Welcome to the Quest Diagnostics First Quarter 2017 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 written consent of Quest Diagnostics is strictly prohibited. Now, I would like to introduce Shawn Bevec, Executive Director of Investor Relations for Quest Diagnostics. Please go ahead..

Thank you, and good morning. I am here with Steve Rusckowski, our Chairman, President and Chief Executive Officer; and Mark Guinan, our Chief Financial 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' 2016 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's 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 and then Mark will provide more detail on the results and take you through updates on our 2017 guidance.

We began 2017 with a strong first quarter across the board drawing revenues, EPS, operating income, margins and operating cash flow. Here are some of the key highlights -- revenues were up approximately 2% on a reported basis and 3% on an equivalent basis. Reported EPS of $1.16 increased 63% in 2016.

Adjusted EPS grew approximately 18% to $1.33 which includes $0.11 of excess tax benefit associated with the employee stock-based compensation; more on this later from Mark. Cash from operations increased 28% to $196 million.

Now before I describe the progress we've made to accelerate growth and drive operational excellence, I would like to briefly discuss PAMA. CMS postponed the deadline for labs to report private commercial payer pricing data under PAMA for 60 days until May 30. We fully support the decision.

However, we continue to have some concerns about the current definition of applicable laboratory, which are those laboratories per quarter to report private commercial payer data.

According to the office of Inspector General's analysis, the current definition of applicable laboratory would cover only 5% of laboratories, representing only 69% of Medicare payments for lab test in 2015.

While we support reform of Medicare payment system, we believe any modification should be market-based and appropriately include all applicable independent and hospital outreach laboratories. Now let's review progress we've made.

As we detailed at our Investor Day at November, our two-point strategy is to accelerate growth and drive operational excellence. We grew revenue in the quarter empowered by continuing to expand relationships with hospital health systems.

Our existing professional lab services relationships including RWJ Barnabas in New Jersey, HCA in Denver and most recently, Montefiore in New York City are performing better than expected and our pipeline for new relationships remains strong.

So in the first quarter we announced the acquisition of an outreach operation of PeaceHealth Laboratories and expect to close in the second quarter. In addition after the close, we will execute a professional laboratory services agreement to manage 11 PeaceHealth Laboratories serving medical centers in three states in the Pacific Northwest.

We are hardening with health plans to improve the patient experience by improving price transparency which will also reduce bad debt.

Our real-time payment determination which we begin piloting in early 2016 enables us to get patients an accurate picture of their financial responsibility or lab testing while those patients to pay at the point-of-care. We are currently live with Aetna, Highmark, UPMC, Florida Blue, and we expect to have more payers in place by the end of the year.

The service benefits Quest and the entire healthcare systems; patients, providers and payers. Avis [ph] Diagnostics which generally includes our genetic and molecular based test grew in the quarter along with non-routine testing.

Major drivers included neo-natal genetic carrier screening, prescription drug monitoring, hepatitis C and QuantiFERON TB testing.

In the quarter we also announced the launch of the new test service that helps physicians evaluate the patient's response to the drug therapy used to treat infection with hepatitis B virus, HBV; this is the first test of its kind available in the United States.

Physicians can use it to tailor more effective treatments for up to 2.2 million individuals infected with HBV. We're also making progress executing our strategy through provider-of-choice for consumers.

In late January, we began providing genotyping for ancestor DNA, a service that today identifies and quantifies individual's ethnic origin based on results of DNA testing. We are pleased with the initial execution of this program and look forward to building on a relationship with ancestors.

We continue to expand our relationship with SafeLink that are now operating at 65 stores. Consumer and employee satisfaction remain high and we are on-track to open a total of 200-patient service centers and Safeway stores by the end of 2017.

We continue to drive operational excellence and remain on-track to deliver $1.3 billion of run rate savings as we exit 2017. Our revenue services partnership with Optum is on-track in helping us to drive down bad debt and denials. As we have often said, quality and efficiency go hand-in-hand.

We continue at near Six Sigma levels of many areas and in the quarter of mid year-over-year gains and many quality measures including reduced patient service center wait times and approved test turnaround times. We expect our commitments to enable our processes will deliver results. We expect to cut paper acquisitions by 50% by the end of 2017.

It will enable patients to check-in electronically at roughly half of our patient service centers by the end of the year. Additionally, we expect our lab systems to be 85% standardized by the end of the year. We received some meaningful recognition in the quarter, once again being named one of the World's Most Admired Companies by Fortune magazine.

Quest was one of only six companies in healthcare, pharmacy and other services industry and the only diagnostic information services company to attain most admired status. Looking forward to the remainder of 2017, we are well-positioned to continue to accelerate growth and drive operational excellence.

We have the right strategy and the right team to execute and create value for our shareholders. Now, let me turn it over to Mark who will take us through our financial performance in detail.

Mark?.

