奎斯特診斷 (DGX) 2012 Q4 法說會逐字稿

Welcome to the Quest Diagnostics fourth-quarter 2012 conference call.

At the request of the Company this call is being recorded.

The entire contents of the call, including the presentation and question-and-answer session that will follow, are the copyrighted property of Quest Diagnostics with all rights reserved.

Any redistribution, retransmission, or rebroadcast of this call in any form without the express written consent of Quest Diagnostics is strictly prohibited.

Now I would like to turn the call over to Ms. Kathleen Valentine, Director of Investor Relations for Quest Diagnostics.

Go ahead, please.

Thank you and good morning.

I am here with Steve Rusckowski, our President and Chief Executive Officer, and Bob Hagemann, our Chief Financial Officer.

Before we begin I would like to share that as part of the new organization structure we announced in October I am moving into a new role in the Company supporting our new value creation organization.

Now I would like to introduce our new Executive Director of Investor Relations, Dan Haemmerle.

Dan?

Thanks, Kathleen.

During this call we may make forward-looking statements.

Actual results may differ materially from those projected.

Risks and uncertainties that may affect Quest Diagnostics future results include, but are not limited to, those described in Quest Diagnostics 2011 annual report on Form 10-K, 2012 quarterly reports on Form 10-Q, and current reports on Form 8-K.

A copy of our earnings press release is available and the text of our prepared remarks will be available later today in the investor relations quarterly update section of our website at www.QuestDiagnostics.com.

A PowerPoint presentation and spreadsheet with our results and supplemental analysis are also available on the website.

Now here is Steve Rusckowski.

Thanks, Dan, and thanks, everyone, for joining us today.

While in 2012 we generated $1.2 billion in cash, a record for the Company, for the year we expanded operating margins by 30 basis points, we reached 17.8%, and this was driven by continued strong progress in our Invigorate cost reduction initiative.

We began laying the groundwork for restoring growth, so in a few minutes Bob will review the fourth quarter with you, but I would like to start by giving you an update on the progress we have made to execute the five-point business strategy we shared with you at investor day in November.

The first element of our strategy is to refocus on diagnostic information services.

We conducted a thorough business review of our assets to ensure strategic alignment and began to pursue strategic options for several of them, including HemoCue and OralDNA.

Last year we sold OralDNA and last week we announced our plan to sell HemoCue.

As a result, we reported the results for these businesses as discontinued operations.

The second strategic element is to drive operational excellence.

I would like to share that we are making excellent progress.

We delivered annualized realized savings in 2012 of $160 million with a run rate exiting the year of approximately $200 million.

This exceeded our goal entering the year for run rate savings of $150 million.

We are clearly on track to achieve our revised commitment to exit 2014 with run rate savings of $600 million and realized savings of $500 million.

As I have mentioned in past calls, I have been very involved in this program which is essential to building long-term value.

This program is now being managed within our newly created operations organization, but of course, I am going to be very engaged in driving progress.

The third element is to restore growth.

We now have a single unified sales team under a strong collaborative leader with new regional sales leaders in place across the organization.

We will have our first-ever national sales force together in two weeks.

This is where we will kick off the year.

We will train our sales reps and motivate them to restore growth in 2013.

In addition, we are executing on our seven key growth initiatives with short-term focus on building sales excellence, growing esoteric testing, and establishing a hospital professional services business.

Fourth, we are simplifying our organization.

When we reported our third-quarter results in October we had just launched our new organizational structure and I had identified the senior management team.

Since then we have been deploying the new organization deep into the business, which includes reducing the number of management layers from 10 to seven.

This is on track to be concluded in the second quarter.

The fifth point of our strategy is to deliver disciplined capital deployment.

In 2012 we reduced debt by $654 million.

We significantly increased our dividend, repurchased $200 million of shares, and announced the UMass transaction which was completed on January 2.

Our UMass Memorial relationship and planned Lab of the Future in Marlborough, Massachusetts, represent a new model for delivery of diagnostic information services for our nations increasingly cost pressured healthcare system.

We have begun integrating this business into our company and the new facility is being prepared for the build out to start in the spring.

Our management team is actively engaged in this integration to ensure we deliver the value we envisioned.

We are actually seeing a lot of interest in this acquisition by integrated delivery networks throughout the country.

We have made progress launching to our employees in November what we are calling our new Quest.

We have engaged our employees in the conversation about our company's new vision -- empowering better health with diagnostic insights -- and our five-point strategy.

I would like to share that this has generated enthusiasm and excitement inside the Company.

It also has confirmed our initial view that by eliminating complexity and empowering our employees we can be more effective and create an inspiring workplace.

There is a strong management commitment to driving operational excellence and restoring growth starting with me.

I've been personally involved in Invigorate initiatives since I arrived at Quest in May.

Another top priority for me is to ensure that we focus more intensely on our customers.

I've already met a variety of customers and health plans, integrated delivery networks, and large physician practices, and I look forward to meeting many more customers during 2013 with our commercial team as we progress in restoring growth.

The revenue guidance we provided this morning is consistent with the commitment we shared at our investor day in November -- to grow revenues in low single digits through 2015 beginning with slower growth in the near term and accelerating through the period.

We see 2013 is a building year as we improve operations and begin to restore growth.

