Quest Diagnostics Incorporated
Q1 2013 Earnings Call Transcript

Published: 17 Apr 2013

[Operator:]

Welcome to the Quest Diagnostics' First Quarter 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 expressed written consent of Quest Diagnostics is strictly prohibited. Now I'd like to introduce Dan Haemmerle, Executive Director of Investor Relations for Quest Diagnostics. Go ahead, please.

[Dan Haemmerle:]

Thank you, and good morning. I'm here with Steve Rusckowski, our President and Chief Executive Officer; and Bob Hagemann, 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 current reports on Form 8-K. A copy of our earnings press release is available, and the text of our prepared remarks will be available later today in the Investor Relations' Quarterly Update section of our website at www.questdiagnostics.com. A PowerPoint presentation and spreadsheet with our results and supplemental analysis are also available on the website. Now here is Steve Rusckowski.

[Stephen H. Rusckowski:]

Thanks, Dan, and thanks, everyone, for joining us today. What I'd like to start with is to take you through our top line performance and then review progress against our 5-point strategy. And then Bob will provide details on the results. In January, we told you we anticipate a continued revenue softness in the first half of this year and that our efforts to restore growth would result in gradual improvement through the rest of the year. So as expected, we saw a continued revenue softness in the first quarter. Now there are a number of factors that impacted our year-over-year comparisons. As you'll hear from Bob later, after considering those factors, our underlying volume was down about 2% versus the prior year. While some of this may be driven by continued softness in healthcare utilization, we believe there is more we can do to restore growth. And I'll share details on those efforts in a few minutes. In addition, we saw revenues per requisition lower by 3.4% in the first quarter, primarily due to the combination of commercial pricing pressures and Medicare cuts. We continue to expect it to be down about 3% for the full year. Our 5-point strategy is aimed at addressing several of the fundamental factors that contributed to this quarter's softness, and we are making progress on each of these elements. Our primary focus in 2013 is on driving operational excellence and restoring growth. Well, turning first to driving operational excellence, we continued to make excellent progress with our Invigorate cost initiatives, which helped mitigate much of the bottom line impact of revenue softness. We exited 2012 with a run rate of $200 million in savings, and we are building on that momentum. In connection with our strategic goal of simplifying the organization, we have implemented a new organizational structure that will remove 3 layers of management for the business. I'm happy to report we're on track to meet our earlier commitment to reduce 400 to 600 management positions this year. It's already enabling us to be more agile, more collaborative, customer-focused, and is contributing a significant cost savings. In addition, we are building a more performance-oriented culture, which includes the creation of the new management process and performance management system. We've gone to educate all our employees on new behaviors and cultural norms, one of which is being more externally oriented, so we can focus more on our customers. We have taken a number of steps to restore growth. We've expanded our sales force and now have more sales people in place than we have ever had. We have filled virtually every management position in the new unified sales organization. We held our first-ever National Sales Meeting in February. And I can tell you the team left that meeting excited about their new assignments, their new selling tools and their new simplified compensation system that actually went into effect on April 1. We have completed the vast majority of customer transitions along with sales reps to make sure that they're more efficiently addressing their new sales territories. We have reorganized the way we approach health plan customers and are having greater engagement at all levels. And then finally, we built a new professional services organization and are seeing strong interest from integrated delivery networks throughout the country. We are executing our plan to restore growth that we shared with you in November, and as we have said, it will take some time to see improvement. The results of these efforts may not be visible in the numbers yet, but we believe we're doing all the right things to motivate, incentivize and focus the sales organization. And we continue to expect results from our efforts to gradually build throughout the remainder of the year. We continue to make strong progress on the remaining 2 points of our strategy, refocusing on Diagnostic Information Services and delivering disciplined capital deployment. We completed the previous announced sale of HemoCue and plan to redeploy the $300 million of proceeds into share repurchases during the second quarter. In addition, we completed the acquisition of the UMass outreach diagnostic services business and announced the planned acquisition of certain outreach testing operations of Dignity Health. We expect to complete additional fold-in acquisitions, consistent with our goal of delivering 1% to 2% growth per year through strategically aligned accretive acquisitions. The Dignity transaction, combined with the UMass partnership, positions us extremely well in 2 states that are leading the way in healthcare reform and is one more indication that hospitals are indeed looking for more cost-effective ways to manage their diagnostic testing needs. We're excited about these 2 opportunities, as well as the growing number of discussions we're having with hospital systems interested in working with us. Well, since we introduced our new vision, goals and strategy at Investor Day last November, we have been driving transformational change at Quest Diagnostics. And as you know, whenever a company undergoes major change at a rapid pace, you might think there's disruptions, even significant disruptions. And knowing this, I have been personally monitoring this closely. I spent time meeting with employees, particularly with sales reps around the country, and accompanied them on many customer visits. The conversations with sales reps and employees have shown that -- them to be engaged, enthusiastic and focused. And I can share with you that I'm not seeing any evidence of disruptions. In fact, I believe we're doing a good job exiting -- or executing our way through this challenging period. I'm proud of some of the most recent accomplishments. First of all, during the quarter, we launched several significant new service offerings, which include the new dementia panel and a non-invasive prenatal genetic test. In addition, an important HIV genetic test was introduced last year, which benefited from the recent HHS guideline change. Each of these address a growing area of demand. Just this week, we welcomed Jim Davis. Jim is a veteran of GEs healthcare business, and he'll be the Senior Vice President to lead our Diagnostic Solutions business. He will oversee Diagnostic Products, our Insurer and Employer Services, Clinical Trials and Healthcare IT. And then finally, we were recognized as one of FORTUNE's World's Most Admired Companies this year and ranked first in our industry category. We see 2013 as a building year, and we will improve operations and begin to restore growth. Now let me turn it over to Bob for a detailed analysis of the numbers. Bob?