Thanks, Steve. Starting with revenues, consolidated revenues of $1.9 billion were up 1.9% versus the prior year on reported basis while equivalent revenues grew 3%. Revenues for diagnostic information services grew by 3.2% compared to the prior year.

Most of this growth was organic with approximately 90 basis points attributed to the 2016 acquisition of Clinical Laboratory Partners. Volume measured by the number of requisitions increased 3.5% versus the prior year, of which 2.6% was organic. The year-over-year impact of weather was negligible in the quarter.

Revenue per requisition in the first quarter decreased by 20 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 variation, business mix, test mix and test per req.

Unit price headwinds in the first quarter continue to be moderate in less than 100 basis points. We note that price fluctuations can vary from quarter-to-quarter, but we continue to expect that unit price headwinds will remain consistent with the last few years.

Beyond unit price and the impact of growth in our POS partnerships, other mix elements including test and fair mix contributed more than 1% to revenue-per-req in the quarter. Reported operating income for the quarter was $279 million or 14.7% of revenues compared to $257 million or 13.8% of revenues a year ago.

On an adjusted basis, operating income was $297 million or 15.6% of revenues, compared to $281 million or 15.1% of revenues last year. Please keep in mind our focused diagnostics products business contribute approximately $8 million of adjusted operating income in the first quarter of 2016.

Excluding the impact to focused, adjusted operating income would have grown approximately 9% and adjusted operating margin would have increased 80 basis points year-over-year, consisting of 30 basis point of operating margin tied to focused in 50 basis point of adjusted operating margin growth.

Reported EPS was $1.16 in the quarter, compared to $0.71 a year ago. The prior year a quarter included a charge of $30 million after tax or $0.21 per diluted share related to the early retirement of debt. Adjusted EPS was $1.33, up 18% from $1.13 last year.

The company recorded after tax charges totaling $11 million in the first quarter or $0.08 per diluted share, representing restructuring and integration cost. Our effective tax rate in the quarter was approximately 32%, compared to approximately 39% last year.

The decrease in the effective tax rate was a result of $16 million or $0.11 per share in excess tax benefit associated with stock-based compensation, compared to a $2 million or $0.01 per share benefit last year.

Bad debt expense as a percentage of revenues was 4.4%, 20 basis points better year-over-year, but 80 basis points higher than the fourth quarter of 2016. As a reminder, bad debt expense rate typically increases sequentially in the first quarter due to the reset of payings in health insurance deductibles at the beginning of the year.

As in the prior years, we expect the bad debt rate to improve gradually throughout the year. Note that the year-over-year compare was also negatively impacted by the fact that our products business had a lower associated bad debt rate. Cash provided by operations in the first quarter was $196 million versus $153 million last year.

Recall the retirement of debt lowered our operating cash flow by approximately $47 million during the first quarter of 2016. Capital expenditures during the quarter were $42 million, compared to $47 million a year ago. Now turning to guidance. We are providing the following updated outlook for 2017.

Revenues unchanged to be between $7.64 billion and $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 $4.73 and $4.88 and adjusted EPS to be between $5.45 and $5.60.

Cash provided by operations is also unchanged and remains at approximately $1.1 billion, and finally, capital expenditures remain between $250 million and $300 million. Our increased EPS guidance reflects the higher expected level of excess tax benefit associated with stock-based compensation and was included in our previous guidance.

Note that our original EPS guidance assumed a similar benefit in 2017 as we recognize in 2016 for the full year which was about $0.06. As you are well aware, our share price appreciated substantially in 2016, which yielded a significantly higher tax benefit in Q1 2017 based on equity vesting and auction exercises.

Our updated reported and diluted EPS guidance for 2017 assumes another $0.03 of benefit over the remainder of the year. However, fluctuations on our shared price and auction exercise activity could add volatility to this figure. Going forward, we would expect to experience some level of excess benefit over the next several years.

However, the time frame and absolute benefit is difficult to forecast given its dependence on our share price and the timing of option exercises. Now, let me turn it back to Steve..

Thanks, Mark. Well, to summarize, we delivered strong growth across the board in the first quarter with gains and revenues margins, operating income, EPS and operating cash flow.

Our agreement with PeaceHealth will further booster our growth later in the year and we are laser-focused on our two-point strategy to accelerate growth and to drive operational excellence. I'd like to now open up for any questions you might have.

Operator, please?.

Thank you. We will now open it up to questions. [Operator Instructions] And we will take our first question from Ross Muken with Evercore ISI. Please go ahead, sir..

Good morning, gentlemen and congrats. Underlying organic volume, I know you called out a few other pieces, but certainly better than we would have suspected, even given that relatively to what we've seen in general on volumes across the market.

So maybe could you help us understand how much some of those entities you called out sort of contributed to the strain versus sort of underlying market, and how you're thinking about the pacing for the remainder of the year given what's implied..

