Quest Diagnostics Incorporated

Welcome to the Quest Diagnostics fourth quarter and full year 2020 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'd like to introduce Sean Vivek, Vice President of Investor Relations for Quest Diagnostics. Go ahead, please.

Thank you, and good morning. I'm on the line with Steve Roszkowski, our Chairman, Chief Executive Officer and President, and Mark Guinan, our Chief Financial Officer. During this call, we may make forward-looking statements and we'll discuss non-GAAP measures. We provide a reconciliation of non-GAAP measures to comparable GAAP measures in the tables to our earnings press release. Actual results may differ materially from those projected. Risks and uncertainties, including the impact of the COVID-19 pandemic that may affect Quest Diagnostics' future results include, but are not limited to, those described in our most recent annual report on Form 10-K, and subsequently filed quarterly reports on Form 10Q and current reports on Form 8K. The company continues to believe that the impact of the COVID-19 pandemic on future operating results, cash flows, and or its financial condition will be primarily driven by the pandemic's severity and duration, healthcare insurer, government, and client payer reimbursement rates for COVID-19 molecular tests, the pandemic's impact on the U.S. healthcare system and the U.S. economy, and the timing, scope, and effectiveness of federal, state, and local governmental responses to the pandemic, which are drivers beyond the company's knowledge and control. For this call, references to reported EPS refer to reported diluted EPS from continuing operations, and references to adjusted EPS refer to adjusted diluted EPS from continuing operations. References to base testing volumes or base business refer to testing volumes excluding COVID-19 molecular and serology testing volumes. Growth rates associated with our long-term outlook projections, including total revenue growth, revenue growth from acquisitions, organic revenue growth, and adjusted earnings growth are compound annual growth rates. Finally, revenue growth rates from acquisitions will be measured against our base business. Now, here is Steve Ruskowski.

