奎斯特診斷 (DGX) 2013 Q4 法說會逐字稿

Welcome to the Quest Diagnostics fourth-quarter and full year 2013 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 introduce Dan Haemmerle, Executive Director of Investor Relations for Quest Diagnostics.

Please go ahead.

Thank you and good morning.

I'm here with Steve Rusckowski, our President and Chief Executive Officer; and Mark Guinan, our Chief Financial Officer.

During this call we may make forward-looking statements.

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' 2012 annual report on Form 10-K and 2013 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's Steve Rusckowski.

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

I would like to take you through the topline performance, update you on utilization and reimbursement trends, review our progress against our five-point strategy, and then Mark will provide more detail on the results and walk you through the guidance.

So we always have said that 2013 would be a building year, and it was.

And we have made good progress.

During the quarter, adjusted earnings per share increased 2% from 2012.

Volume increased 2.3%.

And sequential year-over-year trends improved for revenue, volume, and revenue per requisition.

I would like to start by discussing the evolving industry dynamics.

As you know, lately there's been a lot of discussion about headwinds in this industry.

Specifically from utilization and reimbursement pressure.

Now we identified and discussed this at our Investor Day more than a year ago, and we have provided periodic updates.

So what I would like to do is to remind you of what we said, and share our perspective on the marketplace.

First, it is clear to us that healthcare utilization declined broadly in 2013, and it is conceivable that this trend could continue through 2014 based on the acceleration of employer to employee cost shifting, and benefit plan design.

Second, in terms of the expected market growth from the Affordable Care Act, it is now clear that the benefits will take longer to realize, based upon the slower rollout.

And then third, as we said in 2012, we continue to expect reimbursement to decline 1% to 2% per year on average from 2013 through 2015.

Given this guidance we now expect revenues to be flat to down 2% for 2014, excluding the impact of Solstas.

In a few minutes Mark will give you some color on our 2014 guidance we introduced this morning.

Now we continue to be bullish on the long-term growth drivers of this industry.

This market will benefit from continued population growth and favorable demographics as baby boomers move into Medicare and live longer.

Esoteric testing willing grow as precision medicine drives demand for advanced esoteric tests.

And despite the slow uptake for the Affordable Care Act, more insured lives will gradually begin to enter the market each year.

And then finally, medical guidelines drive physician behavior.

And we expect to see increases in some tests, like hepatitis C.

Over the long term, we see significant opportunity being a high quality, low-cost provider of diagnostic information services, which are essential to healthcare delivery.

With this, we remain committed to executing our five-point strategy, and I'd like to give you an update on our progress.

Well, our top priority for 2014 is to restore growth, and I'm very pleased that our planned acquisition of Solstas Lab Partners is expected to contribute approximately 5% of consolidated revenues on an annualized basis, and strengthen our presence in an important region of the country.

And we will provide Solstas customers with access to Quest's full menu of esoteric testing, and also our industry leading Care360 connectivity solutions.

As you know, our planned acquisition of Solstas is dependent upon necessary regulatory review.

Our five-point strategy committed us to refocusing on diagnostic information services.

Since our Investor Day, we divested four assets, yielding about $800 million in proceeds, and we acquired four organizations which supported our goal to generate 1% to 2% revenue growth per year through strategically aligned accretive acquisitions.

The Solstas transaction meets our stated investment criteria.

One way of looking at Solstas is as of multiple fold-in acquisitions spread across nine states.

Also, this combination strengthens our laboratory professional services organization.

We see laboratory professional services as an important part of our growth strategy.

After building our capabilities and pipeline for over a year, we are now pleased to announce that we've reached agreement with three hospital systems on lab professional services arrangements.

We're excited about these opportunities.

They do take time to implement, and therefore we do not expect to see topline benefits before late in the second quarter.

And this is built into our guidance.

Innovation is another key element of our strategy to restore growth.

Our new clinical franchise organization is helping us focus on servicing market needs and filling gaps in care.

I would like to share just two examples of the progress we made during the quarter.

First, our introduction of BRCAvantage tests, that happened in the fourth quarter, and second we created a partnership with UCSF, as you know, one of the country's top academic medical center.

Our organizations are now collaborating to turn UCSF's biomedical research into advanced diagnostics and autism, oncology, neurology, and women's health.

Our new franchise model is enabling us to act like a focused boutique laboratory, while maintaining the advantages of our scale.

We also continue to make progress driving operational excellence.

Our Invigorating cost reduction initiatives ended the year ahead of expectations, with more than $250 million in realized savings in 2013.

We also exit the year with run rate savings of more than $500 million, and this surpasses the original Invigorate goal that was established in 2011, a year earlier than planned.

This positions us to exceed our $600 million goal in run rate savings by the end of 2014, and this again compares to the run rate of 2011.

We now anticipate run rate savings approaching $700 million.

And we also continue to be committed to our longer term goal of $1 billion dollars of savings beyond 2014.

Now as we have said, operational excellence is not just about cost.

We call our program drive.

It's about improving our quality and efficiency, and this will enable us to improve our overall customer experience.

We additionally simplified the organization, and we're building a new culture so we can improve our operations and grow.