[Robert A. Hagemann:]

Thanks, Steve. Starting with revenues. Consolidated revenues of $1.8 billion were 6.4% below the prior year. Our Diagnostic Information Services revenues, which account for over 90% of total revenues, were 6.7% below the prior year. Volume was 3.4% below the prior year, with approximately 2% due to fewer business days in the quarter compared to last year and about 0.5% due to the impact of severe weather. Partially offsetting those factors was about a 1% volume contribution from the UMass acquisition, which we completed in early January. The resulting underlying volume was about 2% below the prior year and consistent with the comparable measure last quarter. This is also consistent with what we shared in January when we indicated we expect to see continued volume softness in the first half of the year, with improvement in the second half due to more favorable year-over-year comparisons and building momentum on our efforts to restore growth. Revenue per requisition in Q1 was down 3.4% compared to the prior year. This compares to a year-over-year decrease of 2% reported in the fourth quarter of last year, with most of the change due to the Medicare fee schedule reduction, including pathology reductions, as well as certain commercial fee schedule changes, all of which went into effect January 1. The 3.4% decrease reported for the quarter is principally reimbursement-driven as positive test mix is essentially being offset by business mix. We continue to expect that for the full year, the reimbursement decline will average about 3%, with about 1% of the year-over-year impact we saw in the first quarter expected to anniversary later in the year. Consistent with what we shared with you in January, we continue to plan for average reimbursement pressure of 1% to 2% through 2015. Q1 revenues in our Diagnostic Solutions businesses, which include risk assessment, clinical trials testing, healthcare IT and our remaining products businesses, were down about 2% compared to the prior year. Adjusted operating income, at 15.2% of revenues, was about 1.5% below the prior year, with the decrease due principally to lower revenues, particularly the lower reimbursement. A significant portion of the reimbursement and volume impacts is being offset by continued progress with our Invigorate initiative. As we indicated on our last call, we exited last year with about $200 million in run rate savings compared to a 2011 baseline. We expect to achieve $600 million in run rate savings as we exit 2014, and we are on track to reach about 2/3 of that by the end of this year. Our goal remains to bring that number to $1 billion over time. Adjusted EPS of $0.89 was $0.16 below the prior year, with the decrease principally due to lower revenues, partially offset with cost savings realized from Invigorate. Restructuring and integration costs, totaling $45 million, reduced reported operating income as a percentage of revenues by 2.5% and reported EPS by $0.17. Last year's first quarter included $20 million of costs associated with restructuring, integration and CEO succession, which reduced reported operating income as a percentage of revenues by 1% and reported EPS by $0.08. Bad debt expense as a percentage of revenues, which is typically highest in the first quarter due to increased patient responsibility associated with unmet deductibles and co-pays, improved 20 basis points from the prior year to 4%. DSOs were 46 days, down 1 day from last quarter. Cash from operations was $47 million in the quarter compared to $161 million in the prior year. Cash flow in Q1 is seasonally the weakest of the year, and as we explained on our last call, in this quarter, was further impacted by about $70 million of income tax payments, which were deferred from Q4. Capital expenditures were $49 million in the quarter compared to $30 million a year ago. During the quarter, we repurchased 1.1 million common shares at an average price of $57.81, for a total of $62 million. We plan to deploy the entire $300 million in proceeds received from the HemoCue disposition into share repurchases in the second quarter. Turning to guidance. We expect results from continuing operations before special items as follows

[Stephen H. Rusckowski:]

Thanks, Bob. So what you've heard from Bob is there's a number of reasons to believe we will see improved performance as the year progresses. I'd like to add a few comments. First, I've personally seen the efforts of our commercial team, and I know the difference they're making with our customers. And because of this, it gives me confidence we will start to see signs of improvement soon. As you have heard, our guidance does contemplate additional fold-in acquisitions. And based upon discussions we are having, I'm confident that we will see additional contributions from acquisitions later this year. We are actively exploring options to monetize our Celera products and drug assets, and this could present additional flexibility for additional or incremental sales -- share repurchases. So in summary, we continue to see 2013 as a building year, and we have confidence that executing our 5-point strategy will drive increased value for our shareholders over the long term. Now we'd be happy to take your questions. Operator?

[Operator:]

[Operator Instructions] Your first question comes from Amanda Murphy, William Blair.

[Amanda Murphy:]

So I had a question. You mentioned that you were seeing increased traction from the efforts on the Restore initiative. Just curious if you can provide a little more detail there in terms of specifically what you mean as it ramps through the rest of the year.

[Stephen H. Rusckowski:]

Yes, well, thank you, Amanda. First of all, Restore has 3 priorities for this year. We've laid it out in our strategy. We have 7 platforms that we need to invest in over the long term to restore growth, but 3 specific priorities for this year

[Amanda Murphy:]

Well, I guess as a follow-up. I know you've talked historically about, well, your historical market share trends, and obviously, you expect that to turn around through the rest of this year. So -- and I appreciate everything you just said. I guess I'm curious, have you seen anything, from a competitive standpoint, changing? So if you think about all of the enforcing that's been going on by physicians and hospitals buying back practices, and obviously, you're also buying outreach programs. And then whether it be other independent labs, have you seen anything change from that standpoint?

[Stephen H. Rusckowski:]

Well, Amanda, it's hard to get information that you can see there's any change yet. What I can say, it feels like the market is about what we saw in the second half of last year. That's continuing into the first quarter. As Bob said, we had a tough compare. We don't have good data on what's going on with the competition yet. And we don't see a substantial change of what's happening with what we call the hospitalization effort that's -- that has an effect -- that has had an effect on our market. So overall, we don't see a material change in the first quarter from what we think we're doing in the market. We've put in place our 3 initiatives this year to restore growth. We think we've made good progress, but it's too early to say that we've started to see the gradual improvement we've expected for. So overall, not much to comment on yet based upon our performance in the market because we just don't have the data.

[Operator:]

Your next question comes from Ricky Goldwasser, Morgan Stanley.

[Ricky Goldwasser:]

I have a couple of questions here. So first of all, when we think about the outlook for second half of the year, I think we get to around 2% same-store growth -- volume growth in the second half as the sales force productivity kicks in. And Steve, you mentioned in your response to previous questions that there've been made some adjustments for the sales force compensation. So can you share with us like some of the metric that sales force is now tied to and how you think of that in contributing to the growth in the second half of the year?