Steve Ruskowski Thanks, Sean, and thanks, everyone, for joining us today. So, in a year dominated by the pandemic, brought critical COVID-19 testing to our country and delivered record revenues, earnings, and cash from operations for the fourth quarter and the full year 2020. The pandemic has tested our nearly 50,000 employees, and they have responded as heroes by developing COVID-19 tests, building test capacity, innovating new testing models with our retail partners, transporting specimens, delivering results, and of course, supporting our customers. We finished the year as one of the country's leading providers of COVID-19 testing. I'm very proud of what we have achieved and optimistic about what we can accomplish in 2021. So this morning, I'll discuss our performance for the fourth quarter and full year 2020, our ongoing role in the COVID-19 pandemic and update you on our non-COVID-based business. And then Mark will provide more detail on our financial results and our financial outlook for the first half of 2021. But before we get into the details of the quarter and the full year of 2020, we wanted to share our perspective on the new strategy for fighting the COVID-19 pandemic proposed by the new administration. We are pleased by the efforts to expand access to testing across the country, especially in the underserved communities where there are known disparities in healthcare. We support the new administration's approach to controlling the pandemic by expanding the availability of testing supplies, enhancing laboratory testing capacity, and ensuring a clarity of messaging about the use of tests in insurance coverage. We also support the efforts of COVID-19 Pandemic Testing Board, and we look forward to additional details and days and weeks ahead. Now turning to our results, continued high demand for COVID-19 testing drove our performance throughout the quarter and the second half of the year. For the fourth quarter, total revenues grew by more than 55% to $3 billion, Earnings per share increased by more than 126% on a reported basis to $4.21 and nearly 168% on an adjusted basis to $4.48. For the full year 2020, total revenues grew by more than 22% to 9.44 billion. Earnings per share increased by nearly 71 percent on a reported basis to $10.47 and more than 70 percent on an adjusted basis to $11.18. Cash provided by operations increased by more than 61 percent to $2 billion. We announced today that we are increasing our quarterly dividend by 10.7 percent to 62 cents per quarter. And this is our 10th increase since 2011. Additionally, our Board of Directors has increased our share and repurchase authorization by $1 billion. The increased authority is on top of the approximately $900 million that was available as of December 31st, 2020. In the fourth quarter, we continue to see strong COVID-19 testing volumes. The band clearly spiked as the virus surged and people got tested in advance of the holiday galleries. We performed an average of 135,000 COVID-19 molecular tests today in the fourth quarter, well below our current capacity. We continue to innovate to further expand capacity, reduce turnaround times, and gain efficiencies. And finally, we are focused on addressing health disparities in underserved communities through our Quest for Health Equity initiative. We recently held our first COVID-19 testing event at Abyssinian Baptist Church in Harlem in conjunction with leading black clergy and the United Way of New York City. Testing is more important than ever as the vaccines roll out over the coming months to get at-risk patients into care when their beacons still be effective and to isolate infected individuals. We expect 2021 to be another very strong year for COVID testing. Although demand for COVID testing is likely to decline throughout 2021, as more people become vaccinated and fewer new cases are reported. We believe that COVID-19 testing will continue into 2022. Now turning to our base business, organic volumes recovered rapidly throughout the summer and fall. However, the recovery stalled at the end of November and into December, due to the surge in COVID-19 infections across the country. And Mark will provide and share some more details regarding the trends in our base business later. With that, we continue to make progress on our two-point strategy to accelerate growth and to drive operational excellence. Let me share some of the highlights from our strategy to accelerate growth. Our M&A pipeline remains strong, and we achieved our goal to exceed a 2% growth CAGR from acquisitions in our base business over the last three years. We continue to see increasing interest from our hospital partners about how we can help them with their lab strategy, which includes discussions around both their outreach acquisitions and professional lab service arrangements. The deals we closed in 2020, particularly the Memorial Herbman Outreach and Mackle Acquisitions, position us well to achieve our M&A growth target this year. And we remain confident that this year we will execute a more similar type of outreach for tuck-in deals in our pipeline. Last year was also a record year for a Professional Lab Services Strategy, or PLS. And this is the business to partner with hospitals to help them run their inpatient labs more efficiently in the fourth quarter we announced two small pls partnerships with hospital systems in new york and indiana and then in december we announced our largest pls relationship to date with hackensack meridian health the largest integrated health network in new jersey Quest will manage laboratory operations and perform reference testing for 11 Atkins Accredited Health Hospitals. We also continue to execute our health plan strategy by shifting the dialogue to value-based contracting efforts from the recent past when discussions focused primarily on price. We continue to make progress with our new strategic relationship with Ansem. to improve quality and efficiency in the delivery of laboratory services. We're advancing our position with UnitedHealthcare within its preferred lab network and also building momentum with many of our other national and regional health plan partners. Finally, we continue to grow our direct-to-consumer services in the quarter. In December, we announced our zero out-of-pocket Quest Direct COVID-19 testing option. Their service offers appointment scheduling and specimen collection at more than 500 participating Walmart drive-thru locations. And also in the quarter, we saw an acceleration in the number of consumers signing up for MyQuest patient portal. Today, roughly 15 million patients have a MyQuest account, an increase of nearly 2 million since October. And recent market research indicates that our brand is strong and has strengthened over the past year with industry-leading net promoter scores. We have a strong foundation to accelerate growth in our consumer offerings. The second part of our two point strategy is to drive operational excellence. We continue to pursue our goal to reduce our cost base by 3% per year. We also see opportunities ahead to drive further productivity gains, and at the same time, enhancing the customer experience. Now, once again, our Invigorate program delivered approximately $200 million of cost savings in 2020. And we continue to see more opportunities to deliver future efficiency in our cost space. Our new flagship laboratory in Clifton, New Jersey, went live on January 4th. This is the most highly automated laboratory in our network. And over the course of 2021, We expect to consolidate volumes from Peterborough, Baltimore, and Philadelphia labs to this state-of-the-art facility. Now, before turning it over to Mark, I'd like to announce that we plan to update you on our strategy and market overview at our upcoming Virtual Investor Day. And it will be held on Thursday. March 11th. So stay tuned for more details. Mark.