As part of this we're deploying a new set of behaviors, and are becoming more external and customer focused.

And hopefully you can see this by the growing number of partnerships that we're announcing, like what we've done with Hologic, University of Massachusetts, and as I just said, UCSF.

And then finally, we continue to deliver on disciplined capital deployment.

We shared this last year, but our plan is to continue to return the majority of our free cash flow to our shareholders through a combination of dividends and share repurchases.

We met those commitments this year and announced earlier today that we've increased our dividend by 10%.

This is the third increase since 2011.

Well, while we are in a difficult operating environment we are taking the right actions to make our Company a stronger and more effective competitor.

We are making progress.

But at the same time, we recognize there's much more to be done.

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

Mark?

Thanks Steve.

Good morning.

As I discussed in the third quarter call, I am focused on improving our predictability and supporting the business to achieve our five-point strategy.

I am pleased with our performance, and pleased that we exceeded top and bottom-line expectations.

Our commitment remains to provide you with guidance that we believe is realistic and achievable.

Let me now turn to our fourth quarter performance.

Beginning with revenues, fourth quarter consolidated revenues of $1.76 billion were 1% below the prior year.

Diagnostic information services revenues were 0.7% below the prior year.

Volume was better than the prior year by 2.3%, including a benefit of acquisitions.

And our underlying volumes were lower by approximately 0.5%.

Revenue per requisition in Q4 was down 3% compared to the prior year.

Our second quarter acquisitions, principally Concentra's Toxicology business, reduced revenue per requisition by approximately 1% in the quarter.

As we expected, underlying revenue per requisition year-over-year comparisons improved as certain commercial contract changes anniversaried.

Our underlying revenue per requisition was lower than the prior year by approximately 2% in the fourth quarter.

And on a full-year basis, underlying revenue per requisition was lower than the prior year by approximately 3% as we guided at the start of the year.

I also want to address some specific business mix issues in the diagnostic information services business.

During the quarter, we did not see a material change in reimbursement or denial rates on molecular diagnostic codes from what we have been seeing earlier in the year.

We saw strong improvements throughout the year in our toxicology and wellness businesses.

In 2013, our anatomic pathology revenues were lower, principally due to softer volumes, including the impact of guideline changes on our pap business and reduced reimbursement principally from CMS.

Turning to our Diagnostic Solutions business, Q4 revenues were unfavorable to the prior year by 4.2%, largely due to softness in our clinical trials business.

For the quarter, adjusted operating income was 16.1% of revenues, about 90 basis points below the prior year, with a decrease principally due to lower revenue per requisition.

A significant portion of the lower revenue is being offset by continued progress with our Invigorate initiative, as Steve mentioned earlier.

Adjusted EPS of $1.03 was $0.02 better than the prior year, and better than our guidance of $0.93 to $0.98.

As a result of the Company's ongoing efforts to drive operational excellence and simplify the organization, restructuring and integration costs of $12 million reduced reported operating income as a percentage of revenues by 0.8%, and reported EPS by $0.06.

Last year's fourth quarter included $36 million of costs associated with restructuring and integration charges, which reduced reported operating income as a percentage of revenues by 2.1%, and reported EPS by $0.14.

Bad debt expense as a percentage of revenues was 3.7%, or 30 basis points higher than the prior year.

The higher bad debt was driven by payer mix, as changes in employer benefit plan design continue to shift cost to patients, through co-insurance and higher deductibles.

We expect that trend to continue.

Despite that trend, bad debt was stable to improved for every payer type, and the biggest improvement was related to cash collections from patients.

This achievement is the result of dedicated effort in our drive operational excellence program.

DSOs were approximately 47 days, an improvement of one day from the third quarter.

Adjusting for the ibrutinib tax payment in the quarter of $175 million, our adjusted cash from operations was $385 million in the quarter, compared to $380 million in the prior year.

Capital expenditures were $76 million in the quarter compared to $60 million a year ago, with the increase related to additional spending to support our Invigorate initiatives and the investment in our new lab of the future in Marlboro, Massachusetts.

During the quarter we repurchased 1.9 million common shares for approximately $113 million.

For the full year, we have repurchased more than $1 billion of our stock, and we have approximately $828 million remaining on our share repurchase authorization.

Turning to guidance for 2014, we are expecting results from continuing operations before special items, and the benefit of the planned acquisition of Solstas as follows.

Revenues to be flat to down 2% compared to 2013.

Earnings per diluted share to be between $3.90 and $4.10.

Cash provided by operations to approximately $900 million, and capital expenditures to approximate $300 million.

Let me share a few comments about our assumptions.

On Solstas, we have not included a benefit in our forecast at this time.

However, we expect that it could contribute approximately 3% to 4% to revenues this year, and approximately $0.05 to $0.10 to adjusted earnings per diluted share, depending on the timing of the close, which at this point we anticipate in the second quarter.

We expect to finance this deal with debt.

We've targeted a long-term debt to EBITDA ratio of approximately 2 and 2.25, and therefore our intent is to pay down a majority of this debt over the next 18 months.

Just to be clear, the guidance of flat to down 2% does not include Solstas.