You know, so thanks, Ross, certain I'll start and Mark will add to that. Sure, first of all we're off to a good start, we're pleased with our first quarter performance here. Yes, there's up a number of elements that contributed to the growth in the first quarter, we highlighted some of those in our script.

First of all we do believe that will continue to get growth from our professional lab services work that we're doing. We saw some growth from that.

Second is we continue to get nice growth from our advanced diagnostics portfolio and some of the more advance, what is typically referred to as esoteric testing that we do would call about some of those, and we've mentioned in the past the prescription drug monitoring and the work we're doing with the TV coiffure opportunities drive serious growth for us.

We also got some nice growth through some other areas of the business, like our Wellness business, some or other -- some of our other services business. Across the board good balance growth consistent with our strategy that we had to focus at hospitals.

That focus on our clinical franchises and bring new products to the marketplace to commercialize those better than we have in the past. And finally just good execution across the board. So let me turn over to Mark, to give some color round this and throughout the rest of the year..

Sure, thanks for the question, Ross. As I mentioned in the prepared remarks we got about 90 basis points in volume and revenue from M&A, largely that was CLP, work lapping CLP at the end of the first quarter, so we no longer have in that a tail wind. Part of this pretty largely ramped up so that annualize in the first quarter as well.

So those are behind us in terms of strong year-over-year drivers of growth.

Now what we do have in front of us is continued ramp up of HCA, we are just in the early stages of Montefiore, and then obviously we announced Peacehealth which has an outreach element and also in professional laboratory services element that we expect to execute have not close that yet.

When we give our original guidance 2% to 3% to the global in growth. The only M&A included in that was CLP because that been executed, and while we are very optimistic about the closing piece and there's the heat pipeline of other potential M&A opportunities.

Given the fact that we got a pretty broad range of 100 basis points in the work, cautiously optimistic after the first quarter we didn't feel this point compelled to change our revenue guidance yet..

Thanks, and maybe just a quick update on sort of how the Optum relationship that sort of progressing and any further thought, obviously a lot of market chatter or at least financial community chatter on sort of that relationship as a whole and just maybe talk about how you're thinking about obviously the longstanding relationship with the United..

First of all it is going well, we announce it in the fourth quarter of last year. And a big component of it is what we're going round revenue cycle management and our billing operations and as a I said in our opening remarks it's going very well, we're pleased with that.

Like you said this is a relationship so there is multiple areas beyond what we're doing around billing, we continue to build on that relationship and it's -- it's going well as well. We have a good relationship around our wellness business, we are their partner for wellness along with other -- other partners that we sell-through.

Second is we continue to work with them on what we do with clients around data and population health and if you think about what we're doing with our professional laboratory services business, we're calling on the same people that are trying to become more efficient and better in delivering integrated delivery system and so that areas is promising as well; so often good start, doing what we said what we would do and the relationship will only get stronger overtime..

Great, congrats again, guys..

Thank you..

And we will take our next question from Dan Leonard with Deutsche Bank. Please go ahead..

Thank you. I was hoping you could comment further on the yield pipeline whether you're seeing any increased competition for yields of hospital outreach programs or otherwise, and whether you expect that the impact of PAMA timing whether that changes at all would impact the yield pipeline? Thank you..

Thank you. First of all the pipeline as we said is the support of our long-term goal of 1% to 2% of growth through acquisitions; we're hopeful about that going forward. As far as competition -- I would say the competition is stable versus what we've seen in the past.

And finally is in regards to the PAMA, I think PAMA in general is changed that some would argue -- could look more catalyst in hospital outreached business as considered their strategy going forward.

So when we engage with hospital systems run their lab strategy, many CEOs that are engaged with do understand that both the commercial rates as well as the clinical lab fees schedule rates will be under pressure.

And this is one of the considerations that they think about as far as potentially selling their business or partnering with us in their business going forward.

So if in fact there is some price pressure related to the refresh of the clinical fee reschedule that could be a further catalyst to accelerate some of this going forward but as you know, PAMA -- the data submission has been postponed by 60 days, we're still believing based on what they've told us so far that they are committed to trying to refresh the clinical lab fee scheduled by the beginning of '18 but we'll see on that.

But there is another fact that we think is helping us with our discussions with hospital systems around their lab strategy..

So if I could just add two pieces of color to that Dan, one is that -- recall that when Medicare changes reimbursements we're equally impacted. So the buyer and seller are both equally impacted in terms of the value.

If they get credit from commercial rates that doesn't matter to us, it doesn't change our evaluation because obviously we value it as our own commercial reimbursement. So while it might be more of a catalyst, it also reduces the value to both the buyer and the seller.

And then in terms of competition, if you recall these outreach skills are largely cost synergy value creation opportunities, and so at any given outreach is likely to not be work the same to multiple competitors because it's highly dependent on where your laboratory is located, where your logistic routes are, where your patient services are currently located and there are geographical differences amongst any competitor who might be looking at purchasing an outreach.