Thanks, Steve. In the fourth quarter, consolidated revenues were $3 billion, up nearly 56% versus the prior year. Revenues for diagnostic information services grew approximately 58% compared to the prior year, which reflected ongoing demand for COVID-19 testing services offset by a modest decline in our base testing revenue. Volume, measured by the number of requisitions, increased 26.8 percent versus the prior year, with acquisitions contributing 4.5 percent. As we highlighted in our 2020 outlook update in mid-December, organic testing volumes ordered in our base business were down mid-to-high single digits versus the prior year in October and November. The recovery stalled in late November with organic testing volume trends down high single digits versus the prior year in December due to the surge in new infections across the country. Additionally, many state and local governments imposed new orders designed to reduce the transmission of COVID-19. Compared to December, organic-based volume trends remained relatively steady in January versus our pre-pandemic 2019 baselines. For the entire fourth quarter, total testing volumes declined roughly 2% versus the prior year and benefited from M&A and new PLS partnerships that began in 2020. Excluding M&A and new PLS wins, base testing volumes declined approximately 8% in Q4 versus the prior year. COVID-19 testing continued to be a meaningful contributor to volumes during the fourth quarter. We resulted approximately 12.5 million molecular tests and 1 million serology tests, contributing approximately 29% to volume growth in Q4. We exited the fourth quarter averaging approximately 130,000 COVID-19 molecular tests and 10,000 serology tests per day. Revenue per acquisition increased 25.2% versus the prior year driven largely by COVID-19 testing. This was partially offset by enterprise headwinds of approximately 1.6 percent in the fourth quarter, which includes the impact of PAMA and was in line with our prior expectations. Supported operating income in the fourth quarter was $795 million, or 26.5 percent of revenues, compared to $363 million, or 18 percent of revenues last year. On an adjusted basis, operating income in Q4 was $860 million, or 28.6% of revenues, compared to $329 million, or 17% of revenues last year. The year-over-year increase in operating margin was driven by the strong revenue growth in the fourth quarter due to continued high demand for COVID-19 testing. Reported EPS was $4.21 in the quarter, compared to $1.86 a year ago. Adjusted EPS was $4.48 compared to $1.67 last year. Cash provided by operations was approximately $2 billion for the full year versus $1.24 billion in 2019. As a reminder, in the fourth quarter, we returned approximately $138 million of provider relief funds we had received under the CARES Act. Our financial position remains very strong. As we announced this morning, we increased our quarterly dividend approximately 10.7 percent to 62 cents per share. And the Board expanded our share repurchase authorization by $1 billion. So, we now have nearly $2 billion available for future share repurchases. We resumed share repurchases in Q4 and bought back $250 million of company stock during the quarter. Turning to guidance, It continues to be a lot of uncertainty around the trajectory of the pandemic and its impact on COVID-19 testing trends, as well as further recovery in our base business. Therefore, we are currently providing an outlook for only the first half of 2021 and expect to provide updates as the year progresses. Our outlook for the first half of 2021 is as follows. Revenue is expected to be between $4.85 and $5.15 billion an increase of approximately 33% to 41% versus the prior year. Reported EPS expected to be in a range of $5.07 and $6.07, and adjusted EPS to be in a range of $5.90 and $6.90. Cash provided by operations is expected to be at least $800 million, and capital expenditures are expected to be approximately $200 million. The demand for and duration of COVID-19 testing, as well as the continued recovery in the base business, are significant swing factors that remain challenging to forecast. With that high degree of uncertainty in mind, please consider the following. Our first half outlook generally assumes gradual improvement in base testing volumes, but we expect the base business to remain below our pre-pandemic 2019 baseline throughout the first half of the year. COVID-19 molecular testing volumes averaging roughly 100,000 tests per day in the first half of the year. However, we expect average daily volumes to decline throughout the first half of 2021 as more people become vaccinated. Therefore, we assume COVID-19 molecular volumes will be lower in the second quarter compared to Q1. COVID-19 serology testing volumes averaging 15,000 tests per day for the first half of 2021, with demand expected to increase modestly throughout the first two quarters of the year. Given the strength of our financial position and high cash balances, we expect to complete a larger amount of share repurchases in 2021 than we have done historically, while maintaining significant flexibility to execute on our M&A pipeline. However, at this point, our EPS ranges only assume enough share repurchases to maintain a stable share count. We expect to share more details about our capital deployment priorities at our upcoming investor day in March. While we aren't providing a detailed outlook for the full year at this time, I'd like to offer some additional considerations for 2021. As a reminder, there will be no Medicare reimbursement cut under PAMA this year, given the one-year delay included in the CARES Act. We expect organic-based testing trends to slowly recover throughout the year, with volumes likely approaching a full recovery compared to our 2019 baseline by the end of the year. If the country vaccinates a significant portion of the population by the summer, we would expect a continued decline in COVID-19 molecular testing volumes in the second half of 2021, compared to our expectations for the first half. Similarly, demand for COVID-19 serology testing is likely to wane in the back half of the year. Finally, COVID-19 molecular reimbursement is likely to trend lower in 2021 compared to last year. As many of you know, beginning January 1st, CMS moved to a new reimbursement model with a rate of $100 for all tests reported within two days and $75 for all other results. Several commercial payers have now moved to this new reimbursement model as well. Also, while we are encouraged that HHS now plans to extend the public health emergency throughout 2021, prospective changes to COVID molecular reimbursement are still possible. Furthermore, direct client bill reimbursement for COVID testing services remains competitive. I will now turn it back to Steve.