However, assuming we close Solstas in the second quarter, that would imply guidance of 2014 revenue growth of somewhere between 1% to 4%.

Related to the Affordable Care Act, we have signaled for the past few quarters that we are expecting a muted impact from the Affordable Care Act in 2014 due to the delay of the employer mandate, a reduction in the number of states that have decided to expand their Medicaid programs, and initial challenges related to the implementation of the insurance exchanges.

Additionally, we continue to see an increase in the amount of cost sharing deployed through benefit design changes, which will put pressure on utilization and bad debt.

As a result, we believe the Affordable Care Act will be neutral to slightly positive in 2014, but we still expect to see a bigger benefit over the long run beyond 2014.

On reimbursement, CMS reduced the clinical lab fee schedule by 0.75% in January.

The physician fee schedule was also reduced in January by CMS.

In addition, commercial reimbursement pressure continues, although we expect fewer negotiations in 2014 than in 2013.

As we shared earlier, we reached agreement on three new lab professional services partnerships during the past few weeks.

We expect them to be implemented later in the second quarter of this year, and provide some volume lift as we head to the back half of the year.

However, keep in mind they generally carry lower margin than our traditional business.

On Invigorate, we are expecting approximately $200 million in realized savings this year.

These savings will help offset price erosion, inflation in our wage bill, and annual incentive compensation.

And finally, as you build your models, I want to remind you that the sequestration reimbursement cut will not annualize until the end of the first quarter.

I also want to note that the unusual cold and snow and ice storms this month have negatively impacted our business.

This impact has been taken into account in the full-year guidance, and obviously is fully contained in Q1.

2014 has been a challenging year to model, with more operational variables in play than the normal year.

In the short term, there are pressures on our industry.

However, based on our scale, new organizational structure, and progress we are making on our five-point strategy, we believe we have a good plan that positions us well for the longer term.

Now I'll turn it back to Steve.

Thanks, Mark.

Well, to summarize, again, 2013 was a building year for Quest.

We saw sequential improvement in the fourth quarter, and we continue to make good progress.

Despite the current tough environment, diagnostic information services remain critical to healthcare delivery, and we believe this industry is attractive.

Finally, we have the right strategy to help us navigate the challenges and deliver superior shareholder returns.

Now with that we'd be happy to open it up for questions.

(Operator Instructions)

Our first question comes from Michael Cherny from ISI.

I just want to dig into Solstas a little.

You guys have had a pretty targeted M&A approach over the course of the year in terms of buying Hospital Outreach Labs.

Solstas is obviously a little bit of a bigger bite in terms of capital outlaid contribution.

Maybe could you talk a little bit about what initially attracted you to Solstas specifically, how they came on your radar screen.

And then from a growth perspective once you on-board that into your organization would do you think that can do to drive incremental growth as you look to that first point in the restore growth effort?

Let me start and then I'll turn it to Mark.

First of all, and what I said in my comments earlier is that we have said our focus is on Diagnostic Information Services.

Second, I will say that Solstas has always been on our radar screen.

And what we've said in our five-point strategy is we would look for strategically in line accretive acquisitions.

We said on an annualized basis it would be in the 1% to 2% range.

At the same time what we have said we would consider larger acquisitions than what we've seen with the acquisitions we've done to date, which are four.

But at that time same time those don't come around that often.

So Solstas became available.

As you know it was owned by Welsh Carson.

We went through that process.

We're happily saying at this point that we're engaged to acquire Solstas, dependent upon regulatory approvals.

It is strategically aligned with our business, and we believe it meets our accretive thresholds that we have shared as far what we expect to get out of the acquisitions.

So Mark, would you like to add to this as far as what we expect for growth?

Sure.

I will just add two points really, Michael.

One is, the same financial metrics that we have discussed in evaluating some of these small tuck-in deals have certainly been applied to this deal in terms of our focus on ROIC.

We've got an NPV metric.

Also we've talk about the fact that we're looking for things to be accretive in the second year.

Obviously this one looks like, based on the timing, we'll be able to achieve that in the first year.

So the same kind of financial rigor that we put on the smaller deals has been applied to this one.

In many ways you might look at this as kind of a consolidation of multiple small tuck-in deals all at once, because it's very similar to the type of deals that we've been talking about in our 1% to 2% strategy.

The other thing, we've talked about reshaping our portfolio.

Obviously you can't time these things perfectly, but as we monetize some assets last year, and now we've added the Solstas business.

It's kind of swapping out some things that were not key in our focus areas, and then adding, obviously, a large business that's very similar to our core.

Great.

Mark, one quick housekeeping question in terms of guidance.

Any expectations built into the guidance for buyback?

At this point you should assume generally flat share count, but our buybacks would be enough to prevent dilution.

Obviously we'll evaluate things throughout the year in terms of the best use of cash but no significant buybacks within our assumptions, but sticking to our strategy around returning a majority of our free cash flow to our shareholders.

So certainly not deviating from that.

Perfect, thanks.

Our next question comes from Tom Gallucci from FBR.

It's actually Andrea Alfonso subbing in for Tom.

Thanks for taking my question.

I just wanted to follow up on the earlier question about Solstas, particularly if you could provide additional color on operating margin, payer and customer mix, and what type of visibility you might have on client retention following the close of the deal.