[Stephen H. Rusckowski:]

Okay, sounds good. Thank you, Ricky, for the question. First of all, there's several aspects that will help us gradually improve our performance in the second half. First of all, we're talking about the sales forces gaining momentum. You asked about specific metrics. What we've put in place is a more rigorous, disciplined, structured approach, a professional approach to managing the sales force. Giving you an example, we're asking for a target level of -- or targeted number of sales calls per individual. We're rigorously managing that to the individual sales reps to make sure we're calling on our customers in a frequent way and a regular cadence. That's a new approach that we've put in place. And given our experiences, we think that's the best way to gain business and gain momentum in the second half. Second is we are starting to see the advantages of the new teams working together. One of the principles, Ricky, of our new sales organization is to put in a geographic area all the sales reps, which includes reps calling on primary care but also the specialist reps. And in my travels, I could tell you that we're starting to see the advantages. We are seeing primary care reps being called in to specific accounts by specialist reps and vice versa. They're passing leads. They're seeing opportunities. And since, as we said, 65% of physicians' networks are integrated delivery networks, more of the business and more of our relationship is at that enterprise level, so it has to be coordinated by that first-level manager. And that network of sales reps and their incentives to help each other out also will be helpful as we move throughout the year. I would also like to say it's not just the sales force that will help us in the second half. And in my earlier question, I commented that we do have 2 other aspects of our growth strategy that we believe will gain momentum in the second half, and that is around new introductions of new solutions to the marketplace. And that is something that we believe that we will continue to grow from and we believe we can accelerate the growth. And we'll see some of the progress from those efforts in the second half. And the third is the continuation of the opportunity we see with the professional services organization. That will build momentum. We'll see some volume for that in the second half that we didn't see in the first half. So those 3 are the 3 priorities for this year. We invested in those 3 priorities. We have not yet seen the benefit of those in Q1, but we will gradually see improvement as we go throughout the year. Let me turn it to Bob and see if there's anything he would like to add to explain the implied growth that we have in the back half because we're sure there's some questions about that. Bob?

[Robert A. Hagemann:]

Yes, Stephen, and this is what I tried to cover a little bit as we went through the guidance. And just to help people understand a little bit, I'll cover it again. But we talked about the first quarter being impacted by several things, which will either reverse or not recur as we get later in the year. Certainly, the days and the weather impact, which cost us about 2.5% in the quarter, we expect to have essentially a neutral impact for the full year. So you'll see that reversing over the back half of the year. Acquisitions, which contributed about 1% to revenues and volume in the first quarter, we're expecting to contribute about 1.5% for the full year. That's a combination of UMass, Dignity and other acquisitions that we intend to do and expect to do. That can actually even be a little more than 1.5% potentially. The revenue per requisition that was down 3.5% in the first quarter, we're expecting to be down about 3% for the full year. And again, that's as a result of roughly 1% of that year-over-year decline, is starting to anniversary in the back half of the year. And then the Diagnostic Solutions business, which we didn't talk about much but was down 2% in the first quarter, that's a business that we're expecting to have a positive -- or a group of businesses that we're expecting to have a positive contribution for the full year. So again, stronger performance there in the back half. When you look at all of that together, it implies that the underlying volume growth for the full year has got to be somewhere in the range of a little less than 1% to about 1%, and that compares to the negative 2% we saw in the first quarter. So Steve just took us through all of the reasons that we expect that underlying volume growth to improve over the course of the year, and that's how we thought about the year and piecing it together and how we get comfortable with the full year.

[Ricky Goldwasser:]

Now that's very helpful, Bob. And just to clarify, does this guidance also include the potential buybacks that are associated with the potential monetization of the Celera assets? Or will this represent upside?

[Robert A. Hagemann:]

Nothing specific with respect to the potential monetization of the Celera assets, although as we've said, we are actively exploring all of our options there. And that could present an additional opportunity for share repurchases beyond what we've contemplated so far.

[Operator:]

The next question comes from Kevin Ellich, Piper Jaffray.

[Kevin K. Ellich:]

Bob, is this your last conference call?

[Robert A. Hagemann:]

It is, Kevin. It's my 65th and my last conference call.

[Kevin K. Ellich:]

Well, I want to say wish you well, and it's been great working with you, and I hope you have a good venture in your next -- best wishes is what I'm trying to say.

[Robert A. Hagemann:]

Thank you.

[Kevin K. Ellich:]

So I guess, first off, talking -- looking at your 3.4% pricing pressure, and you made a comment about the 1% that's going to anniversary, can you give us any more specifics? Is that going to be in Q3, or is that later in the year?

[Robert A. Hagemann:]

It's really later in the year. Certainly, all in the back half is where it anniversaries, Kevin. And that's principally associated with the commercial pricing changes.

[Kevin K. Ellich:]

Understood. And then you've provided some good detail in your prepared remarks, but I was wondering if you could maybe even give us some more color on the breakdown of that 3.4% pricing pressure. How much of that is attributable to commercial and that did start on January 1, as well as the Medicare pressure you're seeing?

[Robert A. Hagemann:]

Right. And yes, as we said, coming into this year, we expected that Medicare reimbursement, exclusive of the pathology cuts, would cost us about 5% on the Medicare book of business or close to about 1% or so, almost $50 million. And then additionally, on top of that, the pathology codes are going to have a more significant impact on us than others because of the relative size of our pathology business. That, coupled with commercial price changes, is really what gets us to the 3% that we're estimating for the full year. And that's something that we feel as though we've got very good line of sight to at this point.

[Kevin K. Ellich:]

So if I'd kind of back into it, would you say commercial maybe pressure is 50 basis points of the 3.4% you saw?

[Robert A. Hagemann:]

Well, we didn't give out components of it, Kevin, at this point. But you can clearly -- the Medicare fee schedule changes, aside from pathology, they're easily quantifiable. It's roughly 5% on $1 billion or so in revenues. Again, the pathology cuts are going to have a relatively significant impact to us because of the relative size of the business. And then the rest, really, is the commercial pricing.

[Kevin K. Ellich:]

Understood. And then, Steve, is there -- are there any other commercial contracts that you haven't renewed or that are up for renegotiation that we should be thinking about?

[Stephen H. Rusckowski:]

Well, the only one that we're in the process of renewing is CIGNA.

[Unknown Executive:]

That's the only national.

[Stephen H. Rusckowski:]

It's the only national. As you know, we have hundreds of contracts, but that's the one that's notable.

[Robert A. Hagemann:]

Right. And that's fully baked into and contemplated in the guidance.

[Stephen H. Rusckowski:]

It's in the 3% and the 1 point -- and the 1% to 2% guidance we've given past 2013.