Thanks, Mark. Well, to summarize, I'd like to thank all Quest employees who have worked tirelessly over the past year. They've delivered a significant portion of the country's COVID-19 testing while serving the needs of people who rely on Quest every day. Thanks to their heroic efforts, we delivered record revenues, earnings, and cash from operations for the fourth quarter and the full year of 2020. In light of the country's company's strong financial performance, we have increased our dividend and share repurchase authorization while maintaining flexibility to pursue our M&A strategy. We look forward to sharing a more in-depth update on our market views and strategy at our upcoming Virtual Investor Day to be held on Thursday, March 11th. Stay tuned for additional details on that day. Now we'd be happy to take your questions. Operator.

Thank you. We will now open it up to questions. At the request of the company, we ask that you please limit yourself to one question. If you have additional questions, we ask that you please fall back in the queue. To be placed in the queue, please press star 1 from your phone. To withdraw, press star 2. Again, to ask a question, please press star 1. Please announce your name and company. And our first question comes from Ralph Jacobi with Citi. Your line is open.

Thanks. Good morning. I guess I think I heard you say that you expected molecular reimbursement to trend lower. Just wanted to flesh that out to understand that and maybe what have you assumed for reimbursement with PHE likely extended for the full year? And has there been any discussion or thoughts about proactively going to plans and perhaps not continuing to get that sort of inflated PHE reimbursement? in exchange maybe for more favorable, longer-term pricing escalators. Thanks.

Mark, do you want to start it? Sure. So, you know, we are expecting, you know, to still, you know, do quite well in terms of reimbursement in the near term. We believe we can meet the turnaround times, certainly the threshold that's required to be eligible for the higher rate, and then we get paid, obviously, based on the individual tests. So, you know, we're still thinking in the near term that our average wage reimbursement is going to be pretty strong, but we also recognize the reality, you know, of the pressure on the industry from all the various payers, especially the commercial payers. And so, therefore, as we mentioned, you know, throughout the first half of the year, we would expect, you know, some reduction in that reimbursement. not something that would be momentous, but certainly some downward pressure. And as we said, the client area is very, very competitive. So there's quite a few labs at this point given the demand that have a significant capacity, and so therefore in the client area it's very, very competitive. In terms of your question, I'm sure you can appreciate, Ralph, that first off we don't feel we're getting paid excessively for COVID PCR. We feel like we're being paid corporately. But even if you could exactly forecast the volume of our COVID testing and forecast the base business over a period of time, which obviously would be nearly impossible, I'm not sure that we need to trade off anything. We're very happy with the relationships that we've built, as Steve mentioned, with the payers. We've moved away from a focus on price and moved toward more of a partnership and an alignment around value creation, where they're looking for us to save the money and create value. And a big piece of that is moving more work to us, because we're already a very high value compared to the rest of the industry and possible choices for patients. So good question, Ralph. Certainly appreciate it. But for practical and for strategic reasons because of where we think we are with the payers already with some of these new contracts. It's certainly not something that we're looking to pursue right now.

