奎斯特診斷 (DGX) 2016 Q4 法說會逐字稿

Welcome to the Quest Diagnostics fourth-quarter and full-year 2016 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 expressed written consent of Quest Diagnostics is strictly prohibited.

Now I'd like to introduce Shawn Bevec, Executive Director of Investor Relations for Quest Diagnostics.

Go ahead, please.

Thank you and good morning.

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

During this call we may make forward-looking statements and also discuss non-GAAP measures.

For this call, references to adjusted EPS refer to adjusted diluted EPS excluding amortization.

Actual results may differ materially from those projected.

Risks and uncertainties that may affect Quest Diagnostics' future results include, but are not limited to, those described in Quest Diagnostics' 2015 annual report on form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K.

The text of our prepared remarks will be available later today in the investor relations page of our website.

Now here is Steve Rusckowski.

Thanks, Shawn.

And thanks, everyone, for joining us today.

This morning I'll provide you with highlights of the quarter and review progress on our strategy.

Then Mark will provide more detail on the results and take you through our 2017 guidance.

We finished the year on a high note.

We grew revenues, operating income, margins and operating cash flow in the fourth quarter, capping a strong year in which we achieved our commitments and created value for our shareholders.

While Mark will take you through the fourth quarter here are some key highlights for the full-year 2016.

Revenues were up 30 basis points on a reported basis and grew 2.6% on an equivalent basis.

EPS was down 7.4% on a reported basis and grew 8% on an adjusted basis.

And cash from operations increased 30% to $1.1 billion.

2016 was the third consecutive year of progress in delivering on our commitments and creating shareholder value.

Before I describe the progress we have made, what I would like to do it to talk about a few dynamics impacting our industry.

First, we are waiting to see what the new Congress and Administration decides to do with the Affordable Care Act.

As we said in the past, we never realized the full benefit from ACA that we expected, so we wouldn't expect any significant near-term impact if it were to be repealed.

We hope that any potential alternative recognizes the value of diagnostic information services and healthcare.

Second, as you know, CMS has begun to execute a process to refresh its clinical laboratory fee schedule under PAMA.

We are preparing to submit pricing data to CMS later this quarter.

Now, having said that, we're working with our trade association to understand the impact on PAMA of the recent pronouncements of the Trump administration on regulatory review.

Congress has also expressed its intent to act quickly on tax reform.

We are closely monitoring developments and want to share the expected impact of potential changes.

With the majority of our taxable income earned in the United States we could benefit from any material reduction in US corporate tax rates.

We would expect to use a portion of potential tax savings to invest in accelerating growth.

Second, with little forward exposure in overseas cash, we're not likely to benefit significantly for changes in repatriation rules.

Now let's review progress we've made.

As I said before, we grew revenues, operating income, margins and operating cash flow in the fourth quarter, capping a strong year in which we achieved our commitments and created value for shareholders.

As we detailed at our Investor Day in November we are now laser focused on our two-point strategy to accelerate growth and continue to drive operational excellence.

We grew revenue in the quarter, in part by expanding relationships by hospital health systems.

Through the quarter we entered into another professional laboratory services agreement with Montefiore Health System, a premier academic health system, and the University Hospital for Albert Einstein College of Medicine.

Under the agreement Quest Diagnostics will provide laboratory services for Montefiore Health System to help enhance the quality and the value of diagnostic services to patients and doctors at the system's six hospitals.

Quest is collaborating with an increasing number of hospital partners, including leading academic institutions, like Montefiore, that are looking to focus on the core business while taking advantage of our expertise, innovation and scale to help implement their lab strategy.

We continue to expand the work we do with other leading hospital systems, including RWJBarnabas in New Jersey, HCA in Denver and many others.

Our pipeline for developing new relationships is also strong.

In addition, our gene-based and esoteric testing grew mid-single digits in the quarter and approximately 4% for the year.

Major drivers include noninvasive prenatal testing, hepatitis C, prescription drug monitoring, and SureSwab.

Also, we strengthened our efforts to grow advanced diagnostics by adding a senior executive to our team.

I'm very pleased that [Carey Edelton Banner] has joined us for General Electric's healthcare business to provide leadership in this important growth opportunity.

We are also making great progress executing our strategy to be provider of choice for consumers.

At the end of 2016 we had already opened patient service centers in 56 Safeway supermarkets.

Consumer satisfaction is high and so is our employee satisfaction.

We are on track to open a total of 200 patient service centers in Safeway stores by the end of 2017.

This improves the customer experience while also helping us better manage our real estate cost.

Also, we are on track to start performing genetic testing for AncestryDNA at our Marlborough, Massachusetts laboratory later this month.

The AncestryDNA recently reported it sold 1.4 million DNA tests in the fourth quarter, and that's more than all they sold in 2015.

Then, finally, our emerging data analytics business is gaining traction.

We offer data diagnostics in partnership with Inovalon.

The data diagnostic customer list is growing and includes premier health plan payers such as Anthem and Harvard Pilgrim.

We are also proud that an independent panel of 50 industry analysts and influential journalists name the data diagnostic service the most innovative product of the year for healthcare.

We continue to drive operational excellence.

We ended the year with $1.1 billion in run rate cost savings through our Invigorate initiatives, as we projected at Investor Day.