So in term -- there is always -- you know, larger opportunity likely to be a couple of parties at the table but it's not an auction because quite frankly, we're going to value them differently because it's based on that the infrastructure..

All of that color is very helpful, thank you.

Just one clarification, so if the update of the clinical lab fee schedule were postponed to 2019; would the deal funnel soften or is it not that directly linked?.

It's not that directly linked. I think it's a fact out there that CMS is looking at refreshing -- we couldn't let fee schedule as we often talked and so we get all the data, we don't know what's going to happen with that, but it's just a fact out there that is going to be pressure on rates.

And therefore hospital CEOs are thinking about their options for outreach..

Understood, thank you..

We'll take our next question from Ricky Goldwasser with Morgan Stanley. Please go ahead..

Hi, good morning and congratulations on a very good quarter. I have two questions; the first one on PAMA.

I'm just trying to understand the product from your perspective; one, is there anything that you need to do in order to be prepared if PAMA were to be implemented in January on 2018? So how that uncertainty impact you? And then on PAMA you talked about the applicable lab definition; where is that -- what's the status of these conversations and did you quantify the impact? If you [indiscernible] changed for you and should we assume that if this is something that's really kind of like in process that -- that were to happen the January 2018 start date seems unlikely?.

Yes, so thanks Ricky. Let me give you some color around PAMA, now first of all the data put in all the data has been pushed out for 60 days and yet, CMS still is holding to the goal of refreshing the clinical lab fee schedule by the beginning of 2018.

Now with all that said, we just took two months of really tight schedule and the way this will work is they'll get all the data by the end of May - let's call it June.

They have to work through that for four months in of which in those four months, two of those months are in the summer months and then publish their rates that they will look to comment on in the September timeframe. And then they'll publish upon the rates in the fourth quarter for that beginning of January 2018.

So as you think through this, the two-month delay in data reporting clearly is putting pressure on the schedule and that's why people are saying, 'Okay even that they still have the goal, it's impossible that they can get there.' I'll share with you exactly what we're hearing, but there is more pressure on them to put that altogether.

Now with all that said, as trade association, we continue to be actively engaged with CMS. When we're down there for our annual meeting of UCLA several weeks ago, we've met with CMS. This is many members of our industry. They're very, very responsive to us, they listen to our concerns about data.

Part of the response to see would postpone of the data collection is because we are engaged with them and we're also having discussions with them and members of congress about the definition of applicable laboratory.

In the way CMS is implementing the approach right now is excluding a fair percentage of outreach which is a large portion of this market. So there will be another meeting next week with CMS and this is at the highest level CMS with [indiscernible] to talk about two issues; one is the timeframe and second is applicable laboratory.

And we hope to engage as we've done so far as a trade association of being constructive and helpful to get the market-based approach right, which is the intent of the congress with this bill. We continue to work it with them.

You also need to understand that this also has the backdrop of them having a lot on their table in the number of positions across the board in HHS and CMS not being filled. We also know that they've got to work through a lot.

I'm giving you some of the color, but we're actively working this trade association and we believe that by doing so, it's going to serve this industry well..

Rick, just to answer your specific question about is there anything we need to do to get ready, the answer is most of what we need to do is behind us. There is quite a bit of work to get the data together and we got it all together by the end of the first quarter when we needed to.

Now, really what's in front of us is just once they publish the proposed rates, for us to take a look at it and obviously respond to that if appropriate and then as Steve mentioned, through our trade association, continue to push through what we think is appropriate, which is expanding the definition of an applicable lab.

But there's not a lot of work per se between now and when everybody might decide to implement the new rates..

And just to round this off, we also said in our Investor Day in the fall that if in fact it is implemented in 2018, given the size of this business for us, the effect it could have based upon some of the estimates that we're going to be able to absorb that, given the opportunities we have around operators [ph] going forward in normal course of running our business.

That's our position. We believe it's already implied in our outlook that there could potentially be some reduction here, but we don't know for certain until we get all the data collected. But we're managing this proactively going forward and we'll see what happens..

Okay. That is helpful. One other question just regarding the guidance, a question we received this morning. If you think about the guide, very nice leading the quarter and you had the text benefit, you raised by less than your feed.

And I noted you said a little bit earlier in the year to change guidance, but is there anything that you see from operating lines, to the fact of the expense side that is making you wait for time being?.

Well, Ricky, as I said earlier, it's just early in the year. We're cautiously optimistic, but its one quarter and obviously, we're optimistic, we're going to continue with strong performance. At this point, you're correct. The entire change in guidance reflected the excess tax benefit over and above what we have built into our original guidance.

Operator, next question?.

Thank you. [Operator Instructions] We will now move to our next question from Jack Meehan with Barclays. Please go ahead..

Hi, thanks. Good morning, guys..

Good morning, Jack..

Good morning..

I want to follow up on the volume side. Just even after you may call the adjustments around M&A and new business, leap day [ph], it appears there is a real step change in the first quarter for the underlying trend.