In 2013 our focus will continue to be driving operational excellence and restoring growth.

We will build out on the positive momentum of our 2012 Invigorate performance in 2013.

We expect results from our efforts to restore growth to gradually build throughout 2013 and anticipate continued revenue softness in the first half with improvement thereafter.

Our efforts to drive sales excellence, grow esoteric testing, and build a hospital professional services business will gain momentum throughout the year.

This coupled with more favorable year-over-year comparisons in the back half of 2013 is what we expect to lead to improvements in the second half.

We believe the Affordable Care Act will provide volume lift in 2014 as more people gain access to health insurance.

The diagnostic information services industry continues to deliver significant value to healthcare, given it represents a large portion of the information that is used every day to make healthcare decisions while it only represents a small portion of the [healthcare] dollar.

In the future, with the evolving healthcare system that will place more emphasis on evidence-based decision making, we believe this industry, and specifically our company, is very well positioned.

Despite this long-term review, we are prudently planning for reimbursement pressure averaging 1% to 2% through 2015.

In the short term we are projecting that the combination of commercial pricing pressures coupled with Medicare cuts, including the most recent pathology service reimbursement reduction, will approximate a 3% reimbursement decline in 2013.

We expect to be able to achieve double-digit earnings per share growth by the time we get to 2014 with that growth contributed by not only improvements in our operating earnings but continued share repurchases as well.

Our management team and I are focused on driving improvements and return on invested capital.

We expect that executing our strategy will result in value for our shareholders by driving return on invested capital over the long term and restoring growth.

Now I would like to turn it over to Bob for a detailed analysis of the numbers.

Bob?

Thanks, Steve.

I will start by trying to simplify some of the analysis of the results.

Given the movement of HemoCue and OralDNA to discontinued operations, explaining the performance for Q4 and full year 2012 has become more complex.

To assist in understanding the impact of that change we have presented a series of tables in footnote 4 to the earnings release which reconciled the reported results for what is now continuing operations to pro forma results from continuing operations on an adjusted basis had we not treated HemoCue and OralDNA as discontinued operations.

Those pro forma results are comparable with how we had been reporting through the first three quarters and how we presented our financial guidance provided in October.

The tables presented cover Q4 and full-year performance for 2012.

As the pro forma results show, we fell short of our full-year revenue guidance by about 50 basis points.

About half of the shortfall is due to the estimated impact of Hurricane Sandy with the other half softer volume performance than we expected in the underlying business.

Despite the softer top-line performance, the full-year pro forma adjusted EPS of $4.47, which was reduced by an estimated $0.06 for Hurricane Sandy, was within our EPS guidance range.

Our success in driving our Invigorate initiative was a key contributor to delivering the EPS performance.

For the balance of the discussion, I will speak to principally the adjusted results which present HemoCue and OralDNA as discontinued operations and is consistent with how we will report going forward.

In discussing the results I will refer to Diagnostic Information Services, or DIS, and Diagnostic Solutions, or DS.

DIS is made up of the same businesses we previously called clinical testing and was essentially unaffected by the movement of HemoCue and OralDNA into discontinued operations.

What we previously called our nonclinical testing businesses will now be referred to as DS.

HemoCue was previously included in nonclinical testing.

Starting with revenues, Q4 consolidated revenues of $1.8 billion reflect a decrease of 4% from the prior year with an estimated 1.2% of the decrease due to the impact of Hurricane Sandy.

Our DIS revenues, which account for over 90% of total revenues, were 4.4% below the prior year with 1.3% of the decrease due to the impact of Hurricane Sandy.

Volume was 2.4% below the prior year with 1% due to the hurricane.

Revenue per requisition was 2% below the prior year level but essentially unchanged from Q3.

Favorable test mix and an increased number of tests per requisition continued to have positive impacts, but have been more than offset by reimbursement pressures and business and payer mix changes.

Q4 revenues in our DS businesses, which include risk assessment, clinical trials testing, healthcare IT, and our remaining products businesses, were comparable to the prior year.

Q4 adjusted operating income at 17% was 90 basis points below the prior year with the decrease due principally to the impact of Hurricane Sandy.

Adjusted EPS of $1.01 was $0.19 below the prior year with each of the following contributing approximately one-third of the decline -- Sandy, underlying revenue softness, and the year-over-year impact of nonrecurring tax items.

Restructuring and integration costs totaling $36 million reduced reported operating income as a percentage of revenues by 2.1% and reported EPS by $0.14.

Last year's fourth quarter included $11 million of costs associated with CEO succession and restructuring and integration, which reduced reported operating income as a percentage of revenues by about 60 basis points and reported EPS by $0.04.

In response to the softer volume we have seen in the most recent quarters we have taken action to accelerate savings associated with our Invigorate program.

We estimate that Invigorate delivered approximately $160 million in realize savings in 2012 with the run rate savings as we exited the year at about $200 million.

This represents about one-third of our updated goal of $600 million in run rate savings as we exit 2014.

In addition, as you heard at our November investor day, we are evaluating additional opportunities which can bring that amount to $1 billion over time.

Bad debt expense as a percentage of revenues improved 10 basis points from the prior year to 3.4% in the quarter.

DSOs were 47 days, up one day from last quarter.

Cash from operations was $380 million in the quarter compared to $338 million in the prior year.