[Kevin K. Ellich:]

Understood. And then you made the comment about future tuck-in deals, and we've seen you guys do a few outreach acquisitions. When we think about future M&A, is that kind of along the same lines of what you're thinking, Steve, as more outreach programs? Or is there something else that strategically you want to get into?

[Stephen H. Rusckowski:]

No, what you have seen between UMass and now Dignity are 2 good examples of more opportunities that we see to build on our focus on Diagnostic Information Services. We believe that this marketplace we'll continue to evaluate what is strategic and what's not strategic, particularly for integrated delivery networks. Again, as I said in the past, as in my prepared remarks, many hospital CEOs are considering their options, and we're actively in discussions. So you'll see more of what you have seen so far as we go forward. That's what we mean by tuck-ins and strategically aligned.

[Kevin K. Ellich:]

Understood. And then just one last quick one. So recently, Palmetto updated pricing on a number of their Molecular Diagnostic codes. We know Molecular Diagnostics isn't huge for the company, but it seems like you're starting to see some positive news on that front. Is there anything -- any other momentum that would be positive heading into 2014 that you want to call out?

[Stephen H. Rusckowski:]

Kevin, let me give it to Dan. He's got the latest update on that.

[Dan Haemmerle:]

Yes, on the Palmetto codes, we did see that a couple of the rates did increase for a couple of codes. It's still difficult to tell what they'll do with other codes. We are sure that a number of Medicare contractors -- or providers are providing information to the different Medicare contractors to help them understand the costs involved with performing the testing. But it's difficult to predict what they're going to do with respect to additional rates.

[Operator:]

The next question comes from Lisa Gill, JPMorgan.

[Lisa C. Gill:]

I just had a couple of follow-up questions. Bob, when you talked about Invigorate, you talked about $600 million by the end of 2014. So is the right way to think about that, it's $400 million of incremental savings in 2013?

[Robert A. Hagemann:]

Well, Lisa, what we said is it's going to be a $600 million run rate as we exit 2014 with $500 million in the P&L in '14. Where we're at, at the end of last year or where we were at the end of last year was $200 million in run rate savings, with $160 million through the P&L. And for this year, as we exit 2013, we're expecting to be about 2/3 of the way to that $600 million run rate savings. So -- and this is all off of a 2011 baseline. So obviously, it's ramping up as we progress throughout the year. We feel very good about the programs that we have in place. They're all building momentum at this point, and it's an area that we have a lot of confidence in.

[Lisa C. Gill:]

And do you think that they're going to be primarily back half-driven? Just looking at the way that the guidance is setting up based on what we saw on the first quarter, would you expect a lot more of that to come in the back half of the year? I know you made a lot of comments, say, around revenue, but you haven't really talked about the costs as we go throughout the year.

[Robert A. Hagemann:]

Yes, certainly, it ramps up as we go through the year. But this isn't something that we don't have good line of sight to. We have very good line of sight to it. There's a lot of momentum, as I said, around each of the initiatives, which are part of the program. But clearly, just as we saw last year, where we delivered more at the end of the year as we exited the year than we had in the first quarter, we expect the same sort of ramp-up this year.

[Lisa C. Gill:]

Okay, great. And then my second question, Steve, would be for you. As we think about the Affordable Care Act and we start thinking about 2014, can you talk about the discussions that you're having with your exchange Managed Care partners? Are they looking for more restrictive networks around lab? And what do you see as the potential opportunities, as well as what do you see on the cash pay side as far as the risk goes as we think about 2014?

[Stephen H. Rusckowski:]

Sure. Thanks, Lisa. Well, first of all, we continue to believe that the Affordable Care Act will be a net positive for us going forward. And as we all know, 2014 is an important year, where some of the new lives will start to enter the system. And we believe that when we have new lives in the system, that they're going to be what we do, and that will be net positive for this industry but also net positive for us. I could share with you that we're actively in discussions with all the health insurance companies, integrated delivery networks. Everyone's working through how they'll be engaged in this new system as we go forward. And related to that, yes, there is discussions around different networks and more closed networks. And we're actively in discussions of how we can participate in those. So the best way to describe it, Lisa, is there's a lot of activity going on right now. We do believe, again, it's net positive for us as it all sorts out. There will be more lives, that's good for us, and the exchanges will be a part of that.

[Lisa C. Gill:]

When do you think you'll have more color around specific relationships? And my expectation would be that given your relationship with Aetna, if Aetna sees an increase in volume, the relationship should be fairly similar going forward under their exchange product as well. Am I thinking about that correctly?

[Stephen H. Rusckowski:]

Yes, I mean, as you would expect, it's -- with those organizations that we have strong relationships with, we'll build on those relationships. My commentary about bringing sales excellence to Quest, we have strengthened our health plan organization. But also, what we've improved on is total engagement with health plans, starting with me. I'll share with you that I've, firstly, been engaged with many -- in many conversations with CEOs and talking through what's happening with their business and what will happen with the exchanges. So we'll build on those relationships as we go forward. And you asked about timing. As I said, this is happening this year. Hopefully, when we get into the second half, we might have a little more color on this, we can give you more transparency of what that could mean for 2014. It's still very early to provide any of that because it is happening as we speak.

[Lisa C. Gill:]

Okay, great. And I also want to wish Bob all the best.

[Stephen H. Rusckowski:]

Thank you, Lisa.

[Robert A. Hagemann:]

Thank you, Lisa. Appreciate it.

[Operator:]

Your next question comes from Tom Gallucci, Lazard Capital Markets.

[Thomas Gallucci:]

I guess just a follow-up on Lisa's first. Any color that you can give us on pricing relative to some of these products in the exchanges versus maybe whatever your commercial rates are today?

[Robert A. Hagemann:]

Yes, Tom, we're not expecting that pricing on the exchanges is going to be materially different than what we're seeing. In some cases, it might be a little lower. But what we've seen to-date is not materially different.

[Thomas Gallucci:]

In cases where you're saying it might be lower, is that because there is an exchange for a narrower network? Or is there some other dynamic just in terms of how this plays out?

[Robert A. Hagemann:]

It's a combination of things, certainly. I mean, it's the type of product they're offering, it's the way they're structuring the network, et cetera.

[Thomas Gallucci:]

Okay. And then maybe just taking on pricing. You guys have talked a bit about just some longer-term pricing pressure, too, that 1% or 2%, I think, you mentioned a couple of times in this call and in the past.

