, in that range. I think you’re reading the same articles we are - the quit rate in America has certainly come down. I think unemployment is relatively stable, so I think there will be continued tightness in the labor markets, particularly on our frontline employees, and by those employees, we mean our phlebotomists, our logistics, our specimen processors. It’s actually those positions where we see a more competitive labor environment primarily because those three types of roles, they can move from industry to industry. They don’t need to stay in the lab industry. Now, there are lots of things we’re doing to continue to offset that wage inflation. We’ve talked a lot about the use of automation and AI in our laboratories. As we indicated in the script, we just went live with our third highly automated laboratory, full automation in our Lenexa, Kansas operation. We’ve installed what we call some front-end specimen automation sorting types of equipment in several of our laboratories, and we’re getting nice use out of that; and then we continue to expand some of our automated and AI-driven platforms, like the COPAN microbiology platform, which continues to give us a ton of productivity across our laboratories.

Yes, and if I just add a couple of things, David, with regards to just overall productivity and leverage in the P&L as both we look in 2024 and going forward, but we are seeing a couple of positive dynamics there as well that I’m sure you’re aware of. In terms of revenue per requisition, pricing is a modest favorable. I don’t mean to say that it still isn’t a challenging pricing environment in the health system space, but overall we’re getting flat to positive reimbursement. We’re seeing tests per requisition continue to go up versus historically, we’re seeing a nice step up in terms of tests per requisition as well as test mix, which are both giving us a positive in terms of overall revenue per requisition. Utilization, we’ve talked about continues to be positive, and also aided by the fact that we’ve gained share with some of the acquisitions that we’ve done, so overall all of these would drive us to additional productivity and improved leverage as we look forward, and this year in 2024.

The next question comes from Jack Meehan of Nephron Research. Your line is open.

Thank you, good morning. I wanted to follow up with Sam on a couple of points related to the quarterly revenue. First, could you share what the COVID sales were? I'm trying to understand the base contributing to the 4% organic growth. Secondly, it appears that M&A contributed around $100 million in sales for the quarter. How much of that was from the initial five weeks of LifeLabs compared to everything else? Could it have been around 50/50?

Sure Jack, yes. In terms of COVID, we've ceased reporting on it and have stopped distinguishing between base and total as it has become relatively insignificant. What I can share is that it was largely in line with our expectations for Q3. Year-over-year, COVID impacted growth by about 50 basis points in terms of total revenue growth. Regarding M&A, we experienced an 8.5% increase in total revenues for the quarter, with organic growth at approximately 4.2%, meaning M&A contributed around 4%. The contribution from LifeLabs during its first five weeks was about $70 million in revenues for the quarter, which highlights its significant role in M&A growth.

The next question comes from Elizabeth Anderson of Evercore. Your line is open.

Hi everyone. Thank you for the question. Can you confirm the DCP impact for the quarter? I understand it caused some unnecessary volatility, but it was always neutral to EPS. Also, regarding the long-term outlook, it seems like you’re suggesting that unit pricing should be considered stable to slightly positive for 2025. If you could confirm that, I would appreciate it. Thank you.

Yes, regarding DCP, thank you for the question. On a year-over-year basis, it increased around $10 million for the quarter, which negatively affected our operating margin. The impact can vary based on market conditions, but for this quarter, we saw a year-over-year negative effect. Concerning pricing in 2024, if I break it down, the health systems segment is facing challenges due to reimbursement and pricing dynamics, resulting in a net negative outlook. The health plans sector appears to be slightly better, showing flat to modestly positive trends. Overall, when considering all factors, including our government business, we expect pricing to remain flat since the PAMA cuts were deferred. In general, our current outlook is for pricing to be flat to slightly positive. We will provide more details during our Q4 call when we discuss specific guidance for 2025.

Yes, the next question is from Erin Wright of Morgan Stanley. Your line is open.

Great, thanks. With the hospital outreach deals and the market share gains, you’ve been talking about that a little bit more recently, and are there specific geographies where you’re seeing that sort of halo effect around these deals? Has anything changed in terms of your strategy around what you target or how you’re approaching these hospital outreach deals? I guess any way to quantify it as well how much in terms of market share gains is this contributing at the moment, just from either a volume or revenue perspective? Thanks.