Cash flow in the quarter benefited by a deferral of just over $90 million of income tax payments into the first quarter of 2013.

The tax deferral was offered to companies headquartered in states most affected by Hurricane Sandy.

While this deferral helped cash flows in 2012, it will reduce cash flows in 2013 with the year-over-year impact being approximately $180 million.

This deferral, plus the roughly $72 million of cash flow benefit we realized from cashing out certain interest rate swaps in 2012, will adversely impact the comparison of 2013 cash flow to that of 2012 by a total of roughly $250 million.

Capital expenditures were $60 million in the quarter compared to $44 million a year ago.

During the quarter we repurchased 869,000 common shares at an average price of $57.55 for a total of $50 million, bringing the annual total to $200 million.

We also reduced outstanding debt by $147 million in the quarter bringing the full-year total to $654 million in connection with our stated objective to delever by $500 million to $700 million.

Turning to 2013 guidance, we expect results from continuing operations before special items as follows.

Revenue growth of between zero and 1%, earnings per diluted share to be between $4.35 and $4.55, cash provided by operations to approximate $1 billion, and capital expenditures to approximate $250 million, an increase from the prior year primarily associated with our Invigorate initiative.

Now I will turn it back to Steve.

Thanks, Bob.

So in closing this quarter we aggressively drove operational excellence and delivered strong invigorate savings.

We are actively working to regain market share and grow our business.

We have taken tangible actions to increase shareholder returns and improve return on invested capital.

Now I would be happy to take any questions.

Operator?

(Operator Instructions) Tom Gallucci, Lazard Capital Markets.

Good morning.

Thank you for all the details.

I guess first I was just wondering within the guidance, Bob, what do you have assumed for buybacks and the incremental portion of cost savings.

Tom, we don't provide specific guidance on buybacks, but what you can assume is that we are going to meet our commitment of returning the majority of free cash flow to shareholders through obviously the increase in the dividend and the remainder through share repurchases.

And the share repurchases this year should be higher than they were in 2012 with our delevering behind us.

We feel as though we have got much more flexibility now to return cash to shareholders.

The other part of the question was with respect to the invigorate savings.

While again we are not giving specific guidance in terms of what that will be each quarter, at the end of this past year we had realized about a third of the $600 million in run rate savings we expect.

You should expect that we are going to be in the range of about two-thirds of that as we exit 2013.

Okay, great.

Then final one.

Just on volumes what do you peg the market growth as?

Obviously, it would seem that you are maybe losing a little bit of share, so could you just give us a little bit more color on some of the headwinds that you are seeing?

You mentioned before you are expecting sales improvement as you go through 2013.

Besides the easy comps, tell us what you are doing there and what sort of visibility you have on improving that volume or market share?

Appreciate that.

First of all, what we shared at investor day is we believe retrospectively is this market has been growing around 4%.

Now that is a discussion around where are the volumes going and some of the volume being picked up by hospitals in their outreach activities.

They are picking up volume, but also picking up value of share in the marketplace.

But we have been not growing at that market rate.

So what we have said is we have lost share and, therefore, what we are doing with [regards] to our growth is to start by improving our performance, growing the business, and getting back to growing with the marketplace.

With that said, what we saw in the fourth quarter is continuing sluggish market conditions.

We did not see an improvement in volumes and actually, independent of Sandy, it continued throughout the quarter as we saw in Q3 as well.

So we don't see a big change in that so far.

Prospectively we believe this is a good market.

Again, we say the market will grow at 4% going forward.

We believe there will be a pick up in the market size in 2014 with the Affordable Care Act kicking in.

But in the short run, given what we saw in Q3 and Q4, we are anticipating that will gradually improve going into next year but we don't see significant changes in the market going forward.

Thank you.

Ricky Goldwasser, Morgan Stanley.

Good morning.

In the prepared remarks you talk about guidance being backend loaded.

Can you give us some sense as to what percent of revenue and earnings will be first half versus second half?

Yes, so let me start and then I will turn it to Bob as well.

We shared why we believe it is going to be backend loaded.

First of all, we do have a number of programs that we have initiated in 2012 that are gaining momentum and we believe will have the most material impact to 2013 in the second half.

For instance, we are putting an emphasis on growing our hospital professional services business.

We believe there will be volumes in the second half that we won't see in the first half.

In addition to that, if you look at the comparisons versus last year, the first quarter of last year was strong.

It is a tough compare.

As a matter of fact, there is 1% fewer workdays in the first quarter versus last year.

Second is if you look at second half we are coming off a second half that was softer.

So it is a combination of our organic investments materializing in 2013 and also how the year lays out in 2013.

So I will turn it to Bob.

Ricky, while we don't provide quarterly guidance obviously, we wanted to provide this level of understanding so that folks as they are thinking about the first half of the year versus the second half of the year can get it right.

As Steve said, the first quarter last year was a very strong quarter.

Clearly, the strongest volume that we have recorded, so that is going to be one of our toughest comps as we go into next year.

And should we think about pricing in the same way, because I think pricing was fairly strong in the first quarter 2012?

So is it a fair assumption that in 1Q 2013 your -- the metrics that you report on pricing kind of the price declines in 1Q 2013 would be greater than what you reported in the fourth quarter?