Sure.

Good questions.

Obviously we went through a lot of due diligence on this.

We just gave you the comments about the financial thresholds.

We feel very good about the opportunities we have to consolidate this in our existing operations.

This is from a sales perspective as well as from an operational perspective.

We've shared in the past we particularly like acquisitions that a large portion of the synergies are based upon costs.

We see a good opportunity for this acquisition to do that.

And as Mark just said it allows us to meet our thresholds for from our financial targets going forward.

So we feel good about that.

As far as retention, we actually, as part of the planning for the integration, feel good about how we can combine our organizations in each of the respective states.

As I said, it crosses about nine states.

We've done a detailed look, at those accounts we also have taken a look at how we would integrate.

Again, dependent upon regulatory approval for this transaction, integrate our sales forces.

We think that's a prudent plan.

We actually feel good about retaining the majority of the business that we would acquire.

Obviously when you make any change there's always going to be some reasonable attrition.

You can never retain it all.

But we think our plans in place a solid plan.

Mark, would you like to add to that?

Just that as many people are aware, this business does contain a portion of its revenues are through laboratory professional services agreements, and that does tend to come with a lower margin, but once we get through the integration period, we would expect that the like and like elements -- so their core business, margins should be comparable to Quest's organic margins.

And then the laboratory professionals -- professional services margins would be similar to what we expect to get in Quest as well.

It's just that the mix is slightly different than Quest overall.

Thanks for the color.

And separately I did have a question on the quarterly EPS progression.

You touched on a couple of items such as sequestration and the cold, cough, flu.

But I'd be curious to hear if there may be any other changes that you are seeing that typically impact the seasonality, the historical seasonality given the changing benefit design landscape?

I'm not going to get into more detail on the quarters.

I thought it would be prudent just to mention that the weather has had impact, and I guess the good news is that we waited to give our guidance until we had a chance to see that play out.

The other thing that is typical, is it depends, and it really is material, where the holidays fall, it depends, sometimes quarters you have more or less billing days than last year but there's really nothing beyond the typical things that we see year-over-year that drive a little bit of difference in quarter to quarter.

I think the big change which I'm sure everyone was familiar with, but I want to just remind people, sequestration started in April 1 of last year, and then just to address the issue around the weather here in January across the country.

Thank you.

Next question comes from Kevin Ellich from Piper Jaffray.

First off, could we talk a little bit about capital allocation?

Looking at your guidance, capital expenditures looks like it's up a little bit higher than historically.

Is there some one-time or new spending items that you guys are looking at this year?

Yes, so this really is being driven by the next phase of Invigorate.

As we have mentioned previously, the second phase of Invigorate is more about really redesigning our processes and our tools, and some of that requires greater investment.

So I really attribute it entirely to the next phase of Invigorate.

And it should not be seen as a long-term level.

It really is to get to that savings level that Steve referenced which is the $700 million exit rate in 2014, then the $1 billion beyond that.

Would that include consolidating systems and improving those types of operations, Mark?

Yes, those are certainly things that you should expect we're working on.

Those are critical to driving efficiency and effectiveness.

What we actually spent was within our guidance for the year.

So it is consistent with what we shared.

Okay.

He was talking about the $300 million guidance I gave for 2014.

Looking at your 2014 revenue guidance, of flat to down 2%, just wondering, we know what you're thinking about of revenue per requisition over the next couple years but where do you think organic volume is going shake out this year?

I know it's hard to crystal ball that but given the utilization trends we've seen, just wondering if you have any color or thoughts you can provide for us?

Well, let me start.

First of all, consistent with what we've said in the past, is that we are assuming in our guidance, our strategic goal for acquisitions so there's some portion of that in the guidance, number one.

Number two, is we assume some price erosion, which is consistent with our stated guidance that we provided back in 2012 which is 1% to 2%.

And if you recall, we've been consistently saying that 2013 would be a stronger year, if you will, in terms of price erosion.

We actually guided that 3% to 2013.

Then after 2013 we'd see less.

And so therefore we're still saying 1% to 2% for that period of time, 2013 to 2015.

Third, is we still are assuming some question marks around utilization.

And so we put that all together, Kevin, that's how we came up with the 0% to down by 2%.

Again, this excludes Solstas.

Right.

I guess I was trying to see if you could help us out on organic growth, Steve -- organic volumes.

We're not going to give a specific number at this point, Kevin.

But I think directionally, if you think about Steve's comments that we do have some additional small tuck-in acquisitions assumed, because that is part of our strategy.

Then a price decline that would be smaller than we experienced in 2013 obviously to get to that guidance of 1% to 2% over the three years, you can probably land on what we're thinking in organic volume.

The drivers are really the things that Steve referenced, which is we don't expect -- as I mentioned in my comments, that the benefit plan redesign is done.

We continue that -- we expect that to continue to be a driver on utilization so that's certainly one factor.

Another one certainly, there's some uncertainty around the SGR effects.

We don't know how that's going to play out.

As I mentioned, there's a number of variables this year that made it difficult to model.

We think that the guidance range we've given as I've said is realistic and achievable given all that uncertainty.