We're on track to deliver $1.3 billion in run rate savings as we exit 2017.

Our revenue services partnership with Optum is off to a good start.

The transition occurred in mid-November and we expect to drive improvements in bad debt and denials in 2017 and beyond.

In terms of capital deployment, during the quarter we increased the dividend 12.5% to $1.80 a share on an annual basis and repurchased $150 million of shares.

In our December Board meeting we approved a $1 billion increase or share repurchase authority, leaving us with $1.4 billion remaining for future buybacks.

We continue to expect to deliver 1% to 2% revenue growth from acquisitions and have an active M&A pipeline.

Our 2017 guidance, which Mark will discuss shortly, reflects expectations for accelerated top-line growth and is consistent with the earnings outlook we provided at our Investor Day in November.

Now Mark will provide an overview on our fourth-quarter and full-year financial performance and provide you with our 2017 outlook.

Mark?

Thanks, Steve.

Starting with revenues, consolidated revenues of $1.86 billion were up 0.7% versus the prior year on a reported basis, while equivalent revenues grew 1.9%.

Revenues for diagnostic information services, or DIS for short, grew by 2% compared to the prior year.

Of this growth, nearly 1% was organic.

Volume, measured by the number of requisitions, increased 1.5% versus the prior year.

Acquisitions contributed about 1% to volumes in the quarter.

However, note that the impact of Hurricane Matthew presented a headwind of approximately 30 basis points on organic growth in the fourth quarter.

Revenue per requisition in the fourth quarter increased 40 basis points versus the prior year.

As a reminder, revenue per req is not a proxy for price.

It includes a number of variables such as unit price changes, business mix, test mix, and test per req.

Unit price headwinds were slightly less than 50 basis points in the fourth quarter and approximately 70 basis points for the full year.

While unit price headwinds moderated the second half of 2016 we note that price fluctuations can vary from quarter to quarter.

We continue to believe that in 2017 unit price headwinds will be consistent with the last few years at approximately 1%.

As we highlighted throughout 2016, our PLS engagements such as RWJBarnabas Health and HCA, carry lower revenue for requisition due to the nature of the work we are performing.

The strength of our PLS engagements in the fourth quarter continue to impact our revenue per requisition.

Other mix elements, including test and payer mix, contributed more than 2% to revenue per req in the quarter.

Reported operating income for the quarter was $276 million or 14.8% of revenues compared to $239 million or 12.9% of revenues a year ago.

On an adjusted basis, operating income was $305 million or 16.4% of revenues compared to $288 million or 15.5% of revenues last year.

The impact of our former products businesses in the fourth quarter of 2015 benefited adjusted operating income by approximately $13 million or roughly 40 basis points.

Excluding this impact, operating margin would have grown by 130 basis points year over year.

Reported earnings per share was $1.09 in the quarter compared to $1.29 a year ago due to a one-time tax benefit in 2015 associated with winding down a subsidiary.

Adjusted earnings per share was $1.31, up 10% from $1.19 last year.

The Company recorded after-tax charges totaling $18 million in the quarter, representing primarily restructuring and integration costs.

The net impact of these items reduced our reported earnings per share by $0.13.

Bad debt expense as a percentage of revenues was 3.6%, 40 basis points better than the previous quarter and 10 basis points higher than the fourth quarter of 2015.

As a reminder, bad debt expense typically improves modestly throughout the year as patients hit their health insurance deductible.

Note that the year-over-year compare is negatively impacted by the fact that our products businesses had a lower associated bad debt rate.

When taking this into consideration our bad debt rate was flat year over year.

Income tax expense in the quarter benefited from the adoption of the new accounting standard related to stock-based compensation.

The impact amounted to an EPS benefit of roughly $0.01 in Q4.

Our DSOs were approximately 47 days, flat year over year.

Cash provided by operations in 2016 was $1.1 billion versus $821 million last year, which was stronger than the guidance we provided in October due largely to better-than-expected earnings and improved cash collections.

Capital expenditures during the year were $293 million compared to $263 million a year ago.

Now turning to guidance, we're providing the following outlook for 2017.

Revenues to be between $7.64 billion $7.72 billion, an increase of 1.7% to 2.7% versus the prior year on a reported basis, and an increase of about 2% to 3% on an equivalent basis.

Reported diluted EPS to be between $4.65 and $4.80, and adjusted EPS to be between $5.37 and $5.52.

Cash provided by operations to be approximately $1.1 billion.

And, finally, capital expenditures to be between $250 million and $300 million.

I'd like to provide a few items to consider as you think about our 2017 guidance.

First, as a reminder, we benefited from favorable weather and an extra day due to the leap year in the first quarter of 2016.

This sets up a bit difficult compare in the first quarter of 2017.

We therefore expect our earnings growth will not be proportional, with Q1 coming in lower than the balance of the year.

Given this, consensus EPS estimates for the first quarter are higher than our current expectations.

Second, our revenue guidance of 2% to 3% equivalent growth includes some M&A, primarily related to carryover from the CLP acquisition which closed at the end of February 2016.

Finally, our CapEx guidance includes an outlay related to the previously announced headquarters move to Secaucus.

Now let me turn it back to Steve.

Thanks, Mark.