Again, remember last year's first quarter had the benefit in it of the, I will call it, the last quarter of both Athena and Celera in there which drove mix.

That anniversaried as we got into the second quarter and we saw relative stability in the revenue per req throughout the years subsequent to that.

But, yes, as we think about the 3% reimbursement pressure it will be relatively even throughout the year we are expecting.

Okay.

Then lastly on the hospital front, obviously the hospital outsourcing trend is one of the key debates in the lab space.

In looking at the metric that you have provided by payer I see that actually hospital and reference lab revenues have gone up in 2012.

So can you just give us some color on what drove the year-over-year growth in revenue from that payer bucket and how do you think about that segment in 2013?

Thank you for the question.

Yes, you are right.

We did see growth in our hospital reference business and we are encouraged by that.

I think it speaks volumes.

We shared at investor day that we have about 50% of hospitals have contracts with us for their reference work.

Given that a large share of what they give to us is the more esoteric testing, we see it is a trend that will continue.

But also we are going to build on those relationships in a more strategic discussion about where they are heading with their laboratory activities, including their reference testing, but also how we can have more value-added services provided to them, up to and including taking on their outreach business.

So that is our strategy, but we are going to build on that trend that you picked up in the details.

Thank you.

Kevin Ellich, Piper Jaffray.

Good morning.

Thanks for taking the question.

Steve, your comments on the Affordable Care Act having a lift on volume in 2014, I was wondering what is your thoughts on what the impact on revenues will be with the Affordable Care Act in 2014?

First of all, we are not going to provide guidance on 2014 but we do believe that there will be a pickup in the market and, therefore, we should be seeing a piece of that market.

More helpful, Kevin, given what we are doing with restoring growth, that, as I said in my prepared remarks, we see 2013 as a year to get a lot of things working and a lot of things in place to be able to take advantage of that change in the marketplace.

So we are not going to provide guidance on 2014 but we should see a pickup in the market and we should be in a very good place at that point to take advantage of it.

I absolutely agree with you, Steve.

I was just thinking that with the patient testing bucket going down with fewer uninsured that that would have a negative impact on the revenue, partially offset by the pickup in volume that you see.

Plus then you have the impact of the exchanges coming into play which still kind of remains a question mark.

Do you think that logic is correct?

Well, as you are pointing out, there is so many unknowns right now and that is part of the challenge is there is no question there is going to be more volume.

Question is what is going to be the insurance product for those volumes and how will we engage.

States are still deciding what their plans are going to be, so there is a lot of moving pieces of this as it unfolds as you know.

So we believe, as we said in the past, the Affordable Care Act will be a net positive for this industry and for us.

We think will be in a much better place to take advantage of it in 2014 than we were in 2012 with all the work we are doing.

So we will be actively engaged in the marketplace to stay close to it and take advantage of whatever way it shakes out.

Kevin, I would just add to that while patient pay is our highest reimbursement it also carries our highest level of bad debt and contributes to about half of our bad debt overall.

So as we see shifting out of that bucket we should see some benefit on the bad debt side as well.

Sure, that makes sense.

Thanks, Bob.

Then I'm not sure if you guys have provided much detail behind the UMass deal, but I was just wondering what is embedded in your guidance for any volume pickup that you will see from that relationship?

Kevin, as we said when we announced that deal, we expect it to contribute about 1% to revenues this year in 2013 and expect it to be accretive starting in 2014.

And is that all volume, Bob, or is there some price growth that will come in from that deal?

The majority of it is volume; that is the way you should think about it.

Then, lastly, kind of more big picture.

Steve, with the hospitals taking some share as they have made more acquisitions of physician practices, just wondering have your efforts picked up with any of the managed care companies or with the industry to try to shift some of that volume out of the hospitals and outreach programs to lower-cost settings such as yourself?

So the answer to your question is, yes, it is picking up.

As we have said in the fall and it continues to be a growing trend, we are having more and more conversations about what will happen in the future and how hospital systems as they buy physicians will work with us.

We talked earlier on this call about reference testing.

We are talking about more value-added services.

Our engagement with integrated delivery networks and their thinking through how they will work with us going forward has increased considerably from the prior year.

So the trend continues.

Got it.

Okay, thank you.

Dane Leone, Macquarie Capital.

Thanks for taking the questions.

Two quick questions from me.

One, what is the actual cash balance that you need to have on your balance sheet?

Dane, it is probably in the range of $100 million or so.

The reason that you see the cash balance as high as you do at year-end, which is closer to $300 million, it refers to two things.

One, the deferral in the tax payment from Q4 to Q1, so we have cash on hand to handle that $90 million tax payment.

In addition, the cash balance that we had at year-end was there to cover the payment on January 2 that we made to complete the UMass transaction.

Right, so just as a rule of thumb, in a normal environment anything above $100 million could be considered a cash sweep back to either debt paydowns or share repurchases or dividend payments?

Yes, if you look historically at our cash balance it has probably ranged between $100 million and $150 million or so.

Okay, great.

The second question from me is there anything besides the UMass deal that is embedded in revenue growth expectations for 2013, potentially deals not done that are considered?

So our guidance includes UMass and also includes anything else we might have in the year.

As we shared as part of our strategy, we do believe this is an opportunity to continue to look at and fold in acquisitions.

As you would expect, as we deploy our strategy we are looking at those and so we have an active funnel.