Got it.

Thank you, guys.

Our next question comes from A.J. Rice of UBS.

Two things, I guess.

First of all, you made a comment that the uptick, albeit a modest 30 basis points year-to-year on bad debt was largely copays and coinsurance.

I just wonder where you stand now if you have a sense of how much of that bad debt is coinsurance and copays as opposed to truly uninsured?

A majority of it is really copays and coinsurance.

And we expect that to continue.

We actually do reasonably well on the uninsured, and it is a very small portion of our total revenue.

So most of that is coming from coinsurance and copays.

And then my other follow-up question was just to take a quick broad question on the Washington landscape you mentioned the doc fix.

There's also out there for 2015 this proposal to go and review the lab fee schedule line by line, based on technological changes.

Have you had either directly or through the trade association any update on any of those developments, and what we can expect?

Yes.

Yes, we have, A.J. As a matter of fact, this week we're actively working this with ACLA, our trade association.

As a matter of fact, we had a call to talk about where we stand.

We've engaged with members of Congress.

There's two sides of this, as you mentioned, there's the SGR fix.

As you know, in Washington now there's talk about a long-term fix, not just an annual correction, if you will for the problem.

So whether that's going to be successful or not is a question, and how they fund is it the other question mark.

So we're in the middle of that.

We're hopeful that our discussion around the broader discussion around the clinical lab fee schedule will help us.

We've put a proposal on the table.

The proposal will allow us to prudently work with CMS going through the codes.

Do in this a reasonable -- with a reasonable approach, have some time to respond, have some reasonable caps per year, and do this over a period of time with good data with good process, and good discipline.

They're happy to see our proposal.

We're working this as you know, the Washington process works.

So we're actively on this, as a trade association.

Okay, great, thanks a lot.

Our next question comes from Isaac Ro from Goldman Sachs.

On the hospital deals you guys talked about in the call here, can you talk a little bit more about the terms there?

How much do they vary deal to deal?

And then talk a little bit about the pipeline you have for future deals of that nature?

Good question.

First of all, we're very encouraged about our building funnel, the discussions we're having.

As you recall, as part of our growth strategy we believe that many hospital systems and hospitals CEOs that I engage with, many are asking the question about their lab strategy, and you see one of the lab strategies, you've seen one lab strategy, just like any strategy in healthcare.

What I will share with you eventually when we disclose the specifics on some of these deals you are going to see a wide range of arrangements that we have.

You will see community hospitals where we're actually taking on all their lab activities.

That's actually a reasonable revenue number for us.

You will see chains of hospitals that have decided to partner with us.

As you know, we already have joint ventures established with a number of organizations, University of Pittsburgh Medical Center, something we already have.

So we are actually encouraged by the level of interest and the discussions we're having, and we are looking forward to be able to share with you some of the specifics as it gets to the place where we can disclose it.

But a wide rang of possibilities, as you would expect you would see in healthcare.

Got it.

And in the aggregate, fair to say that you think those will be ROIC accretive to the Company over a three- to five-year basis?

Yes, we're not going to do anything that doesn't provide growth and is accretive to ROIC.

Got it.

Lastly, Mark, on cash use, can you rank -- you mentioned the dividend, obviously, and the financing terms for Solstas, but just curious how would you rank order or priority uses of cash this year between the various options?

Sure.

As I gave in the guidance, we're estimating approximately $900 million in operating cash flow.

Obviously we also generate some cash non-operationally as well, so we have more cash than $900 million to work with.

If you take $300 million out for capital, that leaves about $600 million of free cash flow.

Our commitment is to return a majority of that to our shareholders so you should expect more than half of that.

You know what our dividend is going to be, which is a little bit south of $200 million.

Certainly at a minimum, the balance between delivering over half and the dividend payment will be through share repurchases.

And as I mentioned throughout the year obviously we're going look at other cash generation and uses, and then face that decision based on what we think is the best way to create value for our shareholders.

That's kind of the basic guidance at this point.

We'll obviously give updates throughout the year.

That's helpful.

One last one if I could sneak it in, on utilization.

I think some of the managed care companies have talked a little bit about a pull forward effect in the fourth quarter ahead of ACA implementation.

Just wondering if you think it's possible we might see a greater than usual seasonal dip into 1Q and any color there would be helpful?

It's hard to predict this issue now.

There's a lot of effects in the fourth quarter, obviously this past year there's some questions about how holidays fell.

We had an easier compare because of Sandy but at the same time there were some difficult days in terms of our weather in the Northeast.

So you put it all together, and we're not sure it had a material effect on Q4 other than what I just described.

So hard to predict.

Yes, for sure.

Thank you, guys.

Our next question comes from Amanda Murphy from William Blair.

Follow-up on the reimbursement side.

In terms of the 1% to 2% that you gave for 2014, is it fair to say that you probably have some pretty good visibility into that number excluding, of course, the SGR fix?

Sure.

Mark why don't you take this.

Yes, I think it's very fair.

If you look at 2013, because of the magnitude of the reimbursement reduction, we chose actually [explicitly] share that with you.

As we've talked throughout the year and as we mentioned in this call, we hit that pretty much square on.