To summarize, we continued our success in 2016 and ended the year on a high note.

We are laser focused on our two-point strategy to accelerate growth and drive operational excellence.

Our 2017 guidance is both reasonable and achievable.

Now I would be happy to take any questions you have.

Operator?

(Operator Instructions)

Ricky Goldwasser, Morgan Stanley.

Hi, good morning.

I have some quick questions on the underlying assumptions for guidance.

I think you are expecting 1% to 2% of top-line growth from acquisitions.

Can you give us some more detail on the price versus the volume and whether you are assuming any buyback in guidance?

I know that you have the authorization but is it factored into the range you gave us this morning?

Sure, Ricky.

In terms of buybacks, the guidance is based on flat share count.

So, there would be some buybacks necessary to prevent dilution based on our equity program for our employees but there's not any lift in EPS based on reduced share count in the guidance that we're providing.

In terms of price, as I mentioned in my prepared remarks, while we're not giving a specific number segment, we're saying that 2017 we would expect some continued price erosion, and we would expect that apples-and-apples price erosion to be similar to the last couple of years, which was somewhere 100 basis points or less.

When we talk price erosion, that's pure price, freezing all other variables.

So, on a revenue per req basis, we haven't really provided specific guidance.

Okay.

And I know you mentioned that you submitted the data to CMS this quarter on PAMA.

any updates to your thoughts of how we should think of that PAMA impact and how the new cost-cutting or the updated cost-cutting program could help offset that?

First of all, Ricky, we have not submitted data yet.

We are preparing to do that in the first quarter, as required by PAMA.

As you are aware, we are all going to submit data in 2017 for the goal of CMS to refresh the clinical [and flat] fee schedule with 2018.

But what I said in our remarks is, as a trade association we're spending some time to talk about where are we with PAMA, what has to do with what the administration said, how is Congress digesting that, how that might affect CMS.

So, we're not prepared to say anything about that but we wanted to call that out in my prepared remarks, that we are considering how this might, where we are right now with the new Administration, affect this bill.

Also, as we have talked about in the past, it's about 12% of our revenues.

We are well prepared to absorb that given our progress and we see continued progress with the bigger rate.

We have now good line of sight to that $1.3 billion goal in 2017.

We haven't provided exact expectations beyond that but at our Investor Day in the fall we clearly showed that there's more opportunity beyond that $1.3 billion run rate, which gives us confidence if, in fact, there is some price reductions in the clinical lab fee schedule, absorb that in due course of running our business.

Ricky, I would take you back to the Investor Day where I talked about through 2020 a view that we could grow revenues 3% to 5% and grow earnings in the mid to high single digits.

That takes into account some level of anticipated potential price reductions, as Steve said, still to be finalized as we go throughout the year, and then our Invigorate program and our ability to offset certainly a portion of that and grow earnings faster than revenue.

Okay.

And just one clarification on the 2017 pricing, to your point you expect continued erosion in organic pricing, but when we think about the revenue per requisition as it flows to the P&L, should we assume positive price increases based on mix?

Again, I wouldn't call it price, I'd call it mix.

But if you're looking at the revenue per req, you've got two different drivers.

So, as we mentioned, we've got 2% lift in Q4 from test mix and other mix elements, separate from our PLS.

So, there's no reason at this point to not believe that we will continue to get positive mix as we innovate, bring new test offerings that tend to have higher value.

We also have shared that there has been a trend with higher density on requisitions, so we been seeing an increase in the number of tests per requisition.

While it's hard to predict, there's no reason at this point that we shouldn't continue to get some minor lift from that, as well.

But then the one headwind on mix, again, as we've explained, is our professional laboratory services growing at a faster rate than our overall business.

And because of the nature of that work it happens to have more routine testing, fewer tests per req, and therefore a lower revenue per req.

So, how those all come out, we're not providing a specific revenue per req number but the trend that you've seen, we're not expecting those to change.

Okay.

Thanks for the clarification.

(Operator Instructions)

Jack Meehan of Barclays.

Good morning, guys.

I wanted to just get your outlook on the pathology business for 2017, and whether you thought that could begin to moderate a little bit.

Two sides of what we classify as anatomic pathology.

One is on tissues.

We would say that business is relatively stable for us.

The second is with our path business.

We've talked about in the past with the new guidelines that were established a number of years ago we continue to see a decline in that business, albeit the decline has slowed in 2016.

And we expect that will continue in 2017.

So, hopefully that answers the question you asked.

Jack, just to add a little additional color, I'm sure you're familiar that there were some reductions in the physician fee schedule.

So, in terms of our Medicare business for tissue, that price headwind is built into our guidance and part of the 100 basis points or so that I mentioned.

So, there were some reductions coming out of Washington.

Great, that's helpful.

And then one more for you, Mark.

You talked about the unit price expectations for 2017.

How do you think about the magnitude for PLS, the drag on revenue per req there?

Do you think that gets a little bit bigger in 2017?

How does Ancestry impact the optical numbers, as well?

Thank you.

Ancestry is not a business that we're going to include in our revenue per req because it's a separate business.

And we're not actually receiving requisitions.

It's more of a client services business.

So, that's going to be separate from any revenue per req we share.

I'm not in a position to provide a specific number, Jack.