So the guidance includes those as well.

Okay, great.

So to not pin you down to be too specific about quarterly guidance is there an expectation for organic volume trends to turn positive in 2013?

Yes, the answer to the question is yes.

If you go through the math, we do have headwinds with the 3% we have shared.

That price pressure we have to offset with our cost improvement programs and, fortunately, we are in good shape.

We are exiting the year at a nice momentum that will carry into 2013.

With that said, if you go through the math, we are anticipating organic improvement and some of that organic improvement will come from all the activities we have heard about with restore, what we are doing around bringing sales excellence to the Company, making sure that we continue to capitalize on our esoteric testing, and building out our hospital professional services.

So we are planning on it.

Okay, great.

I will yield.

Thank you very much.

Thank you.

Lisa Gill, JPMorgan.

Thanks very much and good morning.

Steve, I was wondering if you had any thoughts around a potential co-pay on the Medicare side.

Obviously still trying to work through the fiscal cliff.

But as we think about that, is that contemplated in your reimbursement pressure of 1% to 2% through 2015?

So, first of all, the work is going to happen to understand what will happen around sequestration and also we are planning for that in our 3% reimbursement cut that we plan on for this year.

As far as co-pay, clearly there is going to be a discussion.

It is hard to understand what might happen eventually, so it is not necessarily in a detailed way part of our guidance.

But we will be working through this, along with many others lobbying, of how that might fold out for the lab industry.

But it is not quite clear yet.

Lisa, if a co-pay were to go into place, it would not necessarily show up as reimbursement.

In all likelihood, if there was any negative impact from it you would see it in higher cost of collections, you would also potentially see it on the bad debt side a little bit as we have to chase those co-pays.

So we are not convinced that co-pays make a lot of sense.

They shift cost to the patient as well as add cost to the healthcare system now having to collect it.

Let me just round that off, Lisa, because you asked about 1% to 2%.

So 1% to 2% is our best estimate of what reimbursement pressure will be in 2015.

Obviously we have more of that in 2013, but the 1% to 2% assumes a mix of all reimbursement pressures.

And so if there is something coming that is in the number.

Then, Steve, you talked about interest by IDNs in the UMass deal.

As many of these IDNs are becoming accountable care organizations are you having discussions with them about becoming the outsource lab now that they will be accountable for those costs, rather than fee-for-service where before it made sense for them to run their own lab?

Are those the types of discussions that you are having?

Yes, it is both.

First of all, this is a fee-for-service industry and it will take time to move over to the accountable care model.

As we have said in the past, you see one ACO, you see one ACO.

The payment reform that is necessary to change how you think about costs and how we contribute to that is still evolving.

So we have both discussions, one in today's world but also thinking about the future.

So when forming these relationships they are thinking about us in the short run as well as the long run and how this might play out.

But in the short run people are thinking about today; in the 2013 it is a fee-for-service world.

Okay, great.

Thank you.

Thank you.

A.J. Rice, UBS.

Hello, everybody.

Maybe just a couple quick questions.

First of all, your guidance range is not a particularly wide range, $4.35 to $4.55 in EPS, but I wondered if I might get you to comment on the variables that you see most relevant in thinking about whether you will end up at the high end of that guidance range or the low end of that guidance range.

Any comment on that by any chance?

A.J., it is clearly volume.

That is one of the biggest drivers.

We feel as though we have got very good line of sight as to the cost savings that are going to be coming through from the Invigorate initiative.

We feel as though we have really nailed down what the reimbursement pressures are going to be this year.

So, clearly, the biggest variable in my mind is where volume ends up.

Okay.

When you think about the savings flowing through and two-thirds of the savings being realized by 2013, obviously a portion of the savings is just offsetting the top-line headwinds that you are referencing in the business and then a portion over time is hopefully driving some margin improvement.

Can you give us flavor for the prospects for Invigorate to drive margin improvement short and maybe long term?

Clearly, in the short term what it has been doing is allowing us to preserve margins given the reimbursement pressures that we see and that is certainly going to be the case in 2013 as well.

You can imply from the guidance that the operating margins aren't going to be significantly different than they were this year.

To Steve's point, in 2014 when we start to see some uplift in the volumes we expect that we can then enjoy very nice incremental returns on those volumes give what we will have done to the cost structure at that point.

Okay.

If I can just add to that, what we have said is that we have committed that we are going to have a run rate savings of $600 million in 2014, realized $500 million.

But what we have also said is that we are challenging organizations to give us more.

Bob, in his remarks, said that we have actually challenged the organization that eventually we would like to have $1 billion in our run rate.

So we are doing everything we can to accelerate what we have committed to and also bring in some more.

So just leave that as a commentary really to the opportunity there.

Okay.

Then just finally maybe a specific question on the -- you have been asked before about the Celera royalty portfolio, any thoughts about unlocking some value there.

Any update on that thought?

I will start and I will turn it to Bob.

First of all, it is not a distraction operationally.

It is a financial asset.

There is some uncertainty around the value.

We are thinking about it carefully and we want to make sure we do the right thing for all shareholders at the right time at the right place to take advantage of that opportunity.

So, Bob, would you like to add to it?

Just that we are evaluating all of the possible options that we have got for those assets and, clearly, we intend to do what is in the best long-term interest of shareholders.