Was there anything else worth flagging or the insourcing, outsourcing tug of war with hospitals? Have you seen any change just on that dynamic as well?.

I don't think there's any step change in the environment. If anything, I think we've comment that utilization has improved directionally over a couple of quarters, so we are seeing some good signs in utilization.

We've mentioned in the past that we monitor what we call our same source name account performance and certainly, we're seeing improvement in that over the last couple of quarters into the first quarter. These things can happen as well.

We don't know whether that's a trend and it will continue, but in the first quarter, if there's anything I could point to outside of the things we talked about, certainly a lot of good deals we've done including things like Ancestry, et cetera are helping to drive some of that growth.

I'd really say it's the utilization seem to be a little stronger than it was in the past year..

And Jack, just to remind everyone, it's this the march we're on with growth. Back when we started with our strategy at 2012, we simply just restore growth and business that was shrinking organically.

We have reduced that decline, we stabilized the business, we started to get some organic growth in '16 and our two strategy focus right now is number one, to accelerate growth.

So what you see in Q1 is the continuation of that march of improvement and we believe a lot of the investments and capabilities and focus that we've put over the last several years is due to yield the results we expected. We're pleased with Q1.

As I mentioned in my earlier comments, the results are a number of areas that led to the growth that you saw in Q1, but we believe we're off to a good start for the year..

And the only other thing I'd add is that the timing of Easter probably mitigated in some of the pack that we lost at the extra day from leap year last year, so it's hard to predict how much that's going to impact you because it's not consistent every single year, but definitely the calendar shift on the Easter into the second quarter certainly helped Q1..

Great.

And then as my related follow up, one of your early scenes from earnings has been around payer mix, so I was wondering, have you seen any changes on the government side and just how that impacted the business in the quarter?.

Something notable, Mark?.

No, there's nothing notable, Jack..

Okay, great. Thank you..

Operator, next question, please..

Yes, sir. We will take our next question from Amanda Murphy with William Blair. Please go ahead..

Hi. Thanks. Good morning..

Good morning, Amanda..

Sorry. If I just snap one more on the volume side, just given all the comments because there's a lot of moving parts. But I just wanted to confirm.

I thought one thing that PLS volumes, those would be done included in the 2.6% organic? Is that correct?.

That's correct..

Okay.

And then is there any way just thinking about all the different points you've made around PLS dynamic, Ancestry, et cetera, versus this basic underlying utilization? Can you quantify if you want those into two different buckets, sort of underlying utilization versus everything else in organic, what the impact was in the quarter from both of those sides?.

Amanda, we've decided that we're not going to break out PLS every single quarter. What I did say at Investor Day was that I would expect over the three year period to 20 that we would get about 100 basis points of less from PLS would be our expectation. So we do have a deep pipeline.

It's going to vary quarter-to-quarter, given the timing of deals and so on and so forth. We're not quite there yet, but we're building toward that, so we got some good solid growths from our new PLS businesses and over time, we're expecting a keg [ph] around 100 basis point lift, but we're not going to break it out every single quarter..

Okay. So I'm going to count that as one.

But thinking in one more, this -- just last slide, I guess I just had a question given your comments on the pipeline that you have and how strong it is? How you're thinking about forecasting or guidance this year? Just given PLS growth potential versus sort of the potential operating margin impact there, or is there a right way to think about the pipeline more like the 2018 benefit?.

There are absolutely assumptions just like we would in winning accounts in our guidance for the year. We have to make some assumptions around how we're going to perform. So we've got a deep pipeline of PLS opportunities. Unlike anyone would, we do some sort of probability adjusting against that in terms of getting those complete, the timing and so on.

So there's absolutely an element of PLS in that original 2% to 3% organic guidance that we gave on an equivalent basis and depending on how things progress, that's why we give a range.

It could be slightly more or less than we assume, but we're confident enough to build in the guidance and then on M&A, just given the fact that that's a lot less in our control. We just thought the prudent thing would be not betting on the com and having any unexecuted M&A specifically in that guidance.

Again, the way I would encourage you to think about PLS is like winning a new account, a new hospital system for our core business, something we go out.

It may not be quite as co-competitive because there's only a handful of labs that could actually perform the PLS deal, because it really takes economies of scale to drive that savings and quite often, these are so complicated, it's not even more than one part negotiation. It's just us alone talking to a hospital system.

In summary, yes, we have some assumptions around our pipeline getting executed this year in that organic growth and we're very confident just like we've done in the past about our ability to hit that..

Just to make sure it's clear, PLS, it is a business. We're managing a portfolio of professional laboratory services accounts and like for any business, these accounts are different stages of the revolution.

In that business, we have a number of accounts that have been with us for some time and like with any business, you're managing those accounts to make sure you have a referable account going forward. That's in our base as well. Second is we're growing new accounts, they're turning on.

There might be some more opportunities to expand it into other hospitals so we've got growth within the install base as well with some growing accounts and then we're bringing on board some new accounts.