All I can say is it's included in the guidance, our best guess of what PLS impact will be.

And, quite frankly, it's somewhat dependent on additional PLS agreements that we might sign throughout the year.

So, it would be hard, even if I wanted to give you that kind of color, to give you a specific number because of the timing and our ability to close these deals within a certain timeframe.

It's still, obviously, to be determined.

But, again, I want to remind people that revenue per req is not a proxy for profitability.

And, quite frankly, PLS is a good profitable business regardless of its revenue per req being lower than our core business.

And some of the higher revenue per req businesses, such as our tissue business, are not necessarily the most profitable.

And some of our lower revenue per req businesses, like wellness, are quite profitable even though their revenue per req is lower than our overall enterprise.

That all makes sense.

Thanks, guys.

Thank you.

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

Thanks.

Hello, everybody.

My first question, I wanted to just ask about an update on the Optum relationship.

I know the employee transition over to Optum on your books was, I think, supposed to happen in November.

Are we seeing, now, the cost-benefit of that, or is that still to come in the first or second quarter?

And any update on the thinking about their ability to help you with your revenue cycle management, either bad debts or non-reimbursed tests, and the timing when you might see that side of the benefits?

Thanks, A.J. Let me start.

First of all, as I said in the remarks, we did transition those employees over in November, as you said.

We're off to a good start.

We are very pleased with how that has gone.

We are actually very pleased.

Both sides, Quest as well as Optum, worked on the change management with our employees.

The people that were moved over are now employees of Optum but are very much part of the team at Quest.

So, we feel good about that.

We're off to a good start.

Now, we did this, just to remind everyone, because we believe by working with Optum we are going to have a better capability of working on our bad debt, our denials, our reimbursement.

And we think, we still believe, there's a lot of opportunity in front of us.

So, Mark, how would you like to respond to the specifics of when we might see that?

Sure.

A.J., as we mentioned previously, there are several elements to this.

The billings savings start this year in 2017.

We did not benefit at all last year.

We have a 10-year contract and they bill over the life of the contract.

Then the other element, which is the gainsharing agreement around bad debt and denial, obviously Optum's just starting that work.

So, we're fully expecting significant benefit from that but it's going to take a little time for the additional things that they are adding to what we were already doing to accelerate the reduction in denials and accelerate our improvement in bad debt.

So, yet to come, as well.

Okay.

And, if I just might, on a follow-up ask you about -- I know you mentioned on Safeway that you've ramped that up nicely.

And I know you were having discussions with other people about similar arrangements, some potentially where the nurses, either in an urgent care or mini clinic type of environment, could help you on drawing the blood.

Two aspects to the question.

One is, now that you've got more of the Safeways done, can you start to quantify on a regular basis what your real estate savings would be?

And is there any update on the discussions with other parties about possibly collaborating with them on a similar basis?

In terms of quantifying the real estate savings it's not something I'm going to do.

It's another element of our Invigorate program.

We don't tease out all the various pieces within Invigorate.

What I did do, A.J., if you recall, at the Investor Day, was I framed for you our total expenditures for draws and broke down what portion of that we're impacting with the Safeway agreement, which is less than 20% when you look at the real estate costs and some of the other things such as cleaning and property taxes and utilities, and so on and so forth.

So, I framed for you order of magnitude and total.

Our largest elements of draws is always the labor and there's no labor arbitrage currently with the Safeway agreement.

We're basically paying the same phlebotomists just to do those draws in a different location.

So, no, I'm not going to be providing specifics around the real estate savings over time, but it's meaningful enough that it's helping us get greater confidence in delivering on Invigorate savings that we talked about, $1.3 billion by the end of this year, and then additional room beyond the end of 2017.

AJ, I'd just remind everyone that this work with retailers is part of our strategy to accelerate growth.

As I said in my remarks, we are now laser-focused on accelerating growth.

And, if you recall, you go back to the Investor Day, we made that five approaches to that, one of which is to be the provider of choice for this industry.

And we think what we're doing with Safeway is a good proof point of providing a great experience for consumers in a different environment.

The feedback has been very strong.

When we talked about this at Investor Day there's a portion of requisitions or orders in this industry that go unfulfilled.

And we believe that having better access and very nice storefront facilities, like what we have with Safeway, will benefit our business, it benefits Safeway, it benefits the patients by getting the testing done they need to get done.

We see this as a growth platform for us not just a cash savings platform.

And then, finally, as we said at Investor Day, we continue to work with other potential retailers on their health strategies.

They are very focused on it.

They see health as a major platform for their growth and an opportunity for them to get more traffic into their stores.

So, more to come on that but we're off to a good start.

And, again, it's a key strategy for us around the consumer.

There's other parts of what we're doing around the consumer.

Ancestry would be another example of that.

What we're doing with MyQuest, the smart app, actually this year as we exit the year, without even pushing it really hard, we have over 3.5 million registered users for MyQuest, getting access to their lab results.

So, a lot of different initiatives underway to build on this growth theme of Quest being the consumer choice in our space.

Okay great.

Thanks a lot.

Lisa Gill, JPMorgan.

Great.

Good morning.

I just had a couple of quick follow-up questions.