Thanks a lot.

Thank you.

Isaac Ro, Goldman Sachs.

Good morning, guys.

Thanks for taking the question.

First one was just on flu; I don't think the question was asked.

I was just wondering that did come a little early this year, has been significant.

I know it's hard to tease out exactly how it impacts the entirety of the testing business, but could you comment on maybe how you would weight the impact between fourth quarter and what you have seen year-to-date in January?

Bob is just getting over of the flu, as you can probably tell from his voice.

So I will ask Bob to answer the question.

And I didn't generate any incremental volume.

But I think flu visits to the doctor's office do not necessarily generate a lot of incremental volume for us and where there is some it tends to be pretty low-priced volume.

So I wouldn't look for any material uptick in the numbers as a result of the flu season.

Fair enough, okay.

Then, Steve, as part of your five-point plan you guys have talked about the trailing look on organic growth in the end markets you serve and then some of the opportunities you have to regain share.

But just wondering if you could give us some color as to when you think the market will revisit a pace of growth that is consistent with past years and how you think that will map against your own performance?

Is that something that you are looking at on a 12- or 18-month horizon or maybe longer?

So what we have said is that we don't see significant -- we are not planning on significant changes in the marketplace in 2013 and that is our assumption in the guidance.

The second is that we do expect that there will be a pickup in 2014 with the lives entering the system with the Affordable Care Act.

And so what we said earlier is we are planning on some organic improvement in 2013 to offset the price pressure.

We have a number of initiatives and programs that we started in 2012 so we do have momentum coming out of the blocks in 2013 that will pick up momentum throughout the year.

That is why we have said that we will gradually improve throughout the year and better performance in the second half than in the first half.

Then as we enter 2014 we believe that we will be in much better shape than where we were in 2012 and be able to hit 2014 with a better organization, better delivery model, a better way to capitalize on the opportunity we see in the industry.

Got you, fair enough.

Feel better, Bob.

Thanks.

Amanda Murphy, William Blair.

Good morning.

I had a follow-up question on the hospital professional services business that you are moving into, or I guess more into.

Could you just help us understand how the economics of those contracts might work?

So just thinking about pricing and margin relative to the base business.

First of all, what we have shared is this is a professional services business with a set of capabilities that we will offer to healthcare systems through a whole continuum.

First of all, the basics that we talked about an earlier.

There is a large portion of hospitals, about 50%, that we currently provide reference testing to today so we already have a relationship.

Then if you know all of the way to a fully outsourced where we purchase and outreach activities like we did with UMass is the end of the spectrum.

So in that continuum there are services that we will look at running labs or providing consultancy services, if you will, for the labs.

As we start to build the business it is a combination of reference work as well as total outsource.

Bob, would you like to add some comments about the margins for it and the pricing of it?

Yes, just a point on that, and we mentioned this at investor day as well.

To the degree that some of that growth is coming from outsourcing, us, i.e., managing laboratories for hospitals, that does tend to be lower margin business.

But given the fact that there is very little capital investment required to do that for us it tends to be high incremental returns on invested capital.

As we said that is one of our goals is to drive returns on invested capital because we believe it will drive value for shareholders.

As you noticed, we have gotten away from giving guidance around operating income percentage because again it is not necessarily about the percentage.

It is about the top-line growth and the profits that it can deliver.

So would this involve then incrementally more TC type business, TC only?

And just what are your thoughts on that general model, the TC/PC split?

It certainly could involve doing more technical work, but that is on the AP side.

So as we are talking about hospital outsourcing it is much broader than AP.

There is some pieces of the services that will offer some portion of their services to us in the short run as we build that client base.

Got it, okay.

Then just on the reimbursement side.

Obviously, you have talked a lot about that and the Medicare reimbursement pressures are well known.

I'm just curious on the commercial side have you seen -- is there something that has changed in terms of how the commercial payers are viewing the lab business or how they are negotiating the contracts at this point relative to last year?

Well, in the 3% is Medicare.

Also, we included in there the large pathology cut that we have received and will be taking this year.

And then, third, is we do have some reasonable commercial pricing changes, but I would not say in the 3% that we are planning or do we see a substantial change in our relationships and pricing in the industry.

Bob, would you like to add to that?

There is nothing unique happening in 2012 on the commercial side that wasn't anticipated.

This is fully consistent with what we had expected coming into the year.

As we have been talking through 2012 about reimbursement pressure that was clearly one of the reasons that we felt as though we had to up the ante on the Invigorate initiative so that we could mitigate that, which is what the plan is.

And just to give some color on the 3%, the Medicare piece, we do have a large pathology business so it has more significant impact to us than maybe some of the other players in the industry.

So that is in the number.

Got it.

And so your point is on the commercial side it is really just a couple of contracts that are -- if there is anything in there it is from a couple contracts versus a broader change?

Well, I wouldn't say that it is just a couple contracts.

Again, we have spoken about the reimbursement pressure generally and I think that exists with just about all of the payers.

I wouldn't point to any one or two contracts that are driving what we expect in 2013.

The big hits this year are Medicare and the pathology services cut.

Got it.

Okay, thanks very much.

Darren Lehrich, Deutsche Bank.

Thanks.

Good morning, everybody.

I guess just want to get a little bit more flavor, Steve, on the 3% to the extent you can just help us think about this a little more.