So we have pretty good visibility throughout 2014, and we've built that into our assumptions.

Other than SGR we wouldn't expect there would be anything that would surprise us materially.

Again that 1% to 2%, just to be clear is 2013 through 2015.

So I guess I was going to ask about 2015, given that maybe had a bit more uncertainty, particular with the clinical lab fee schedule review.

So are you still comfortable with that 1% to 2% in 2015 as well?

We don't really have any new information on 2015, and as you've seen recently with the physician fee schedule, there can be numbers that are thrown initially before there's really a lot of substance in terms of the discussions.

So as Steve mentioned we are actively engaged with the trade association with CMS on discussions.

So we really don't have any information on which to update that estimate at this point, but that estimate, when it was put out in the Investor Day in 2012, did not contemplate any significant repricing of that schedule in 2015.

Got it.

And then obviously you've talked about M&A being a driver for you guys.

Are you seeing anything, or just an increase in opportunity at this point given the reimbursement environment, maybe not so great for some particular labs?

As part of our five-point strategy we said we're going to continue to build our funnel of perspective acquisitions.

They have to be strategically aligned, they have to be accretive.

We've said this many times.

We were targeting to try to get to 1% to 2% growth per year.

As we said, we've actually been on the high side of that range in 2013.

We feel good about that.

If you saw the Solstas acquisition what I will share with you we have other prospects on our list.

We'll continue to evaluate those.

Whether there's more on the list because of the environment, I can't say that.

But, again, we continue to be proactive, looking for areas where it would make sense.

So we can fold into our business organizations that would be aligned with what we need geographically, and to be able to return good returns for our shareholders.

Got it.

Thanks, guys.

Our next question comes from Darren Lehrich from Deutsche Bank.

I just wanted to go back to the hospital deals you referenced Steve.

Can you just maybe help us think about the kind of partners you have and the ones that start in Q2, can you just talk a little more specifically there?

Unfortunately I'm not going to give you any more color than what we've done, Darren.

But I'll share with you, you're going to see eventually when we disclose some of the arrangements, they're wide range.

And I think this is very positive.

It's not one specific type of arrangement that we'll have.

And I think that speaks volumes to what we're willing to engage what healthcare systems are doing.

We approach many of these systems with a good reputation.

We already deliver reference services to about 50% of the hospitals here in the United States, we have existing relationships in place, and so many CEOs in these integrated delivery systems are asking us for our help in thinking through their lab strategy.

These take the form of large academic medical centers, smaller community centers, hospital chains, and they all have different plans and different expectations.

We'll work with them, provided that in the end we can deliver what they're asking for.

Second is, we'll get growth and a good return on invested capital.

So it's a broad range of possibilities.

As we start to disclose this you will get a better feel for the different types of arrangements we'll have, and I think it speaks volumes, again, to the flexibility we have, the capabilities we have to be able to deliver on that.

Got it.

And then just one thing as it relates to this topic and Solstas.

What is the status of the minority partners that were previously involved in the Welsh Carson deal, folks like Ascension.

How are you thinking about the opportunity to work with them and what is the status of their involvement?

Obviously, it's a critical part of the Solstas acquisition.

And while we won't comment specifically on some of the interactions, we wouldn't have moved forward with this deal without full visibility to how that relationship might continue.

We're acquiring 100% of Solstas so therefore this comes with the acquisition.

We think it's going to be a good relationship, and obviously we're counting on continuing that into the future.

Okay.

And just one last guidance question, if I could.

With regard to the molecular pathology nonpayment issue, how does that get factored into your outlook, and have you been able to resolve at this point any of that issue with some of the key states?

Yes, absolutely.

So first off, how does it get factored in?

Obviously we've learned a lot since some of these changes have taken place over the last year.

We have had a number of successes in getting reimbursed, where initially there was some confusion or some issues with getting that.

Some of it was just the time it took to some of the states to figure out the process for gaining reimbursements.

Some of it was just a new requirement for more supporting data.

As we've partnered with the various payers, we've learned a lot and I would say we're making progress.

And in fact in the fourth quarter, we actually had some success in one particular molecular reimbursement code with state Medicaid program that we've been working on all year.

So absolutely making progress.

Great.

Okay, thank you.

Our next question comes from Ricky Goldwasser from Morgan Stanley.

Good morning and thank you for all the details.

So in the past you guided to your cost structure in stating about 2% to 3% every year.

So does this still hold true?

And then keeping that in mind, thinking about the contribution from the acquisitions, how should we think about margin expansion for this year?

Basically what type of topline growth do we need to see in order to start to see margin expanding taking into account the benefits from Invigorate -- kind of like all in?

Let me begin, and then I'll have Mark fill in some of the details.

It feels like you have two questions there.

One is related to Invigorate and the impact to the bottom line.

And what we said this year that we're targeting $200 million for delivered savings in 2014.

However, this will be offset by our typical offsets.

One is, we talked about price, we provided the guidance around that already in the call.

Second is, we've talked about wage inflation, which we have every year.

We had that last year.

We'll continue this year.

And then there will also be some other offsets to it.

So our guidance assumes the Invigorate savings we planned for in 2014, and also the offsets.