So the highlights we've talked about at those new accounts, you put those three together and that has a business in its aggregate growing, but don't forget, we still have this install base of existing business that we could hear ourselves as well.

We need to think about it as an existing business with managing accounts, growing accounts and then executing brand new accounts. But with all those three components, this is a growing business for us, it's a good business for us and it positions us nicely with integrated delivery systems..

Next question, operator?.

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

Hello, everybody. I'd like to first just ask about the revenue cycle; a couple of aspects of revenue cycle management and issues. You talked about in your prepared remarks an issue around some payers like Aetna for better price transparency and that might help collect a co-pays in deductibles upfront.

Can you give us the read on what your experience has been there and then you mentioned Optum obviously, once you go there on the revenue cycle management. I'm understanding if the benefits on the revenue cycle management were probably going to take two or three years to realize.

Is that true? But there was also a cost-savings initiative of transference of employees over to them.

Is that fully reflected in the first quarter results?.

Let me start. First of all, the relationship with Optum for revenue cycle management has three components. First of all, we believe by working together with them, we can continue to become better and more efficient in our building operations and the efficiency associated with that, A.J.

is part of our $1.3 billion bigger rate savings and efficiency goal that we have. So this is parts of many programs we have to drive efficiency. So a portion of our results and a portion of our achievement against that goal will include what we're doing here.

Second is we believe by getting smarter with them around the interaction between class and patients and payers, we can go a better job of bad debt and denials and specifically, they will help us with what we talk about as far as real-time adjudication with patients that we've mentioned, four [ph] payers that are initially working with us on that, but we expect with Optum's help, we could get some more.

And then finally, it's just completing the data set and their relationship with payers in general we think will be helpful of getting paid both from a standard perspective of bad debt, but also with the denials associated with more advanced diagnostics.

Mark, anything you like to add to that?.

A.J., as we've shared before, we signed a 10-year agreement with them to manage our revenue cycle management and we do have commitments for them on cost savings to run that operation and yes, that started in Q1, but it gets feathered in over the life of the contract.

And then the second element is Optum helping us reduce denials and bad debt as Steve mentioned. Although we started the real-time adjudication prior to the relationship, Optum is helping us to drive that faster and more deeply and maybe we could have done on our own.

We feel very good about what they're doing and I can tell you that early on, we've seen a reduction in patient bad debt in the areas where we roll this out. So we're feeling good about it, we're seeing what we would expect. It's still early because at this point, it's largely just the patients who are engaging our patients service centers.

We're working on solutions that will be available in obviously the change managements plan to roll it out in the physician office where about 60% of our volume comes from. So today, it's really patient service centers moving in office phlebotomist and then eventually moving into the physician's office where ultimately we'll get the full benefit.

But we're very encouraged and we're absolutely seeing a reduction in the rate of patient bad debt where we've rolled out this real time adjudication..

All right. And if I might ask you about one other initiative as my follow up. You said you're in 65 Safeway stores.

Can you sort of update us, is this mostly having a benefit from the perspective of patients who are getting higher patient satisfaction? Are there other benefits to you and I know there has been on and off discussions with urgent care clinics, medic clinic type of entities.

Is there any update about working with them for a similar type of program?.

Thanks, A.J. Safeway relationship, we believe is the beginning of our consumer initiative working with retailers in a bigger way and part of this is around providing better access.

We believe we have unparalleled access in the market, we're 2,200 patient service centers, we have 2,800 phlebotomist and physicians' offices, about 6,000 access points, but we believe some of these retailers we could be working with and safely as one had better locations and there is anywhere from 15% to 20% of laboratory requisition orders that go unfulfilled.

So we're helpful by having better access. We're going to get more fulfilled requisitions and that's going to help our growth and also help some share if we have better access.

We hope when a patient has a choice and who ask the question, 'who do you like to go to?' for their laboratory testing, that the patient will remember a better experience in a more convenient location for that experience and they'll choose Quest based upon our movement here.

That's both growth, but also as you would expect as we start to come on board with some of these centers, we rationalize our presence in a zip code and we might shut down some of our smaller patient service centers and saves us some money as well. It's both growth and efficiency.

And we do continue to have relationships and we do continue to have pilots with some of the other players in this retail space. We continue to have UBS [ph] as the client and we're optimistic about other retailers as they continue to evolve their health strategy.

They see it as a nice expansion from what they do today around pharmacy and also it helps these retailers for getting traffic into their stores as well. It's a multi-faceted program for us that directionally, we're very, very optimistic about and I think we're off to a great start..

We'll move next to Bill Quirk with Piper Jaffray. Please go ahead..

Great. Good morning. This is Alex Nolan [ph]. I got in for Bill today. I was just hoping if you could - good morning - when you're looking at deals for the future, I was wondering if you could just rank priorities.