Let me just add to that. Speaking to demand, what I would share is that over the course of the last 10 months, we've brought up our capacity considerably, and we're going to continue to build it. And the reason for that is we want to continue to be prepared in the event that we do have another surge. And then secondly, is we want to make sure we really have a capability to meet turnaround times that are expected in the market. And over the last 10 months, obviously a lot of our testing has been for the clinical purpose. And what we believe as we enter the second half, and we're having many discussions in this regard, There's going to be a lot more demand for return to work programs with employers, which have been pushed out, as you all know. Return to leisure activities. There's a number of cities that have large tourism bases that are thinking about what they need to do to get people back into those venues. And there will be a lot of activity around just return to life. And I know that we are still trying to figure that out, and that's going to offer us a lot of opportunity in the future. And with that, there's always a COVID task, but there's also a number of services we provide, and those are yet to be defined. So we're still trying to understand what that second half opportunity would be, but what we see so far, we will continue to have strong demand But it may take a different form as we get into the second half and as we go into 22. Thanks, Ralph. Ralph Becker Jr.: : Thank you.

Operator, next question.

Pito Chickering with Butch Bank. Your line is open.

Justin Bowers on for Pito. Just with respect to the guide, can you kind of frame the high end and the low end for us in terms of your testing assumptions? And then also the thought process on the increase in serology testing through the quarter.

Yeah, sure, Justin. So, you know, it's multivariable. So there's several ways you could come to the high and low end. So what I would say is, you know, they're all based on the three major drivers, with most of it being on the base volume recovery side. and the level of PCR, you know, volume to a lesser extent serology. So, you know, if we don't see a significant fall off from where we stand today in PCR, or if it, you know, surges up again, you know, because of these variants or some other unknown factor, certainly that would take us, you know, to the higher end combined with, you know, if the base business also were to continue to recover and not, you know, go the opposite direction as COVID surged again. So there is some negative correlation, obviously, between the two. But if they both move in the same direction, that would move us to the higher end. And then if for some reason COVID fell off markedly, even more than we're planning, as we talked about, we are planning for a decline over time in this first six months at that midpoint. and the base business did not show recovery or even, you know, potentially took a little bit of a step back for economic or other reasons, then that would take you to the low end. But, you know, I can't at this point provide exact, you know, changes in the base and COVID because obviously there's multiple ways to get to either one. But directionally, that's what, you know, ring fences our guidance with the midpoint being, as I said, you know, a modest recovery but not full for the first six months of the base business. And then some step off, but still significant COVID testing for the first six months, with the second quarter being markedly lower than the first quarter.

Okay, got it. And then just to clarify the earlier comments, it sounded like the base business right now is kind of running stable. month over month from December levels? Are we interpreting that correctly? And then just in terms of the molecular tests reported on the website at, you know, 32.8 million, is that the right number? It looked like kind of a huge step up from February to January. But more importantly, is that kind of where you guys are now for total molecular? And I'll hop back into you. Thank you.

Steve, do you want to take that or would you like me to?

The step up is the step up that we've seen based on the strong delivery that we have in the fourth quarter in the beginning of January. As I said in my introduction comments, we are one of the leading providers of COVID-19 testing. Second is it does not include serology. You did ask a question about serology because we do believe there will be increasing role of serology throughout 21. We seem to see some early indications that there's interest in understanding whether you have the antibodies or not, which might inform patients and physicians around their urgency of getting vaccinated. And at the same time, we're bringing out a new capability called quant serology testing. And this will allow physicians and patients to see if, in fact, they do get the spike protein from the vaccines. And we'll be bringing that out of two platforms in the next few weeks. And this can't help us, you know, determine if the vaccine is being effective. So we do believe that there will be some increased demands for serology. And this is on top of what we already do. And Serology is providing a really important role for management of the disease, overall surveillance, epidemiology, and in measuring the response of what's happening pre and post the vaccinations in broad populations. So we believe there's an opportunity in front of us in 21 in that regard.

And, Justin, just to close out on your other question, yes, 32.8 million was the total through as of Monday, and that was up – 1.8 million over the prior two weeks. So about 130,000 a day in the prior two weeks. Operator, next question.

Jack Meehan with Nefron Research. Your line is open.

Hey, Jack. Hey, good morning. Steve, you mentioned the focus of the new administration on COVID testing. Can you talk about how you think Quest's role might change at all serving the pandemic? And if we start to see greater adoption of home testing, how do you think Quest is going to be positioned for that?