So, Mark, would you like to add anything to that?

I know there's a lot of interest in margins.

Typically people are looking for margin accretion.

We're not going to give specific margin guidance.

We understand the value, all other things equal of accreting margin.

But the laboratory management deals as we mentioned do come with lower margin, but they're going to give us growth, and they're going to give us improved ROIC.

And we believe that those are the two things we really need to focus on more than anything, given their high correlation to shareholder value creation.

In terms of Invigorate, as Steve mentioned.

We do have some things to pay for, whether it's price erosion, whether it's the wage inflation.

And as I mentioned we also have some incentive comp to cover year-over-year in 2014.

So not going to get specific on margin, but some of Invigorate drops to the bottom line but a lot of it is paying for some other things, some costs that we have to offset.

As far as the market is concerned, in our opening comments, we provided you the color.

It is an uncertain market.

First of all, we talked about utilization in general.

We do see this growing trend of employers passing more of the healthcare cost to their employees.

That affected us, as you know, in terms of our bad debt.

Mark commented about.

We're believing that could have an effect on further reductions and utilization in 2014.

We don't know, but we're cautious about that.

Second is we did say that the Affordable Care Act, because of its slow rollout have neutral to positive -- slightly positive effect on 2014.

It's hard to predict, based upon the new lags entering the systems with the new insurance products.

At the same time the net number has not been clear, and we're still work our way through that.

Then finally the price structure that we've talked about up-front.

We feel good about the guidance we provided back in 2012.

We feel we could still fit in that envelope, and that is assuming also -- or includes what we did in 2013.

So you put that all together, you see the uncertainty that we see, and we've considered all that in our guidance for this year in 2014.

Again, the guidance for our top line does not include Solstas.

Mark made that clear.

With the Solstas it is a different number, so hopefully that's clear.

And then secondly, we're hearing a lot of chatter from payers and providers around in fact the evolution from fee for service to outcome-based reimbursement and risk sharing.

Does that come up in the conversation that you have with your payers and providers?

I would say it's a growing trend.

We continue to see this as an evolution.

Obviously with many organizations engaged in ACOs, there's discussion about eventual change from fee for service to a bundled payment, [captive in] payment system.

However it's moving at a slow rate, so it's not materially going to affect us in 2014.

Okay.

Thank you.

Our next question comes from Bill Bonello from Craig-Hallum.

So I guess I'm trying to look at your business with a slightly longer term perspective here and understand, I get what you believe are the dry, or the pressures that you're facing in 2014.

You've been really clear about that.

I guess what I don't understand is why you think that 2014 is different than any normal operating year.

In other words, why wouldn't we expect those same kinds of pressures in the future?

And then along with that, what do you think is a normalized model for you in terms of kind of revenue and operating income growth?

I appreciate the question, Bill.

And I'm guessing that many of you see the same longer term attractive features of the market, and Steve mentioned those, certainly the demographics.

I think the pickup from the Affordable Care Act, a little bit muted, but going to the future.

So I guess your question is more targeted towards -- are some of the headwinds going to go away?

I don't think our expectation would be that they're going to go away.

There's always going to be pricing pressure, but certainly the utilization issue that we've talked about at some point, benefit plan redesign kind of gets done, and it gets its equilibrium and its impact on utilization.

Obviously there's some aspect of deferral where people are consuming less healthcare because they're deferring it versus they're just avoiding it, then that deferral catches up.

So we can't predict the future any more than you can, but the expectation is that some of the things that we're pointing to most specifically are going to either be reduced somewhat or are going to go away.

We're still trying to figure this out.

But ultimately the biggest thing is that the tailwinds, and it's not just the Affordable Care Act.

But our belief that it's in the best interest of healthcare and society to do more diagnostics, because if you want early detection or prevention, the way you do that is through more diagnostics.

And we really believe that we are going to have the innovation, and we're going to have the technology to help drive better decisions and ultimately better outcomes and lower costs.

So that's our reason for optimism.

Not that we think that pricing pressures and some of the typical challenges are going to go away.

It's really more that the tailwinds and the attractiveness of this space is a reason to believe.

So let me just add to that Mark.

Thanks, Bill, for the question.

As we continue to believe the Affordable Care Act will be net positive for the industry and for us.

However, the rollout is going more slowly than we ever imagined back in 2012.

So you asked the question, why isn't this going to be the continuation for the future.

We continue to believe that the train has left the station, there will be more and more insured lives in the system, and when there's more and more insured lives in the system, they're going to need what we do.

That's point number one.

We do not see that effect in 2014 yet.

We hoped for that two years ago, but we're not seeing it.

You know as much as I do around that topic.

Second is around demand.

We've had three or four years of muted healthcare utilization of slowdowns, very slow demand.

We look at most studies.

They cite the weak economy, the great recession, coupled with employer benefit redesign.

And we're all hopeful with some recovery in the marketplace this will have the offset of what we've seen for the last three or four years so utilization will return.

With that you talk to people in the healthcare system, there's a fair amount of pent up demand that should show itself back in the system, and that will prospectively show itself mid- to long-term.

We're not expecting in this 2014.

We do expect that should -- things should start to improve as is what I just described changes over time.