First, Mark, as we think about the cadence of the revenue growth throughout the year, I know you talked 1% to 2% coming from acquisitions.

Can you maybe just talk about the visibility around acquisitions?

Should we be thinking that will perhaps be more towards the back half of the year?

So, the 1% to 2%, as you recall, is a CAGR over a period of time.

It's not necessarily any given year.

When I talked about guidance for 2017, we don't have any unexecuted acquisitions within that guidance.

So, the only M&A within the current guidance is the carryover from the CLP outreach purchase that we closed last February.

I think that should answer your question.

Any other M&A would obviously begin to be executed and would be more loaded toward the back half of the year because the benefit of CLP carryover ends in the first quarter and I'm not counting on any unexecuted M&A in my current guidance.

Right.

So, that 1.7% to 2.7% growth includes no incremental M&A.

I just want to make sure I am 100% clear on that.

That's correct.

Okay.

And then, secondly, as we talk about the consumer aspect of the business and your Safeway relationship, is there a way to quantify the number of reqs or the number of patients that you are seeing, just to get an idea of the growth going from 56 to 200 stores and the potential opportunity.

I know it's probably pretty small today but is there any metric around this business that you can give us as we start to think about the growth?

It's an interesting idea, and we will think about how and if we do that, because it is helpful to get some idea of how much flow we're getting.

So, we thank you for that idea.

Lisa, I just want to make sure we are clear.

Most of the volume that's being done in Safeway was done previously in a patient service center.

So, it's not all incremental.

It is a lower-cost and we think a more consumer-friendly environment.

What Jim Davis had shared at the Investor Day was that the initial -- and it's early -- view was that we were seeing new patients, we were getting some incremental growth.

And it's hard to be precise but as I pointed out, even a couple of basis points of difference, in an industry that's growing to 2% to 3%, again, a 1% to 2% lift doesn't sound like a lot but all these small things start to add up.

We had says it's really early, we're definitely seeing some incremental growth.

Whether it's sustainable or not, we don't know.

Whether it will accelerate, we don't know.

Whether we will see it at every single site as we move from 50-some to 200, not sure.

But we will certainly try our best to give you some color and give you a sense of quantifying that value beyond just directionally, if we can.

As Steve said, appreciate the question and we will think about and see what we can do to shed some more light.

And as we keep on saying, the initial results are encouraging.

So, at due course we will share more.

All right, great.

I'm looking forward to it.

Thank you.

Thank you.

Dan Leonard, Deutsche Bank.

Good morning.

Thank you.

My first question, Steve, you mentioned in your prepared remarks that if there was any tax benefit from change in corporate tax rates that you would invest a portion of that.

Can you talk about how much you would invest of any tax benefit and what some of the key areas are you would be focused on?

First of all, it's all if -- right?

So, we were very careful to say it could, we're guess.

And we're not going to provide specifics of what we would possibly do because it's very hypothetical.

But our two strategies that we're focused on is accelerating growth and driving operational excellence.

And if we get some benefit then we will consider the best way of considering what we do with that gain.

But we're not providing any specific clarity beyond that.

Okay.

And just a quick follow-up, and I might have missed it, did you provide tax guidance for 2017?

No.

We did not.

So, at this point there's no reason to believe that our effective tax rate should deviate significantly from 2016 or the last couple of years.

Got it.

Thank you.

Isaac Ro, Goldman Sachs.

Hi, good morning, guys.

Thank you.

A question on PAMA.

As the data collection process goes through, and if we also just figure out what it means, I imagine that there will be a lot of smaller labs that are going to struggle with the economics.

And I'm curious if you have seen any signs of opportunity to take some share from smaller facilities, either because they're looking to partner with you guys or they're just not as competitive and can't provide good service.

I'm curious if that's something tangible right now and if at all there is anything baked into your guidance as it relates to share.

As you know, PAMA, if it lands where the goal is, which is for implementation in 2018, and if by gathering the data in fact there is some price erosion against the clinical lab fee schedule, these smaller laboratories and hospital outreach have a higher proportion of their revenues from the clinical lab fee schedule than we do, so they are much more exposed, I think.

As we've talked about in the past, we believe this is a good catalyst for Mark to continue to consolidate.

That's why we still feel confident around that 1% to 2% growth through acquisitions.

We demonstrated that for the past four years, we were able to do that.

We feel good about the prospects of our M&A funnel.

And then, also, if you look at the competitiveness of our business going forward with this dynamic in place, I think it just speaks volumes to the opportunity we have in front of us as a very strong player that brings a lot of value to our industry that should get stronger for years to come.

Also as far as PAMA is concerned, you probably have all seen the Inspector General report that was published in the fall.

As a trade association we continue to be concerned with a few facts there.

First fact is that from, what they have shared, is it's a small fraction of the total laboratories they think will be gathered in this data collection, about 5% -- 5% of the laboratories that are billing in CMS.

Now, that represents about 69% of the total Medicare billings but it's not even close to 100%.

So, this is not the intention of Congress.

So, we're are evaluating that as a trade association.

And then second is, in that data I'm assuming they make some assumptions around the gathering of data in hospitals, knowing what they need to do around the net provider number and whether they are an applicable lab or not.

So, the more data we get into CMS the more representative it is of market-based pricing, and that was always the full intent of Congress.