[Stephen H. Rusckowski:]

Yes.

[Thomas Gallucci:]

Just wanted to make sure I understood. That's just the pure price as opposed to your sort of revenue per requisition, so it's just -- it doesn't include any benefits of mix or anything else, that's the underlying pricing?

[Stephen H. Rusckowski:]

Yes, the 1% to 2% is what we're looking at for price erosion. That's past 2013 if we've modeled out what we think will happen on the commercial side and also what we know will happen on Medicare so far, and that's what's in the number.

[Robert A. Hagemann:]

And Tom, that is pure reimbursement or price, as you might think about it. The other dynamics that we've got, obviously, are test mix, which we'd expect will continue to be a favorable factor for us. And then the business mix always -- also factors in there.

[Thomas Gallucci:]

Right. And what are the lengths of the average contracts these days on the commercial side?

[Robert A. Hagemann:]

Yes, they're still in the 3- to 5-year range generally. I mean, there are some that are shorter, obviously, but we're looking generally at kind of the 3- to 5-year range for some of the larger ones.

[Thomas Gallucci:]

Right. So when you're thinking out to '15 or so, a lot of that is already on the table relative to the commercial side of the equation?

[Robert A. Hagemann:]

I would say we've got a reasonable visibility into some of that. But as you know, yes, every year, there's always contracts that are coming up.

[Thomas Gallucci:]

Right. And just 2 more questions. One, you talked a lot about the sales force and building some momentum. And a couple times, you mentioned new tools at their disposal. Is it possible to get an understanding of sort of the different types of things that might be doing?

[Stephen H. Rusckowski:]

Sure.

[Thomas Gallucci:]

And it sounds like you expect to gain some market share. So where do you think that market share is going to be coming from?

[Stephen H. Rusckowski:]

Sure, sure, thanks, Tom. Well, we had a sales force that didn't have some of the contemporary tools that contemporary sales forces have today. So we've put in place a new CRM with the salesforce.com. We have a sales engagement tool called SAVO. We've put both in place. We also equipped them with contemporary devices. So we gave them each an iPad. And the reason for this is to make sure that we really take advantage of the collaboration that we need with the new environment we see going forward in health care. And as I mentioned in my comments, we're actually seeing some of this. When I've been out in the field, sales reps are seeing the advantages of being in all their different specialties and bringing in what we could do with pathology, what we could do with neurology, what we do with cardiology and taking advantage of that and also seeing the advantages of leveraging our enterprise-wide presence with integrated delivery networks. And to make all that happen, you need to have contemporary tools. So that's what we meant by that comment.

[Thomas Gallucci:]

Okay. And my last question. Just, Bob, the Q2 buyback, you're using sort of the HemoCue proceeds, was all that contemplated in the original guidance, or is that sort of just a tweak given that, that deal is actually done at this point?

[Robert A. Hagemann:]

That was contemplated in the original guidance because, as you recall, coming into the year, we already had HemoCue listed as discontinued operations and had fully committed to the disposing of that business.

[Thomas Gallucci:]

Okay. And I just like to give you thanks to over the last 15 or 20 years that we've worked together, Bob. Good luck with everything.

[Robert A. Hagemann:]

Thank you very much, Tom. I appreciate it.

[Operator:]

Your next question comes from Gary Lieberman, Wells Fargo.

[Gary Lieberman:]

I'm just going back to the commercial pricing. Could you tell us, was that just the commercial payers following suit with Medicare, or was that more of market-driven pricing pressure?

[Robert A. Hagemann:]

It's not necessarily a function of Medicare, Gary. These are contract negotiations that we've had over the years, things that we've done to expand access and the like, lock-in certain contracts. And as we said, we expected it coming into the year. It's pretty much consistent with what our expectations were.

[Stephen H. Rusckowski:]

If you recall, Gary, we said 3% for the full year. And so what you saw in the first quarter is what we expected, to Bob's comment, and it will feather down as we go throughout the year, as we said.

[Gary Lieberman:]

Okay. And then, Steve, it sounds like you remain pretty confident in the sales effort and have given some granularity. Any challenges that you found that you maybe didn't expect?

[Stephen H. Rusckowski:]

Just as we said in our commentary, when we kicked off our restore initiative, it will take time. It's always challenging to grow the top line. It will take time to build out the momentum that we see and that we've put in place and the investments we're making. And we believe that we will get gradual improvement over time. And so it's very important that this year, we have 2 priorities

[Gary Lieberman:]

Okay. And then maybe just a final question on guidance. You said you'd come in probably closer to the lower end of the prior revenue range at 0%. You didn't make any changes to the range on EPS. So is that all a function of being able to take and accelerate the cost savings? Or should we expect you to may be towards the lower end of the EPS than we would've priorly thought?

[Stephen H. Rusckowski:]

Bob, why don't you tackle [ph] the question.

[Robert A. Hagemann:]

Yes, Gary, we didn't change the EPS guidance because we feel as though we've got good line of sight to the cost reduction efforts that we've got going on. As I said earlier, the momentum is building there. And while we did tweak the revenue guidance a little bit, it's not significant. Additionally, we feel as though we've got opportunities to deploy our cash more aggressively, and I cited some of those. So all in, we feel very comfortable keeping the EPS range where it was while still tweaking the top line a little bit.

[Gary Lieberman:]

Okay, great. And Bob, again, thanks for all your help over the years.

[Robert A. Hagemann:]

Thank you very much, Gary.

[Operator:]

Your next question comes from Glen Santangelo, Crédit Suisse.

[Glen J. Santangelo:]

Steve, I just want to follow up with something in the comments you made in your sort of prepared remarks. I think you seem to suggest that volumes maybe in 1Q were somewhat of a continuation of maybe what you saw in the second half of last year. And I'm just kind of curious, I mean, I understand the ramp in the back half of the year and all the building blocks to kind of get there, but are you assuming any improvement in the overall market growth? And could you give us a sense for maybe where the market growth is today? I'm trying to understand if things are getting better on the Anatomic Pathology side given the reimbursement cuts or if you're still losing a little bit of share to hospitals. If you could just help me through that a little bit, that will be helpful.