How does that split out between Medicare pressure and some of the commercial or managed care reimbursement pressures that you see in your book of business, broad strokes?

Sure, [I am going to repeat this].

First of all, Medicare, second is the pathology services piece of that, and the third is commercial pricing.

We provided visibility in the past on the size of Medicare cut, roughly 5%.

It's a significant cut on pathology services and that is significant for us because of the size of our pathology practice.

The rest is commercial.

Bob, would you like to provide a little more color to that?

Yes, Darren, as you know, we have disclosed that our Medicare revenues are in the range of $1 billion or so, so the 5% on that is $50 million that drops right down to the bottom line.

As Steve pointed out, while we haven't provided guidance or specific information relative to the CPT codes on the pathology side that are facing the biggest cuts, it is a sizable piece of our business and some of those codes are facing reimbursement cuts in excess of 50%.

So those are big drivers that we have this year that we haven't had in the past.

If I could just as it relates to the molecular diagnostics coding changes, do you have at this point any visibility in terms of what the MACs are paying you?

And are they paying you a different rate in calendar year 2013 based on those molecular diagnostic codes that were set for change?

Yes, it is still very early and we haven't yet seen the reimbursement come through on many of those codes.

We are working with the Medicare intermediaries as well as the commercial plans to try and mitigate any impact that would be there.

We are helping them try and crosswalk where they can, providing additional information.

Our hope is to mitigate as much as possible any impact that there may be there.

But, again, rates are not yet published and we have not yet seen reimbursements on those.

And just so I am clear about your managed care commentary you are dialing this 3%, is that based on your outlook for perspective contract negotiations that will be happening this year?

Or are you assuming that private payers will follow Medicare to some extent on some of the Medicare reimbursement changes that you have talked about here in the past and the fee schedule?

As we said, the 3% reimbursement is a combination of multiple things.

It is the Medicare fee cuts, the AP CPT code feed cuts, as well as commercial.

Obviously, commercial rates can be influenced by Medicare rates.

We don't have contracts, many contracts that necessarily float with Medicare but it is a reference point in all of our discussions around pricing.

But at this point what we have baked into that 3% is what we fully anticipate and have good visibility to at this point.

Okay.

Then just last thing for me here.

I wanted to just clarify, Bob, what you said about the cash flow guidance.

I understand the tax payment.

Just in terms of the year over year cash from operations being lower in the outlook, can you maybe just remind me what you said and how much in terms of restructuring cash costs are also built into that guidance on a year-over-year basis?

Sure.

Two things that you have to look at in comparing the year-over-year cash flow guidance.

One has to do with the deferral of a tax payment this past quarter into the first quarter of 2013.

That was roughly a $90 million deferral, so it has $180 million year-over-year impact.

Then, as you recall, in the third quarter of 2012 we unwound some interest rate swaps that we had that generated about $72 million in cash flow for us that we are not expecting to have next year.

So those two factors combined create about a $250 million impact year over year.

In terms of restructuring costs and the like, while we haven't provided guidance on that, the cash impact of restructuring costs is probably not going to be significantly different than it was this past year.

Got it.

Okay, thanks very much.

Bob Willoughby, Bank of America and Merrill Lynch.

Steve or Bob, have you indicated any idea what kind of proceeds you get from the two divestitures that you have announced?

And should we expect significantly more activity going forward or are we near the end of the pipeline there?

Bob, we have not given any guidance on that.

I will tell you though that the OralDNA sale that did close very modest proceeds from that.

Obviously, since we are in discussions around HemoCue right now we are not providing any estimates as to what the estimated proceeds might be there.

What you also heard us say at investor day though is we were evaluating the entire portfolio that includes the other products businesses, the Celera products businesses.

As we referenced earlier on this call, we are evaluating all of our options for the Celera drug assets as well.

Okay, but you wrote a fairly sizable check for HemoCue a few years back.

Are we getting half of that back?

Is it a total wash?

How do we think about that relative to what the premium paid at the time was?

Yes, Bob, as you did see, we recorded a charge in discontinued operations so, clearly, we are not expecting proceeds from those businesses which will match what we paid for them.

But, again, at this point I don't think it would do any of us here a service by speculating what we might get at this point.

Okay.

Did you mention the CapEx number is higher this year?

What exactly are we spending on this year that wasn't in the numbers last year?

Yes, Bob, there is two things principally that are driving the increase.

The first and biggest component is the spending relative to Invigorate, which we expect to ramp up as we start to now rationalize and optimize the footprint, look more at automation opportunities, etc.

That is ramping up this year.

In addition, in connection with the UMass transaction we are building out the facility that we are going to move into and that is adding some additional expenditures.

Those are the two principal drivers.

And would you hazard a guess; obviously 2014, 2015 but the number should trend down from a peak level in 2013 or no?

What we said at investor day is for the next several years we expect that CapEx will probably be about 1% of revenues higher than it has historically run.

And we expect that to be the case for the next couple of years or so.

I would just like to add as we continue to get some refinement on our Invigorate program -- we shared in the past there is a number of initiatives that we are taking cost out of the operation from, but the longer-term structural improvements will require investment in the future.

We haven't exactly sized that, so we want to make sure that it is clear that we will continue to invest in the business to make sure this is a stronger business.