So, this is what I'm referring to in my commentary -- that we are evaluating based from what we've heard from the Inspector General, what we know is happening in Washington, as we speak, around reviews of new regulation.

And we will decide in course of what we need to do, if anything, going forward as far as a position as a trade association.

That's very thoroughly, thank you.

And then just to follow-up on the prior tax question, I just want to make sure I understand conceptually, if you guys were to get a tax break, that the benefit of that would be deployed through reinvestment in the business to accelerate growth.

Is that, in your prepared comments, what you were trying to say?

No.

That a portion of it -- what we're trying to do, Isaac, is, we don't want to get out in front of ourselves because, although there's a lot of press about it being a priority for Congress, we have yet to see when, if, and for sure, and how.

But there were a number of other healthcare companies recently that made some comments, so we didn't want to be silent.

So, in order to have people understand our thinking, is, as we mentioned, any statutory reductions, since we earn basically all of our income in the United States, would be significant.

Obviously there could be other changes beyond the statutory reduction that could mitigate some of the savings.

So, we'd have to see that.

And we just wanted people to understand that we wouldn't necessarily drop dollar for dollar to the bottom line, that a significant reduction in statutory rates would, in fact, give us an opportunity to look at, as we balance short term/long term, some opportunities potentially to invest.

And if and when that happens we will give you more color.

But we just wanted people to understand, so they won't get ahead of themselves and do some math, that we wouldn't necessarily drop every single dollar to the bottom line.

Okay.

Understandable.

Thank you.

Ann Hynes, Mizuho Securities.

Thank you.

I'm going to ask one more question on tax because our analysis that we've done, if, say, the statutory tax rate dropped from 35% just to 25%, that could imply a 14% increase in free cash flow.

And that is such a big increase in free cash flow.

I know you don't want to give details on what the reinvestment would be, but would that actually change your strategy a little bit?

I just feel like this is very significant.

Would you look at the different business with that amount of more cash coming in?

Ann, I wouldn't say it would change our strategy.

I think as we mentioned, is that, as you said, any large statutory reduction would be significant for us.

Therefore, again, as we balance short term and long term there could be a decision by us to take a portion of that -- a portion of that -- likely a small portion of that -- and invest it in some longer-term growth opportunities.

Not a strategic shift, just really expanding some opportunities that maybe are just not making the cut right now because we have to balance short term and long term.

That was really all we're trying to imply -- not a strategic shift.

But, to your point, if it did happen it could be significant, which is what I commented on in my prepared remarks.

Ann, if it happens we're going to take a step back and think about the best use of that, let's call it a windfall for now, to get the best share of the return, as you would expect we would do.

But, again, it's all very hypothetical.

Don't want to speculate.

But you could trust, like we've done in the past, we're going to carefully think through the best use of any type of additional earnings to do the right thing to get a good return for our shareholders.

Ann, on that note, just to close out, we are going to stick to our capital deployment strategy.

It was implanted prior to my start, back at our Investor Day in 2012.

You've seen we've adhered to that.

This would not change our very disciplined approach to deploying our capital.

All right.

Great.

Can I ask about the UNH contract?

I think -- and I could be wrong -- I know LabCorp's in a long-term contract that ends in 2018.

Do you expect, since we're coming toward the end of that, that contract to come out to RFP?

And if it does, do you expect maybe a potential opportunity?

Because I know that you have said in the past that you still process a lot of reqs for them out of network.

So, how do you view that contract over the next couple of years?

As we said, our relationship with United Healthcare Group continues to get stronger.

We are a big provider today already in laboratory services.

We do have a number of areas where we actually do have a carveout, if you will, of providing services on contract.

We haven't gotten specific on that, but we do.

And our work with Optum, our revenue cycle services just reinforces our relationship.

I was asked the question when we did this in the fall -- does this help you with United -- and my answer is it doesn't hurt you.

It's very visible and we are clearly a strategic partner of United Healthcare Group.

And then, also, we had mentioned that we are partnering around wellness.

We're the partner for Optum as they provide wellness solutions to their client base.

And we're happy about that.

What I will share is that obviously we're trying to get the best possible access as possible with as many healthcare insurers in our portfolio.

We are not a national provider for United today.

And we're hopeful as we go forward we're going to get stronger with United as they work through their contract considerations.

We're hopeful that we could be more of a provider than we are today.

But we don't have any specifics to share with you at this time.

Okay.

Thanks.

Bill Bonello, Craig-Hallum.

Hi, good morning, guys.

Just a question.

There's some large properties, I think, up for sale, and some that maybe should be.

What's your appetite these days for larger-scale acquisitions but within the lab space?

If things are presented, is that something that you would consider?

Or are you strictly focused on some of the more regional and hospital deals?

First of all, what we said we will continue to do going forward is what we said in 2012.

Our business is diagnostic information services.

Anything we do in terms of potential acquisitions fit into that scope.

So, everything has to be strategically aligned.

The reason why we're so committed to it, and we've cleaned up our portfolio to support that, is that we think there's substantial opportunities in that scope of our market.

So, with that, we've said there are a number of smaller positions we could do, which are in that 1% to 2%.

But we've also said over the years is that if something were to come to us that made strategic sense, that we could build a value creation case for our shareholders, we wouldn't rule it out.