Between esoteric testing to gain access to different technology, looking at core testing labs to build geographic positions and then finally looking at hospital business partnerships. If you could just rank those three on what your priority is looking for doing a deal with one of those three in the future? That would be great..

Yes. All that you mentioned are strategically in-lined with our direction. So we have for the last several years cleaned up our portfolio, we're entirely focused on diagnostic information services. Our first filter for any deal is does it fit into our scope of our strategy and from what you just mentioned all do.

Second is we do believe that there's our growth strategies and we've outlined in the fall five areas that we're focused on for accelerating growth. One is related to partnering with hospital systems and so, the hospital average deal fits in that strategy as well.

Second is to continue to invest in advance diagnostics and bringing new capabilities to the marketplace. So some of the potential acquisitions we could do there would fit there as well.

As part of these priorities, what we have shared in the past is we continue to be very, very rigorous in making sure that if their strategically in-lined, that we have the thresholds we expect to make for our shareholders with any acquisition.

I would say that's generally more of the cut we have is we're the strategic in-line where they fall out in terms of use of our cash and are they getting acceptable returns of invested capital, providing us with the growth we expect and at the same time, become accreted to earnings in a reasonable period of time.

That's generally how we rack and stack acquisitions and it served us well so far. That fits into the strategy that we had or 1% to 2% growth of acquisitions.

As you can see from our prior acquisitions over the past four or five years, do you see all those categories and it's more of a matter of when that come in and when we can execute it and less to deal with the sorting of what we'd like more of a priority than others. But we haven't had the problem having not enough cash to execute things.

We think we should do strategically and also that we think has a good return for our shareholders.

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

No, I think you covered it..

Okay. That's very helpful and then just a quick follow up. Could you just remind us what the margin profile is of your hospital relationships and just comparing that to your core business? And then what's the opportunity to expand the margins in the hospital business? Thanks..

Right. When you say hospital relationships, that's multi-faceted. I think it might be specifically time about special laboratory services where we're actually serving them for the work that is not explicitly billable. So it's the laboratory work they have to perform in order to get paid under the DRG for inpatient outpatient et cetera.

Those margins as we've shared are lower than our core, but double-digits. That's as explicit as we've been and then in terms of our relationship and that word is really important, when we have our relationship with a hospital and we do professional laboratory services, we typically get most - if not all of the reference work.

So we've talked about the fact that we do reference work for half the hospital in the country. That is the high end at more esoteric type work, but either they are not able to, or have made a rational decision not to perform given limited size and scale, so there's a handful of people that do their work.

We have the largest reference work at any laboratory. So that's another part of our relationship with hospitals and then certainly the other part of the relationship is we've got other businesses that [indiscernible] hospitals their large employers, we've got our wellness business so we can help them keeping their population healthy.

We've got some of our diagnostic tools that certainly can help them manage everything laboratory spend to benchmarking their clinical practice of utilization of diagnostic. So there's a lot involved in a relationship with a hospital, but specifically on the PLS, its double digits, but slightly lower than our core margin..

Let me just underscore what Mark just said and remind you what we shared with you in the fall because it's important in our strategy in what we're doing every day.

When we're talking about hospitals, it's about 60% of our market if we look at it and we have laid that out in three ways - one is what we could do to help them with their inpatient laboratory cost. These are cross centers that we could save the money.

Number two, what Mark just went through as far as the reference testing, the advanced diagnostics to sell the hospital that they can't do themselves, they rely on laboratories like ourselves and then finally is outside of the hospital and some have outreach businesses, but they also are buying physicians and they're looking at serving geographic area and providing the laboratory services with those physicians that they now own or affiliate with.

So when we have a discussion, it just was last week with a very large integrated delivery system, their lab strategy includes all three.

We talk about our relationship with hospitals, yes it's the inpatient laboratory but it's a holistic view of how we approach the marketplace in a much more progressive holistic view as they build integrated delivery system. S it's all three components when we approach the systems and it's serving us well as you see in our good start of the year..

And in fact, that PeaceHealth is a perfect example..

Exactly..

So as we engage with PeaceHealth, the decision was made to sign with us on PLS deal, they are selling us their outreach and then obviously we have a reference relationship with them as well.

Next question, Operator?.

We'll take our next question from Donald [ph] with Seabanc [ph]. Please go ahead..

Great, I just have one question here. I'm really curious about this. I know it's new but this relationship with IBM.

I realized it's new, but how that might play out on what you're seeing and experiencing with them around cognitive computing?.

Yes, appreciate it. In our advanced diagnostics business, we have our oncology franchise and related to that, if you recall several years ago, we formed a relationship with Memorial Sloan Kettering where we put together a product that's called OncoVantage. It's going to take some of their content, some of the research with 34 actionable genes.

OncoVantage essentially is a product that delivers on precision. That is [indiscernible] oncology. And what we also realized with Memorial Sloan that we needed a cognitive computing partner. So we at this fall announced now teaming up the two of us with IBM and this is for IBM Health Watson. They are our cognitive computing partner.