Yeah, so I think, you know, the new administration is leveraging what we've done in the past as a country and as an industry. and taking it to the next level. I mean, you see the capacity that's out there now in the country. Back a few weeks ago, we were doing about 2 million COVID-19 molecular tests. So obviously up considerably from where we all started last March. But going forward, Jack, I do see that there will be a change beyond the PCR test, as I mentioned earlier. There's going to be greater demand, you know, for Programs that get to portions of the population that help us get back to work, get back to leisure activities, get back to life. And so we're having a number of dialogues around that. And that will include the role of antigen testing and more rapid testing workflows that allow us to see the fact that a person that wants to engage in whatever the activity is, is negative and unsafe. for a reasonable period of time to participate. So when we get into that world, you know, we'll obviously provide you with testing, but as I said earlier, there's a number of services and also IT solutions that you need to provide. And like so much in healthcare, you see one, you see one, but we're currently engaged with a number of organizations, a number of municipalities, and a number of corporations. what they will be doing in this regard, particularly in the second half. I think the first quarter is outlined in our guidance. We're going to start to see improvement as we get into the second quarter. I think the second quarter will be a telling quarter for us all. And we do see a lot of people getting prepared for better infection rates, better position for populations to get back to work life and and leisure activities, and we're going to start to see more of that, and Quest has a significant role in helping in that regard.

Great. And then just to follow up, I have a two-parter on unit pricing. I was curious if you could weigh in. Do you have any notable commercial contract renewals in 2021? And then maybe more broadly, as you have discussions with commercial payers now, do you feel like you have a little bit more of a you know, good footing, you know, in terms of negotiating price given, you know, the role the labs have served, you know, amidst the pandemic?

Yeah, let me start with where you ended. I think our relationship with the health plans has never been better. As you've seen over the next last number of years, we've increased our presence. We have the best access to lives now that we've had in over a decade. And so we are in a very strong footing. And also during the pandemic, I'll share that we were deeply engaged with many of the plans of what they needed to take care of their membership and also their employees. So the relationship has continued to strengthen. And as I said in my introductory remarks, and Mark said as well, we're shifting the dialogue away from exclusively price to the value we deliver. And when you go back to what we've talked about in the past around what we bring to the table in terms of our value proposition around quality, our service performance, our innovation, all at a very affordable price, we believe our value proposition is really second to none. And as I said, in the course of the last year, we've done surveys to look at our reputation in the industry and net promoter scores, and those are quite strong. So when you bring those facts to the table, Jack, our position in terms of working out the forward-looking relationships has provided a much stronger foundation and a better understanding on the other side that we really do deliver a lot more value. So we're in a good position with our plans. We're in a good position with our contracts. We obviously don't provide specific details, but we feel very good about that. And also, I shared that we continue to make progress with our united relationship with the PIRD Lab Network and the building relationship with Anthem, we're quite encouraged about as well. So we feel good about our relationship and the progress we've made, but also the opportunity in front of us to continue to build on what we've been talking about. So, Mark, anything you'd like to add there?

Sure. So, Jack, I understand the question. And several years ago, I think there was an expectation or, you know, people holding their breath, every time we extended a contract with a major payer because it would imply some sort of major price concession. I can tell you this has become largely invisible to you all, unless we talk about it, like Anthem, which was really a new contract and brought together a number of states under a single contract as opposed to having different periods of time in which we were negotiating across the Anthem network. We just extended with a major commercial payer. He didn't hear about it because there was no price concession. And, in fact, we made huge headway with this payer, getting them to acknowledge that in the world of PAMA, the whole notion of a discount to the CMS NLA rates no longer will apply going forward and that, in fact, You know, CMS will be setting the market and that they should feel confident is a market rate that they can feel comfortable and represent to their prospective or current members. So, you know, really that's what it's been about is they all want to make sure that they can say they've got good prices and now you've got an external benchmark. you can look to. So we just extended with a very large national. We do have one coming up this year, but I can assure you that it's not going to be, it will not come with a major price concessions. You know, we're going to continue to work on the value-based contracting. And with that actually comes good pricing that we feel, you know, represents the market. And then these come with upside, whereas we perform you know, we both share in the benefit of that upside. That's the way we're really contracting, you know, the last couple of years and how we would expect the contract going forward.