As we push to get more in from our Invigorate program and strive for that $1 billion goal it will require some investments in our facilities and also our IT systems.

That is what we are trying to size and when we get visibility of it we will provide it to you.

Thank you.

Glen Santangelo, Credit Suisse.

Thanks, guys.

This is Jeff Bailing in for Glenn this morning.

Just one question for you on the anatomic pathology in-sourcing trend.

What are you guys seen in respect to this, and do you think that the pathology cuts could actually ultimately maybe help shift some of those volumes back to independent laboratories like yourself?

First of all, it is early so the market is digesting the cuts.

Clearly, it was a significant cut for that service.

It is on the technical side, so you put the technical side together with the professional side and it is not big as a cut but it is a material change for that portion of the marketplace.

So we are watching.

We are not sure how it is going to pan out, but you can't ignore it.

So we are anxious to see how it will wash through given we are a significant player.

There will be some change happening in the marketplace and we are keeping our eyes on it.

Great, thanks.

Thank you.

Anthony Vendetti, Maxim Group.

Thanks.

Most of my questions have been answered but if we can talk just a little bit about what particular parts of your business right now you feel are stronger, what particular testing categories are stronger?

If you want to talk a little bit more about your genomic esoteric goals in terms of percent of your business going forward.

I will start and then pass it to Bob.

We talked about the hospital piece having growth, so we are encouraged by that.

Second is we continue to have a focus on the more sophisticated esoteric testing.

We continue to be encouraged by the growth we see there.

The third is that we continue to see some specialized areas of that [we are in].

Prescription drug monitoring continued to grow nicely.

As we go forward what you have seen from us in terms of organizational structure we put more emphasis on our new organization to commercialize all of the science and innovation and capabilities in this company, which I believe have not been properly utilized.

So you will see more specific areas of testing and solutions around that testing which we believe will help us restore growth.

Bob, would you like to add to that?

As we have shared with you already, we are organizing around certain franchises, disease states.

You might think of them as neurology, infectious disease, cancer, cardiovascular disease, women's health, general health.

And we believe that we are going to be able to drive growth in each of those.

A lot of it will be on the esoteric testing side, but there is also some areas that we expect to regain some traction on.

Women's health, an area in particular that we would expect that we could see improved performance versus what we have seen over the last year or so.

Okay, thanks.

Thank you.

Gary Taylor, Citigroup.

Good morning.

Couple questions; one just a quick housecleaning.

The HemoCue business that was sold, that was never reported in any of the testing revenue disclosure in the supplemental disclosure, is that right?

So when I look at some of the year-to-year changes none of that would have been impacted by the reclass of HemoCue?

That is correct, Gary.

It was a products business and it was included in what we previously referred to as our nonclinical testing segment, which today is called diagnostic solutions or DS.

So it didn't impact any of those other metrics that you saw, volumes or revenue per req.

And just to clarify, HemoCue is not yet sold.

We plan to sell it.

Correct.

Okay, thanks.

2013 operating margin, I guess kind of our back of the envelope at the middle of your guidance is that if you deploy after dividend all your free cash flow to repurchase then the operating margin assumption is roughly flat.

And if you repurchase no shares then operating margin would be down about 100 basis points to kind of get to your midpoint of guidance.

So given that you have said you will do more share repurchase -- I mean are we essentially framing that correctly that somewhere between flat and down 100 basis points is in the range based on the amount of share repurchase?

Well, we certainly do anticipate doing share repurchases, and as I said earlier, I expect that it is going to be greater than the level that we did in 2012 given that the delevering is behind us at this point, although we haven't given specific guidance on that.

But the other thing I would mention to you is while we have not provided guidance relative to the operating income percentage, given that we are expecting 3% reimbursement pressure next year, much of the Invigorate savings is going to mitigate that at this point.

You shouldn't expect there to be significant expansion in margins next year.

In 2014 Steve had mentioned double-digit earnings.

I guess given that share repurchase in any given year looks like it could add 5% and you are expecting a little bit of volume growth, is it fair to say your expectation on operating margin in 2014 is flat to up?

Well, let's not go to 2014 at this point.

We are not prepared to give guidance there other than, as you have heard us say, we are optimistic that we are going to see an uptick in volumes.

Certainly we expect that any incremental volume we start to realize in 2014, given what we will have done to the cost structure, can be very profitable.

What we said is that our earnings growth will be a combination of operating improvements as well as share repurchase.

Right.

So I did hear double-digit earnings growth in 2014 though earlier in the call, correct?

Correct, 2014.

(multiple speakers)

Final question.

Bob, could you just remind us on 2013 and 2014 commercial contract renewals, any of the big guys that stand out for those two years?

Yes, this year there is only one national contract that is coming up.

We have mentioned that Cigna is the one national that is coming up.

Every year we always have regional plans that are coming up that we are dealing with, but just the one single national contract this year.

And then 2014?

We are not going out in terms of 2014 and giving you specific guidance on contracts.

Okay, thanks, guys.

Thank you.

Thank you for participating in the Quest Diagnostics fourth-quarter 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 800-835-4610 for domestic callers or 203-369-3352 for international callers.

Telephone replays will be available from 10.30 a.m.

Eastern time on January 23 until midnight Eastern Time on February 23, 2013.

Goodbye.