[Stephen H. Rusckowski:]

Glen, thanks for the question, I appreciate that. My comment about the comparison versus the second half, actually if you look at our first quarter volumes, they were up a little bit versus what we saw in the fourth quarter. Some of that you expect because of seasonality we typically get in Q1, but they were softer versus last year, and we went through the reasons for that based upon a difficult compare, the very strong year last year. But if you look at what we're assuming in our guidance going forward, we're not looking for a material change in the overall environment in the marketplace. And if you look at our second and third and fourth quarter of last year, and we did see some softening already in those quarters, so now, as we said in our comments about the easier compare, that's factored too into our discussion or in our guidance as well about the second half. So no material change in the environment going forward. So what we saw in the first quarter and what we saw in the second half of last year is what we expect to see going forward.

[Glen J. Santangelo:]

Maybe if I can just follow up, given the relationship you guys have with Aetna, obviously, the Coventry deal should be closing here shortly. I mean, have you built in sort of any increased volume assumptions based on that acquisition? Or is that not that meaningful?

[Stephen H. Rusckowski:]

Yes, we continue to be engaged with all our partners. Aetna is one of our strong partners. We are working with them proactively. And as you would expect, we're working on that integration plan with them. We're hopeful that we could pick up some volume from that. But that's one of a number of initiatives that we're working on with Aetna, but we're doing the same with other partners as well.

[Glen J. Santangelo:]

Maybe if I can finish up with one last question on the reimbursement front. I mean, the President's budget, obviously, was released last week, proposed some additional cuts to the lab industry looking at a little bit longer term. I mean, is that kind of in line with your expectations? Was that a little bit worse than your expectations? Or any thoughts around the longer-term reimbursement perspective would be helpful.

[Stephen H. Rusckowski:]

Well, the discussion has started so it's too early to comment on whether that's going to hold. As you can imagine, the trade association and ourselves individually, as a company, is doing our share of talking to the right people in Washington. We believe that this industry has paid. You've seen it significantly this year, we've got 3% overall price erosion, and a large portion of that is related to our government business. So there is a proposal on the table, whether that will hold up or not after all the dust settles, is unclear at this time, but we'll continue to work it as we have worked it. And the position that the industry has taken is this is an industry that adds a lot of value to health care. We argue that the majority of healthcare decisions are made with the benefits of what we do. Some people estimate that to be 70% of healthcare decisions. And 3% of the costs, we have had significant cuts so far. We also had the pathology cut this year. So we're making sure that Washington and the policymakers hear that. We will continue to do that, and we'll see what happens as time goes on.

[Operator:]

The next question comes from Robert Willoughby, Bank of America Merrill Lynch.

[Robert M. Willoughby:]

Bob, maybe I'd tag you one last time before you leave here. But one quarter doesn't a year make, but the deal spending is doubled with more on the way, the CapEx is up year-over-year, the outstanding debt is up sequentially, it's not exactly consistent with that improving ROIC story that you're seeing in the income statement or trying to make on that income statement. So is there a commitment to reduce the capital base with $600 million in cost cuts over the next couple of years?

[Robert A. Hagemann:]

Yes, Bob, just a few points on that. Yes, the debt has been reduced significantly from a year ago. You saw a modest tick-up of about $40 million or so in the first quarter. That's just seasonal working capital requirements there. Yes, with respect to the deal spending, Steve's articulated that a key element of our strategy, to deliver strategically aligned, accretive acquisitions, and when we laid out the criteria for those deals, one of them was improving ROIC. So it had to be accretive to our planned ROIC. In many cases, we're looking at mid-teens ROIC within 3 years on these transactions. So we don't see these as dilutive to ROIC, we see them as accretive. And then additionally, we are looking for opportunities to refocus the business and then take the proceeds from that refocusing and deploy it back to shareholders. You've seen that with HemoCue. We have additional opportunities as it relates to the Celera drug assets and the Celera products business. So there's a real focus on improving ROIC here. And I think we've shared with you in the past that management is heavily incented as part of our long-term incentives to drive improvements in ROIC. So I think you'll see a lot of discipline there, continued discipline.

[Robert M. Willoughby:]

Would it be -- can you size the expected divestiture proceeds versus the expected deal spending this year? Is it possible to get some kind of idea?

[Robert A. Hagemann:]

Well, without projecting deal spending this year, certainly, the HemoCue transaction and the proceeds there will fund most, if not all, of any planned acquisitions we've got this year. And then on top of that, we've got additional opportunities for proceeds from the various Celera assets, the drug assets and the products business.

[Robert M. Willoughby:]

5x, could it be that wide, the spread between proceeds versus divestitures?

[Robert A. Hagemann:]

It's very, very early, Bob, and it'd be very speculative at this point.

[Robert M. Willoughby:]

All right, Bob, good luck.

[Robert A. Hagemann:]

Thank you.

[Operator:]

Your next question comes from Isaac Ro of Goldman Sachs.

[Isaac Ro:]

We've covered a lot of ground here, but I did want to clarify your assumptions on guidance. You guys are -- it sounds like assuming 1.5 percentage points of acquisition contribution this year, minus 3 on pricing. So if we look at the first quarter volumes that you had, it looks like your full year guidance for a 0% revenue does call pretty much for a big acceleration in the underlying volumes for the rest of the year. And even if we put in context your easy comps, can you help us get comfortable of why you would see that kind of acceleration, particularly as you reorganize the sales force?

[Stephen H. Rusckowski:]

Yes, Bob, why don't you take it through the year to kind of -- think about the year and what that means to the back half?

[Robert A. Hagemann:]

Yes, and Isaac, let me, again, just take you through some of the pieces here. The comps do have a pretty significant impact in the back half of the year. That, plus the weather, impacted us by about 2.5% in the first quarter. It's going to be neutral for the full year, so that full amount anniversaries. As we said, we do expect there to be additional contributions from acquisitions. We've labeled that as about 1.5% for the full year, up from the 1% that we saw in Q1. And there's the potential for that 1.5% to be even a little higher than that. Revenue per req, we took you through portions of that, that anniversary. And I did mention earlier as well the Diagnostic Solutions business, which we expect to be a contributor to revenue growth in the back half of the year and positive for the full year as well. When you cut through all of that, clearly, it does mean that we're expecting improvement in underlying volumes. But for the full year, we're looking at something in the range of about 1 point or so in the underlying volume growth, and that compares to down 2% in the first quarter. So we are expecting a ramp-up. But for all the reasons Steve cited, we're pretty confident in that because we are seeing some building momentum there and expect to see the progress as -- mostly as we get into the second half of the year.