But what I will again share is we're not going to do an acquisition that we can't see a path to value creation with.

That has been something that we have delivered against in our capital deployment strategy.

It's served us well.

So, no matter big or small, everything we do is going to create value for our shareholders.

Okay.

That makes sense.

I don't know if you are even allowed to comment on this but is there a bigger pipeline of bigger opportunities out there than maybe there has been in the past?

Bill, what I would say is there's always a pipeline.

And when you say would we consider, we have looked at some larger opportunities in the past, but obviously we haven't shared.

And for various reasons, some of it being What Steve talked about, we have passed.

So, we're always looking at the best path for shareholder value creation, and it doesn't mean that a large transaction couldn't be the best path.

We evaluate those things regularly.

I wouldn't say that in today's world there's any more opportunities.

And sometimes you create opportunities by reaching out to people and having a conversation.

So, it's not as if we sit on the sidelines to see if somebody is declaring that they are looking for some sort of a transaction.

We are very actively engaged with a number of people in the industry and geographically around the world.

And we are considering capital deployment options all the time.

What it comes back to, as Steve said, is we have some very hard and fast M&A metrics, and that is our litmus test for value creation.

And if we found a larger transaction that made strategic sense and met those metrics, and we felt good about the chemistry and the integration path, we certainly would seriously consider that.

Got it.

Thanks a lot.

Brian Tanquilut, Jefferies.

Good morning, guys.

Steve, in the past you have talked about, you gave a pricing outlook, basically, through 2017.

And I know you're forecasting the 100 basis point decline this year.

Where you sit today, take out PAMA, how are you thinking about pricing trends beyond this year?

Thanks for the question, Brian.

What I had mentioned is that through 2020 I would expect the pricing environment to continue to be similar to what it has been the last couple of years, separate from PAMA.

And then if you also recall, I did a slide on if PAMA happens, some of it, especially at some of the lower-end possibilities, within the variability.

As you look at this year, we had about 50 basis points erosion in the back half, certainly higher than that in the first half.

So, if PAMA ends up contributing overall, another 30, 40 basis points.

It's almost within the variability of what we've seen.

Obviously if PAMA ends up being AT the high end it will be a little more significant.

But, as you might expect, we've considered all of that in the outlook that I gave in earnings growth relative to revenue through 2020.

I appreciate it.

Mark, just a different question.

Cash flow was pretty strong in Q4.

As we think about capital deployment, you've said no incremental deals in the guide to buy back.

Basically you just offset the dilution from the stock grants.

Number one, is there anything to call on the Q4 cash flow that drove that strategy?

And then, second, capital deployment for the incremental cash that you haven't baked into the guide being deployed, is that basically your upside driver for the rest of the year?

How should we be thinking about that?

I want to make sure I'm clear on the question, Brian, so tell me if I'm answering what you were asking.

Cash flow was stronger than we anticipated this year.

We did actually take that as an opportunity to accelerate a couple of capital investments into this year.

And our free cash flow still was stronger than the guidance that I provided so we felt we did that responsibly.

And that was some strategic decisions to try to accelerate some items that we are working on in our Invigorate program, and so on and so forth.

Going into this year I am guiding to flat cash flow year over year.

Obviously, as you know, there's various moving pieces, one-time things that could impact positively or negatively.

So, net-net $1.1 million of operating cash flow, $250 million to $300 million of expected capital investment.

And then the rest of the free cash flow, half of that at least, is going to be committed to our shareholders through our dividend, which, again, we increased recently by double digits, and then supplemented by some share buybacks.

With the rest of the free cash flow -- back to an earlier question I got -- it's dependent on executing M&A, and, if not, then we will buy back additional shares.

So, really, that's to be determined.

Got it.

That answers the question.

Thank you, Mark.

Stephen Valiquette, Bank of America Merrill Lynch.

Good morning, Steve and Mark.

Congrats on the results.

I think just for us just a quick high-level volume question.

To the extent that some in the investment community, let's say rightly or wrongly, try to gauge lab industry volume growth by looking at things like physician office visit data, hospital volume data, it seemed like most of these data points were suggesting that lab providers could see some accelerating growth in volumes in the fourth quarter.

I just forgot where you guys stand on how much you also look at these external data points, but also your latest thoughts on how much you think investors should focus on this external data.

Since you guys had decent volume growth in the quarter, don't get me wrong, but it didn't correlate to that expectation of accelerating growth, and that some investors may have garnered from that external data.

Thanks.

Let me start on that.

We look at it all, Steve.

We look at all the different metrics and leading indicators.

What we've mentioned in the past, we have an internal measure.

We take a look at 1,000 accounts that we know they are our accounts and we do a same-account look year on year to say -- what's going on with the underlying utilization of the patients that those physicians are seeing.

What we have said in the past, and we will continue to say, because we looked at this in the fourth quarter, it's been relatively stable.

And this is really a good representation of utilization for the market, we think.

So, it's relatively stable.

Prospectively, that's what we implied in our guidance.

But on top of that, what you see is everything that's driving the marketplace -- that is, more innovation coming into the marketplace, more tests per encounter in the marketplace, and aging populations.