Thanks. Thanks, everyone.

Kevin Caliendo with UBS. Your line is open.

Great. Thanks for the question. This is Adam Noble and for Kevin. I just wanted to, I guess, double back to your comments around reimbursement for COVID PCR. One, just to confirm that you're assuming throughout the first half that the PHE is extended so that the Medicare rate with the add-on payment remains 100. And then you talked about the kind of the commercial reimbursement potentially declining over time. Just any thoughts around kind of what the magnitude of changes on the commercial side you guys could potentially see in PCR?

Yes, sure. I'll comment on that, and Steve may want to add. So, yes, we would expect that as long as the federal health emergency continues, that the structure with the opportunity to earn $100 per test from CMS will continue. Now, that is a very small portion of our volume, but we would expect that. However, as I said in the prepared remarks, there is some risk. They could decouple it. There's no guarantee that that will continue. So, and, you know, not only could they decouple the reimbursement with the FHE, but they could also, like they did January 1st, change the approach. However, you know, at this point, yes, we are assuming the highest probability is that as long as the FHE continues, CMS will continue to pay us under this new method. You know, on commercial, obviously we're not the only player And so while we defend and feel like we do a good job of explaining why a reimbursement makes sense, as we've negotiated some new payment methodologies, including some who wanted to move to the Medicare methodology. We think we've done a good job. But obviously, there are other labs as well. And to the extent that other labs don't do as good a job as we do, there could be additional pressure on us. So that's why it's hard for us to predict exactly where this is going. But certainly in our mind, you know, we would expect to continue to defend our commercial contracts as well through the FHEs. And the same basis for CMS paying us at that rate should apply to the commercial payers as well. I also want to remind everybody that as long as the zero patient out-of-pocket applies, that is also a huge tailwind for us. Because, you know, to avoid having to bill patients where historically we've shared that we get about, you know, 70 cents on the dollar. and actually get 100% of that payment from the third party is also a large enhancement to our revenue and our profitability as well. So that's a factor I don't want people to forget about.

Steve? Yeah, just to add to the CMS new methodology for reimbursement. As you know, we are reimbursed at $100 when we report the results in two days, and $75 for all other results. And to Mark's comments, we have seen a few payers to look at this model as well. But we're encouraged by the public health emergency extension through 21. And also, just to share, our timeliness of our results are quite good. We have met that threshold of 50% of COVID molecular test results in less than two days. We did that in the last few months. And I'll share that the majority of our testers are resulted in two days or less. So my other comments, I did mention that we're continuing to build capacity because it just gives us a lot more operational flexibility to meet better turnarounds times based upon where the demand is coming from. So I think we're progressing well. We're a very good provider of the test. Time is one element. and quality and reliability and also the type of testing we have done. You know, our methodology for PCR tests, both on the LDT side and obviously the kits are somewhat consistent throughout the industry, are really quite strong. So if you look at the accuracy and the quality of our testing, you know, people have come to consider us the gold standard. And I think that will blow it as well going forward as well.

And if I could just make...

Eugene, Kim, your line is open with Wolf Research.

Good morning, and thank you for all the color around guidance. Apologies if I missed this, but have you guys provided the average reimbursement levels for the PCR testing in Q4? And can you comment whether you are embedding similar levels in the first half guidance?

Yeah, so we didn't specifically call that out. But I can tell you that it did not change much in Q4 from where it was in Q3. And, you know, so, you know, it was above $90. You know, we do have some client-built customers that are less than 100, and we don't, you know, get paid for 100% of the testing. Sometimes due to missing data and so on and so forth, we do get some denials. But, you know, certainly north of 90 was the AWR previously. Now, we did talk about the fact that we expect that to have some pressure and to reduce over time through the first half. That doesn't mean that it absolutely will, but in our guidance, in the midpoint of that guidance, we did make an assumption that, you know, given the new model with the $75, not just with TMS, with some commercial payers, we're not going to get paid for 100% of our tests at that 100 where we had been done previously. Still a large majority, as Steve said, meet that two-day turnaround time. So that will create a little bit of erosion. And then also I mentioned that, you know, there's a lot of capacity and therefore a very competitive environment in that client bill arena aside from the third party.