[Isaac Ro:]

Okay, that's helpful. And then just my follow-up would be on the earnings side of the guidance range. The scenario that gets you to the high end of the range that you guys still have, I mean, is that going to be largely a function of accelerating Invigorate savings? Or is there an operational driver beyond that we should think about that would actually allow you to get to the high end of the range? Just trying to think about the sort of bare -- bold case scenario.

[Robert A. Hagemann:]

Yes, it's accommodation of a couple of things, obviously. In any time you're doing some modeling, you always have multiple levers here. And while we're estimating that revenues are going to approximate the prior year level, that means that it could be a little bit on each side of that. And certainly, if it's to the upside of that, that contributes to positive earnings. Certainly, some of the things that we've got going on with Invigorate can give us some uplift there as well. And then potentially, anything that we might do with additional share repurchases from proceeds from divestitures could give us some upside towards the end of that range.

[Operator:]

The next question comes from Darren Lehrich, Deutsche Bank.

[Darren Lehrich:]

Just a couple of odds and ends here. First, as it relates to the Celera portfolio, I just want to clarify, are there other royalty or drug license assets outside of the Celera portfolio that are included in this process? I just want to try to clarify, do you expect the bulk of what you're working on there to come from the Celera piece, or are there other pieces?

[Robert A. Hagemann:]

Yes, Darren, when we speak about the drug assets, they are the assets that we acquired as part of the Celera transaction. Quest, prior to acquiring Celera, did really not have any assets like that. Celera had participated in the development of certain drugs

[Darren Lehrich:]

Okay, yes, just I wanted to confirm that there weren't any legacy things in there, so that's helpful. I guess the other question or clarification, you've given us a lot of helpful commentary on how the guidance builds, so I'm not going to revisit the volume piece, but given the sequestration hit mid-quarter, and I think your commentary was that some of the Managed Care pricing impact, about 100 basis points, anniversaries much later in the year, is it reasonable to assume that Q2 pricing is actually similar or even slightly worse than what we saw in Q1? I just want to get a sense for the progression of the pricing piece.

[Robert A. Hagemann:]

Yes. Without giving -- attempting to necessarily give quarterly guidance here, the improvement that we expect in revenue per req or reimbursement is really in the back half of the year as something start to anniversary out. Yes, I wouldn't expect the year-over-year change in Q2 to be materially different than what we saw in Q1.

[Darren Lehrich:]

Okay, that's helpful. And last thing is for Steve, and you talked a bit about the things you're doing to develop a professional services organization, particularly to pursue some of the hospital opportunities. Steve, I guess, could you just maybe give us some color on whether you're seeing the sales cycles for some of these hospital opportunities start to close in and just how you're looking at that?

[Stephen H. Rusckowski:]

Yes, thanks, Darren. It is building. And it is building actually faster than what I have anticipated. I've shared with you all that I've done a number of sales calls. Even last week, myself and Everett Cunningham went to visit the hospital system in New England, and they're contemplating what they do going forward with Diagnostic Information Services, and they're thinking about how they can work with us. We have that as one opportunity just as an example of -- this is happening at a very rapid pace. So that call just came in about 2 weeks ago, and we followed up on it. That's one of many examples. There's a lot of interest on what we've done so far. We're building a reputation of having a capability to do this. We wanted to use UMass and now Dignity as great examples of where we can buy an outreach business. But also we have other ways of working with integrated delivery networks. So what we can see so far, Darren, is I think our reputation is building, I think the activity level is better than I expected, and I am encouraged by it.

[Darren Lehrich:]

That's great. Bob, all the best to you.

[Robert A. Hagemann:]

Thank you, Darren.

[Operator:]

Your next question comes from Gary Taylor, Citigroup.

[Gary P. Taylor:]

Bob, good fortune to you. You've always been very patient with us analysts, so we all appreciate it, I think.

[Robert A. Hagemann:]

Thank you, Gary.

[Gary P. Taylor:]

Just a few quick numbers questions. On G&A, $295 million, I guess I was a little surprised given, I guess, both the revenue weakness and the cost-cutting initiatives that, perhaps, G&A wasn't down sequentially. So I know you don't give quarterly guidance, but can we just kind of talk around kind of the run rate of G&A on a dollar basis? Should we be expecting that to come down on a dollar basis, or are we still kind of thinking about G&A avoided as a cost save, so to speak?

[Stephen H. Rusckowski:]

Well, first of all, let me tell you that Bob will comment on the adjusted SG&A, and a portion of what we've mentioned that we enjoyed in the quarter is the benefits of the Invigorate. And we're pleased with the progress that we saw in Q1, and it allowed us to mitigate some of the softness that we saw from the bottom line because at the top line, some portion of that Invigorate savings does hit G&A but also hits our selling costs as well. And what you're probably looking at is the total reported numbers and there were some onetime restructuring charges in that number. So Bob, how would you like to give them a little more transparency of our progression of expenses because the trend line is good.

[Robert A. Hagemann:]

Yes, and Gary, the SG&A line, G&A in particular, is where we're seeing a lot of the benefits of the management delayering and the like at this point. And when you look at SG&A as a percentage of revenues, it's down almost a full point versus...

[Stephen H. Rusckowski:]

Adjusted.

[Robert A. Hagemann:]

Adjusted from last year. And actually, on an absolute basis, it's down as well. So we can circle back to you and take you through the numbers, but both on an adjusted basis and a reported basis, it's down versus the prior year. And on an adjusted basis as a percentage of revenues, down pretty significantly.

[Stephen H. Rusckowski:]

Yes, absolutely. [indiscernible]

[Gary P. Taylor:]

Right. We pulled the restructuring out of that, I just -- I was looking at it more sequentially, I definitely have it down year-over-year, but I was thinking more sequentially. My second question is when we look at the total revenue decline in the quarter, do you have a rough estimate of organic revenue decline year-over-year?

[Robert A. Hagemann:]

Well, yes, when I took you through the analysis before, the -- when I spoke to underlying volume down about 2% versus the prior year, that's -- aside from reimbursement, yes, that's what we saw as the organic volume decline.