So, that's giving us the growth that we are seeing but also the market perspective growth that we anticipate, as well.

So, that's what we see now.

I will remind you that in the fourth quarter we did have a hurricane event which affected us in Q4.

It showed up in October for us and the industry.

It does have an impact on the business.

Mark, any other color you would like to add to volumes in Q4 but also prospectively?

As Steve mentioned and I said in my prepared remarks, we got about a 30 basis point headwind, by our calculation, from Hurricane Matthew.

We do have a significant business in Florida.

And, although only northern Florida was hit, because of the preparations, there were a lot fewer office visits and a lot fewer lab draws in the state of Florida while Matthew was going on.

And then certainly it headed to the Carolinas, as well, significantly, so we had some impact there.

That certainly dampened what the growth would have been otherwise.

And without getting too much into math, there is a difference in the calendar.

We don't always talk about this but weekends we do less business, weekdays we do more.

Any given quarter, depending on how many weekends there are versus weekdays versus the prior year, there can be some impact, as well.

We don't get into too much detail but you can take a look at the calendar and see how Q4 compared to 2015 and see that there were fewer weekdays.

Okay.

Got it.

That's helpful.

Thanks.

Ross Muken, Evercore.

Good morning, guys.

It seems like your main competitor is mimicking or getting closer in its strategy on the hospital to what you have been doing.

Is that a positive relative to maybe getting more of those types of transition over the goal line just because you have two, maybe, forces pushing there?

Or how do you think about it in general in your ability to execute against what's been sitting in the pipeline?

First of all, we've had a strategy for years now focusing on what we believe is an important element of what's happening in healthcare in the US.

That is, hospitals have a big influence over laboratory strategy in general.

We shared at our Investor Day, it's about 50% of the marketplace, if you look at all the laboratories that are part of the inpatient acute care setting, and they have to run those.

We can help them with those laboratories to make them more efficient.

And then, second, is they are a big part of the non-hospital market, where about roughly one-third of the market is from those hospital systems competing with us.

So, we, three or four years ago, said this is an important part of our strategy.

Back to 2012, we said it was one of our three focus areas.

So, we have been investing.

It's not something you can just put out a shingle and get into the market easy.

I will remind you, there's three areas we work with hospitals on.

One is providing the most sophisticated advanced testing, sometimes called reference testing.

We're the leader there.

Second is we help them become more efficient with their inpatient hospital cost.

The deal that we just announced today with Montefiore, is a good example, where they leverage on our efficiency.

It saves them money and makes them more efficient so they can focus on what they want to focus on as a system.

And then, finally, is outreach.

And in some cases we buy outreach businesses where we have an outright purchase.

What we announced last year with the relationship with Hartford Hospital in Connecticut is an example of that.

The best place for us to be is we are Quest inside of their lab strategy, where we're helping them with reference work, we're helping them with their inpatient laboratory, and we're their partner for outreach.

So, it's all three.

We've been at this for a while.

By being at it, we've invested in capabilities, repeatable methodologies, how do you price them.

How do you call on the C suite.

What I will share is this is not a typical laboratory sale.

It is not at a physician level.

It's not at a lab director level.

It's typically with the CEO and the CFO of an integrated delivery system.

This is strategic, so many of these conversations are the most senior level.

So, I think it is a big part of, has been a big part of, our strategy for a long time.

We are gathering momentum, as you can see, with the deals we've announced.

Last year we announced Barnabas, we announced HCA.

We have yet another one in the first quarter.

So, we have shown that we are gaining momentum and we have a strong pipeline.

And as far as others participating in the marketplace, I think that reinforces their interest in the marketplace.

It's a big market.

There's plenty of opportunities.

There's thousands of hospitals.

Do we think we're going to be the only competitor in this space?

No.

But I think it's just another data point that this is a good strategy that we've been working on and there's obviously a lot more interest out there than just what we've done in a few deals.

It's gaining momentum in general in terms of integrated delivery systems thinking about their lab strategies.

So, we're encouraged about the progress we've made and we are very optimistic about the future growth opportunity.

That's helpful.

And maybe, Mark, just quickly, on Q1 you obviously gave a bit of color.

Could you also just remind us on SG&A cadence, I remember, while you did have a bit of a step up, obviously, in volume in Q1, you also had maybe a bit more of your SG&A for the year.

Just any color you could provide on how that OpEx cadence may look for how to consider what happened last year.

Sure, Ross.

Typically we don't give any quarterly guidance around SG&A.

But I can assure you that, different from last year, you shouldn't expect a quarterly differential of note.

Last year we were building some key capabilities around our data diagnostics and other things, investing upfront, as necessary, ahead of some revenues.

But I don't anticipate anything significantly similar this year.

Thanks and congrats, guys.

I think that was the last question and we thank all of you for joining the call.

As we said at the beginning, I'll close with this, we had a strong quarter and a solid 2016.

We're looking forward to accelerated growth and driving operational excellence this year in 2017.

We thank you for all your support, and you have a great day.

Thank you for participating in the Quest Diagnostics fourth-quarter and full-year 2016 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 866-373-9234 for domestic callers, or 203-369-0282 for international callers.

Telephone replays will be available from 10.30 AM Eastern time today until midnight Eastern time on February 9, 2017.

Goodbye.