Yes, so the three deals we announced, Allina in the Minneapolis market and closed Ohio Health in Columbus, Ohio, and University Hospitals which we expect to close later in the quarter in Cleveland, Ohio, all three of those markets had the characteristics of the majority of independent physicians were owned by health systems and therefore using the labs of those health systems. It puts us into those three marketplaces. Our share in those markets was de minimis before these acquisitions, and so now we have a strong presence in those three markets, all of which are big markets, growing markets. We will continue to look for other markets in the U.S. where we have strong payor access. By the way, in all of those markets, we were in network with obviously all the nationals and all the Blues plans that play in those markets, so we had strong access but our ability to sell, given that the physicians were largely owned by the health systems, was very limited. Those are the characteristics of the markets that we look for in terms of these outreach acquisitions. We look for markets where we have strong access, which we do nationally, and we look for markets where health systems have dominated in that space and they may be willing to get out of that market.

Next question, please?

Hey guys, thank you so much for taking my question. You had in the prepared remarks comments about volume and revenue benefits from narrower networks at the MA plans, so I was curious, given some of the challenges those clients are facing, could you see potential for an accelerated pace of adoption of this strategy and some forward benefits in the coming few years?

I believe that all Medicare Advantage plans will inherently have narrower networks compared to traditional Medicare, which allows any willing provider. Generally, health systems perform well in the Medicare space across the country. When a beneficiary transitions from a Medicare plan to a Medicare Advantage plan, they usually encounter networks that are more defined and limited, resulting in positive outcomes. Moving forward, while Medicare Advantage plans are facing increased utilization, which is beneficial for us, they are also dealing with profit pressures. If more of this work is directed to independent labs like Quest Diagnostics, it signifies high-quality service at lower costs. Therefore, we are eager to collaborate with all Medicare Advantage plans to shift work away from expensive out-of-network labs to Quest Diagnostics.

Next question, please?

Thanks very much, good morning. I just had a couple of follow-up questions on LifeLabs. Jim, I think in your prepared remarks, you made a comment that the demographics are more favorable in Canada. Can you maybe just help us understand what market growth looks like in Canada, and then secondly, you talked about the margins being below the corporate average at Quest today and that over two to three years, you’ll get there? Can you give us an idea of what the margins look like today for LifeLabs?

Yes, the population growth in Canada is notably higher than in the U.S., consistently over 1% for several years, which is positive for us and our stakeholders. Additionally, the average age in Canada is older than in the U.S., and similar to trends seen in the U.S. with Medicare and Medicare Advantage, older populations tend to have more medical visits and generally higher healthcare needs. This demographic aspect is advantageous for our industry. Although there are some differences between Ontario and British Columbia, where we primarily operate, we consider Canada to be an excellent market. Regarding margins, the operating margin for LifeLabs is currently lower than our company average, but we anticipate that through synergies and the exchange of best practices over the next couple of years, we will bring the margin rate back in line with the average at Quest.

The next question comes from Andrew Brackmann of William Blair. Your line is open.

Hi guys, good morning. Thanks for taking the question. Jim, I wanted to go back to your comment on integration and digestion. Can you maybe just sort of talk about how your integration efforts or tactics have evolved over the last few years, the things that you can share which maybe give a little bit more comfort on keeping up this accelerated pace of deals going forward? Thank you.

Yes, it really depends on the specific deal. For example, with LifeLabs, which operates in Canada while we're based in the U.S., there aren't significant synergies because we’re not closing any labs or altering the phlebotomy or logistics networks. What we focus on in such opportunities is procurement synergies—comparing what we pay for items versus what they pay and selecting the best prices, which typically favors Quest Diagnostics. Additionally, we evaluate their operations against ours in terms of metrics like phlebotomy performance and logistics efficiency. Within the laboratory, we assess both the entire lab and specific departments like microbiology and automation. We aim to share best practices from both sides, and we also learn from them to enhance our own operations. In the case of health system deals, we generally acquire a portfolio of business rather than labs or logistics. Often, we retain the phlebotomists serving that network. The primary focus on integration involves IT systems, ensuring compatibility with their physicians’ platforms, whether they use Epic, Cerner, or another EMR system. We also transition work from hospital labs to Quest Diagnostics, seeking logistical synergies and enhanced productivity in phlebotomy. We assign dedicated full-time teams to these integrations, functioning within Quest’s regional structures. Depending on the region, these teams address IT, phlebotomy, logistics, and laboratory needs. As Sam mentioned earlier, it will take several quarters to reach the profitability levels we aim for with these business portfolios. It requires significant effort, and our team has extensive experience in this area.