[Gary P. Taylor:]

Right. I was trying to think of how you thought about the total revenue number organically, but just because I think there's kind of maybe moving parts on the reimbursement side as well. But so we'll take the negative 2% organic volume and just assume that the price per session decline is essentially organic and add those 2 together.

[Robert A. Hagemann:]

Right, that's a good way of thinking of it.

[Gary P. Taylor:]

Okay. Two more quick ones. On the Dignity outreach program you acquired, can you disclose the purchase price, or will you be disclosing the purchase price?

[Robert A. Hagemann:]

We are not disclosing that, Gary. We typically have not on some of these fold-in deals, obviously, for competitive reasons and the like.

[Gary P. Taylor:]

Okay. Can you give us kind of a thought process on a multiple of revenue or pro forma EBITDA that makes sense for these outreach deals, which I assume are mostly pretty -- the bulk of which are probably routine testing?

[Robert A. Hagemann:]

Right. In many cases, it is routine testing. Yes, as we said earlier, we had several criteria that we use in evaluating each of these fold-in acquisitions. First is it's got to create real value for our shareholders. So as we look at the purchase price that we're paying versus what we expect the value to be on a discounted cash flow basis, there's got to be a substantial value created there. Additionally, as I said earlier on the call, we want all of these to be accretive to ROIC within a reasonable timeframe. And we want them to be accretive to earnings per share within 2 years in each case as well. So with that as the discipline that we go through, you should expect that the multiples that we're paying are very market-driven. Obviously, some of these are competitive situations; others are not. But really, the real value that's created in these fold-in deals is through the cost synergies. In many cases, we see that the hospital reimbursement is higher than us, and there's actually negative revenue synergy when we reprice a lot of that. But that is more than offset by the cost synergies that we realize because in most cases, and the Dignity deal is a good example, we're not really acquiring infrastructure, we're acquiring a book of business that we're running through our existing infrastructure, and that generates very strong incremental margins for us.

[Gary P. Taylor:]

Okay. My last quick question. Cash from ops, $47 million versus $161 million. You cite the $70 million deferred tax benefit you had in the first quarter of '12. But that total tax payable line swung almost $120 million against you year-over-year. So I presume that's not recurring and normalized cash from ops, obviously, given you reiterate your guidance, normalized cash from ops was better even than, perhaps, the $47 million plus the $70 million. So is there anything in that -- anything else in that tax payable line that we should know about outside of just seasonality and typical movement?

[Robert A. Hagemann:]

No, and I'd be a little careful because sometimes you got reclasses between the taxes payable and the deferred taxes line. The actual change in tax payments -- total tax payments in the quarter was about $74 million versus the prior year, about, yes, $84 million in total tax payments in the quarter versus about $10 million last year.

[Operator:]

Your next question comes from Sandy Draper, Raymond James.

[Alexander Y. Draper:]

Yes, I think actually all of my questions at this point have been answered, so I'll just echo my comments, Bob, it's been a pleasure working with you, and good luck going forward.

[Robert A. Hagemann:]

Thank you very much, Sandy. I appreciate it.

[Operator:]

The next question comes from Anthony Vendetti, Maxim Group.

[Anthony V. Vendetti:]

Yes, just a follow-up on CIGNA. You mentioned, Bob, 3 to 5 years is the normal contract. Some of these larger insurers, sometimes those contracts are obviously larger or longer in length. Can you talk about whether or not you expect the CIGNA contract to be a 5-year or longer kind of contract? Is that your goal?

[Robert A. Hagemann:]

Yes, Anthony, we really don't comment on specific contracts.

[Anthony V. Vendetti:]

Okay. And then lastly, on the Invigorate program, there's $500 million that will flow through the P&L. What's going to happen with that other $100 million? Why is that different than the other $500 million?

[Stephen H. Rusckowski:]

Well, the $600 million is run rate as we exit 2014, and $500 million is realized in that period, 2014. So [indiscernible].

[Anthony V. Vendetti:]

Okay. So when all the cost cuts eventually come through, they will be on an ongoing run rate, but it will be after 2014 because $500 million will be realized at that point, at the end of 2014. Got you. Got you.

[Robert A. Hagemann:]

Yes, I'll remind you, too, we've said our goal is actually $1 billion in cost savings over time.

[Stephen H. Rusckowski:]

So we're not stopping at the $600 million.

[Anthony V. Vendetti:]

Okay, great, great. And I'll echo the same comments. Thanks for everything, Bob, and good luck going forward.

[Robert A. Hagemann:]

Thank you very much, Anthony. I appreciate it.

[Operator:]

Thank you for participating on Quest Diagnostics' First Quarter Conference Call. A transcript of prepared remarks on this call will be posted later today on Quest Diagnostics' website at www.questdiagnostics.com. A replay of the call may be accessed online at...

[Dan Haemmerle:]

Operator, wait, can we get one more comment for Steve just to close up?

[Operator:]

Sure. Thank you.

[Stephen H. Rusckowski:]

Thank you very much. Well, since I think we've answered most of your questions, we don't want to finish this call without acknowledging Bob. Bob doesn't expect this, but I'm going to do it anyhow. So I know many of you have commented, but I want to make sure that we recognize the critical role that Bob has played in building this company since he joined here in 1992, so a long time. As most of you know, this will be Bob's last call. But before Bob moves on, I wanted to make sure that all of us on this call, and I want to make sure that he hears it from me, and also, you hear it from me, that on behalf of the entire organization, we want to thank you for what you've done for this company, we want to thank you for all your contributions, and we wish you well in all your future endeavors. Bob, thank you very much.

[Robert A. Hagemann:]

Thanks, Steve. It's been a real privilege to be the CFO for this company, and it's been exciting for me to be part of what we've become. And I'm -- as I've told people before, I'm very excited about the future of this company, and I'm going to be watching it. And it's been a real pleasure, and I thank everybody on the call for their remarks as well, much appreciated.

[Stephen H. Rusckowski:]

Thanks, Bob.

[Robert A. Hagemann:]

And thank you for yours, Steve, much appreciated.

[Stephen H. Rusckowski:]

Thank you. Okay, Dan?

[Dan Haemmerle:]

Okay, that's it. Gwen, I'll turn it back to you.

[Operator:]

Thank you. Once again, if you would like to access the replay, it is at www.questdiagnostics.com/investor or by phone at [phone] for domestic callers or [phone] for international callers. Telephone replays will be available from 10