Okay.

So that's helpful.

Just to push back slightly on that answer, and just kind of see what else you're thinking about.

It feels a little bit, not just from Quest, but from the industry as a whole that I have been hearing that same discussion since 2008.

And so I guess one of the things I'm curious about is as you sit around at the Board level and think strategically, do you create contingencies for -- gosh maybe this recovering environment never comes and are there other ways that we can be a growth business, if the underlying growth doesn't really recover?

Are there things you can still do to grow yourself?

Good question.

We were doing that, Bill.

First of all, we're not assuming that this is going to change quickly and we're going get a sunny day quickly in the overall market.

We believe our growth strategy is the right one.

We focused on three areas this past year in 2013.

We'll continue to do that in 2014.

First of all, we are the market leader, but there's plenty of opportunities in our existing market, and our focus and our sales organization will allow us to do a better job of executing what we deliver in this market, so that's point number one.

Point number two, as you know there are areas of this market that are growing, and so we've invested a portion of our portfolio of spending into those areas that are growing.

We were one of the early introductions this year with the Supreme Court decision in June of BRCA.

That's a new market opportunity for us, we'll get growth.

We continue to see nice growth in our prescription drug monitoring business.

We continue to see nice growth in our wellness business.

So with our clinical franchises we are investing in those portions of this marketplace, despite the overall market that is soft, but are growing, and that will help us get growth back into our business.

And then finally, is the third area we talked about earlier, is we've invested in laboratory professional services.

We think this is, again, a new opportunity for us.

It is going to build this year, and we think the prospects are still bright around that.

So those are the three priorities that we talked about last year.

They will continue this year.

And it's an example of how we're taking control, if you will, of our own destiny despite the soft conditions that we see overall in the market.

The last thing I will add, Bill, we've talked about in this the past, we believe pricing transparency is a huge advantage for us, and we believe it's just at the beginning, but we're going to see more and more pricing transparency which will absolutely be an advantage for us in terms of our share in the market.

Those are hugely helpful answers and encouraging I appreciate that.

And just one final question.

Thanks for taking the time.

Can you talk a little bit what you are seeing out there in the environment from other labs?

Are you seeing a meaningful up-take in the number of labs that are starting to cry uncle and looking for ways to get out of the business?

On the flip side, there had been some trend to hospitals taking share with internalizing tests and molecular tests and buying physician practices and whatnot.

So has the environment shaping up in terms of what the other participants seem to want to do?

Let me start, first of all, in the fourth quarter there's been some announcements with some of our competitors in this marketplace so it is a tough environment.

Those are some of the larger players, but also the number of the smaller players you would you expect to see the same pressure.

I know I don't need to remind you but I will say it anyhow.

Our dependency on Medicare is much less than many of the players in this marketplace who are much more dependent on Medicare.

So all the pressure that we're talking around Medicare will affect others more than us, and that's felt out there in the marketplace.

Second, as far as hospitals, they continue to look at becoming really integrated delivery systems.

And to my earlier point about our discussions around laboratory professional services, they're now asking the question.

Do we want to continue to stay in hospital outreach?

Do we need to focus on what we do well and rely on leaders like Quest Diagnostics to do what they do well for us?

And that's a growing trend that we're seeing.

We're early in that.

We're having active number of discussions in that regard, and we're hopeful.

So, I would say what you will see happening is an evolution of integrated delivery networks and actually some settling out of what they will focus on in their organizations, given their acquisitions of physicians in the past and what that means to focus on as a focus issue going forward, and we think that provides opportunities for us to grow.

Excellent.

Hey, thanks so much.

Our last question comes from Gary Lieberman from Wells Fargo.

I think most of the questions have been answered here.

Could you maybe give us an update on the competition that you're seeing in anatomic pathology business?

Sure.

Pathology in general hasn't changed a lot.

I'm often asked the question, given the substantial cuts last year in reimbursement -- has there been a change of some of the movement we've seen with insourcing and hospitals?

What I have said in the past, I'll saying again today, there's not a notable change in the marketplace.

We continue to be a market leader in that regard.

We think it's an important part of our business.

It's very strategic to our oncology clinical franchise, so we're deeply committed to it.

But we also know, and others are in the middle along with us is with the reimbursement cuts last year, it's a much more difficult business to make money at, and we're working through what we need to do to be successful with it long term.

Okay.

And then maybe going back to the comments you made on the assumptions for pricing in guidance and specifically on the SGR fix is there some pressure that you are quantifying in the guidance or would that all be incremental to the guidance, if there were any cuts to lab reimbursement as part of any healthcare legislation?

Mark will take this one.

Certainly it was taken into our thinking as we gave the guidance.

I'm not going to share with you what was our explicit point estimate for what the SGR might be, but as we looked at all the drivers and the distribution of potential outcomes we took that into account before we came out and gave that guidance of flat to down 2%.

Okay.

Thanks very much.

Thank you for participating in Quest Diagnostics' fourth-quarter and full-year 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 800-937-2485 for domestic callers, or 203-369-3858 for international callers.

Telephone replays will be available from 10:30 am Eastern time on January 30 until midnight Eastern time on February 28, 2014.

Good-bye.