The next question is from Kevin Caliendo of UBS. Your line is open.

Thanks for taking my question; I appreciate it. I want to go over some of the key elements. I found your insights on 2025 helpful, but let me know if I'm off base thinking that revenue growth should be stronger, considering the M&A activity that will be more apparent next year. You mentioned that organic growth is still expected to be around 3%. The cost trends, including wages, are projected to be between 3% and 4%. Hopefully, Invigorate will help offset that, and when we factor in the benefits from the maturation of LifeLabs, which is likely to exceed the $0.10 to $0.15 range since you'll have an additional quarter than expected, along with the decreasing dilution from Haystack, isn't it reasonable to expect that EPS could grow faster next year than your typical CAGR, just reflecting on all these factors?

Yes, I think you have the key elements right, Kevin. As we discussed in our prepared remarks, M&A excluding LifeLabs is anticipated to grow at the upper end of our guidance at around 2%. LifeLabs will contribute a full year of revenues, which will also boost overall revenue growth. Additionally, we're experiencing some carryover from the M&A activities conducted this year. Regarding cost pressures, it's premature to conclude that we will face fewer headwinds overall, particularly concerning inflation, which we still expect to remain in the 3% to 4% range. We do not foresee a significant moderation in this area next year, so we anticipate that inflation will continue in that range. We’ll provide more details on pricing dynamics during the Q4 call, but generally, it aligns with what we are observing now — flat to slightly positive. However, we are noticing competitive trends in the health system sector. Currently, we see EPS growth in the high single digits. If any new information arises on the Q4 call that deviates from this outlook, we will share it; but for now, given the variables at play, we feel confident affirming the EPS growth rate. There are no negative factors that we're withholding; we are just comfortable with the understanding that the current situation places us at the high end of our prior guidance range.

Our last question will come from Michael Riskin of Bank of America. Your line is open, sir.

Great. Thanks for squeezing me in, guys. I’ll close with one, a lot of this has been covered. I wanted to ask a little bit on PAMA - obviously it’s been delayed. You made some comments about potentially working on a permanent legislative solution. Could you expand on that a little bit, like what that could look like, and obviously PAMA has been delayed for a number of years now, so we’re kind of used to this, but any sense of what the future could look like there, just so we’re not in a constant delay cycle again? Thanks.

PAMA has now been delayed for five consecutive years, which is certainly a relief for us and the entire industry. However, SALSA remains on the legislative agenda. It's a challenging process to get these approvals, as it involves navigating one Senate committee and two House committees. With the upcoming election, there's a possibility that the leadership and members of these committees will change. Our trade association, along with its members, will diligently work after the election to identify supporters within these committees and find a solution to the ongoing challenge of deferring cuts each year. We were pleased with the SALSA proposal, which would allow for another year of delay followed by a new data collection process. While some reductions were agreed upon, I’m uncertain if that will be our proposed solution. Despite the positive aspect of delaying cuts for five straight years, it has resulted in significant wage inflation and other inflationary pressures, so we will advocate for an increase in Medicare rates. Our rates have increased through our commercial plans. Although there has been pressure on our hospital reference pricing, we believe that the inflationary context from 2019 to 2024 warrants a rise in rates. We plan to propose a new data collection process that will demonstrate that when comparing our pricing across commercial plans, it should support an increase in Medicare pricing. This is the direction we will pursue moving forward. Okay, so thank you very much for joining the call today. We appreciate your support. Have a good day, everyone.

Thank you for participating in the Quest Diagnostics third quarter 2024 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 800-839-5154 for domestic callers, or 203-369-3358 for international callers. Telephone replays will be available from approximately 10:30 am Eastern time on October 22, 2024 until midnight Eastern time November 5, 2024. Thank you for your participation, and goodbye.