So collectively now, the threesome is going at the market and the opportunity in front of us is about 70% of oncology here is in community healthcare centers, not in large urban centers like what Memorial Sloan will be serving.

This is a big opportunity for us and we have our own dedicated sales force, it's backed up with a brand and the content from Memorial Sloan, but now when working with IBM, we believe that their sales force and their presence with integrated delivery systems and also just in general, public awareness of precision medicine in computing and healthcare is being helped by IBM.

You might have seen some of the ads. They have been running and one of those specific ads that need to actually do highlight the work they're doing with us in Memorial Sloan in the field of cancer. So we think it's a step in the right direction and it's often running well..

Great.

I didn't see that and I was just -- what would take a reasonable time frame to you at this relationship? How might it evolve? This is a year's process, I assume?.

We continue with all our partnerships, so this is the beginning. There's other things we could do with IBM. I'm not prepared to talk about that, but we believe all our partnerships start with something and they go from there..

Thanks, Don.

Operator, last question please?.

Yes. Our final question will come from Steven Valiquette with Banc of America Merrill Lynch. Please go ahead..

Thanks. Good morning, Steve and Mark. Congrats on these results. Thanks, good morning. Just a question around the PAMA cuts. My view is that if they are delayed beyond January of 2018, it would likely be in that positive request just because of this simple math of how it no longer potentially negatively impact the 2018 revenues.

But as I'm talking with investors, I'm kind of surprised I keep getting this view by some that a PAMA cut delay could actually be a slight negative request and the thought pattern is that if the PAMA cuts themselves, we're to theoretically cause some lab provider competitors to either go out of business or want to exit the business, that would obviously help your volume gains and also help your M&A pipelines with PAMA cut delay would potentially delay these types of benefits.

So I guess senses just keeps coming up in my discussions and just to have more of a full discussion around this with you guys, I mean how are you thinking about the net impact of the PAMA cut delay on your overall business for 2018?.

First of all, the refresh of the clinical lab fee schedule from PAMA -- I would just argue is a reality that's creating some catalyst on hospital systems; I must say all laboratories to consider their options going forward.

And I would argue that as independent of whether any refresh takes place in 2018, 2019 or even 2020, it's just sitting there; that how they get paid for Medicare is being revisited and even though you've said that, its cuts is unclear on what the outcome will be until we gather all the data and we've talked about this before.

Until we gather all the data, we don't have the visibility about the data, it's uncertain of what effect it would be.

But we review that in general this review and the pressure that's on payment in general and we believe it's on the Medicare side with PAMA, but also on the commercial side is a good catalyst for us having these conversations with integrated delivery systems without the laboratories on the strategy going forward.

So that's the first point I'd like to make. The second is the goal is still 2018; obviously if that's postponed or delayed, and if in fact you had a negative consequence associated with how we get paid, it would be helpful in 2018.

But right now we're assuming that what they tell us is what they're going to do and therefore 2018 is what we're assuming and we'll see if that does happen..

So while the other element, Steve, is that if it's delayed because they expand the definition of applicable lab, we would assume that's probably a positive for the industry and certainly for us; and I can assure you that when I laid out the view from 2020 in terms of the 3% to 5% top line growth and mid to high single digit bottom line growth, I was building in some level of COGS on the clinical lab fee schedule into our revenue growth assumptions, but that was not building in some sort of a steep change in the competitive environment where we were picking up significant volume because people couldn't survive in a world where Medicare cuts were made.

So I would be cautious about assuming that we're hoping that cuts happen as large as possible, as quickly as possible; we certainly would not -- be disappointed if things get delayed..

It's helpful. Well, just real quick housekeeping type question; you mentioned the Easter planning and how that could have helped 1Q '17 just on a year-over-year comparison.

And some people have asked, could it actually be a little bit of a volume headwind in 2Q '17? I'm thinking about those year-over-year comps; is that worth flagging or am I just spending too much time thinking about how it is?.

Well, it's absolutely all other things equal going to be a volume headwind in Q2, just like it helps us a little bit in Q1. But you know, there is so many factor that go in, it's just one element of growth in the second quarter.

But if you're looking at -- if there is something in the second quarter that would be a headwind, yes, the fact that Easter is in the second quarter is something to factor in..

Okay, we appreciate all the questions. Thanks again for joining the call. As you heard, we had a strong quarter and we're off to a solid start in 2017. We're looking forward to meeting your commitments by our two-point strategy which is to accelerate growth and to continue to drive operational excellence.

We appreciate your support and you have a great day..

Thank you for participating in the Quest Diagnostic's first quarter 2017 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 888-203-1112 for domestic callers, or 719-457-0820 for international callers. Passcode is 7180587. Telephone replays will be available from approximately 11:30 AM Eastern on April 20, 2017 until 11:30 AM Eastern on April 25, 2017. Good bye..