Got it. Thank you. And just as a quick follow-up, On the base business, can I confirm, you said you don't think you'll get back to pre-pandemic levels in first half. Is that compared to 2019, or does that include acquired volume as well? Thank you.

Yeah, that is correct. What I said was, you know, as we're looking at the back half, even though we're not giving guidance because there's too much uncertainty around it, we expect it to be back. to pre pandemic levels towards the end of 2021. So in the first half, we still expect to be down versus 2019. We felt, you know, even though the pandemic didn't start largely for our business till March, easiest compare and how to talk about it is 2019 volumes. Um, we did have a, uh, a large growth for the first two months of 2020, as we shared at our first earning quarter earnings call, you know, so that confounds things a little bit on the year to year comparison. But, yes, we're going to continue to talk about our volume performance relative to 2019 because it's the cleanest compare for the whole year.

And when we speak to that, I heard it in your question, we are looking at organic growth. And so, you know, we spoke of a couple acquisitions that we closed last year. And, you know, in our organic discussions, we're excluding those and any other deals we might do. So it's organic-based business we're talking to.

And we think that's the best representation of utilization. So that's why we think it's important. Our organic performance versus 19 kind of gives a sense of our size and reach. We think where the market overall is performing.

Yeah, so the acquisition revenue will be on top of that. We obviously announced a couple of deals, and what we said is we have a good funnel, and anything we might do prospectively would be on top of what we said.

Derek DeBrown with the Bank of America. Your line is open.

Hi. Great. Thank you, and good morning. So just one quick one. Can you provide a little bit more color on how should we think about the margin progression throughout 21, and particularly how much of your With the core business still being down, how much of that is a margin headwind? Just sort of thinking about the dynamics as we go from the first half to the second half with, you know, COVID volumes testing coming down and the return to basically more normals for the core business. Just wanted to get some thoughts on the margin progression of workflow, please. Thank you.

Sure. So it depends when you say is it a headwind. It depends on to what you're comparing it. As we expect the base business to improve, that's a significant margin tailwind versus the prior period because we are, in any given window of time, a highly fixed cost operation on our base business. And while we took some significant cost actions, in the second quarter of last year in response to the significant downturn in our volume, and we've continued to manage our costs very, very tightly through the back half recovery to not get out in front of ourselves. You know, we're not planning on any significant restructuring in the near term with, you know, volumes that are down single digits at this point. So our cost structure in the base business is to some extent what it is, and we'll add small, you know, pieces that are necessary as it recovers. But that, you know, growth and recovery in that base business sequentially is a nice tailwind. Now, on the other side, as we talked about, you know, expect erosion in our COVID volumes, you know, that, you know, creates a headwind. And how those two pieces offset each other is hard to predict slightly, you know, specifically. But, you know, I would at this point expect that the COVID reduction more than offsets the base, but at least they do partially offset each other as we move forward. And then the other dynamic is obviously reimbursement on the PCR test. And we shared that we expected some, you know, pressure on that as we go, you know, from the first quarter into the second quarter sequentially and then likely even more so in the back half of the year. So without getting into specifics, those are kind of the things you should, you know, specific numbers. Those are kind of the things you should think about as you think about where our margins are going to go through the first half and into the second half of 2021. Thank you.

Lisa Gill with JP Morgan, your line is open. Thanks very much. Good morning. Thanks for taking my question. I just wanted to follow up on your comment around the acquisition opportunities. Steve, you know, one of the things that was anticipated that with PAMA, there'd be a lot of pressure and you'd see more acquisition opportunities. With PAMA now being pushed out, does that change anything, number one? And number two, when we think about reimbursement, as we've been talking about for molecular tests, et cetera, I would think a lot of these labs have done well during this period of time. Does that change what their expectations are at all around what their business is worth as we think about acquisition opportunities?

yeah so thanks lisa for the question so so um the first part is really about acquisition opportunities around hospitals and you know you see that we announced a couple of deals last year that we we uh we're happy we did and that's going to help us and we could continue to see a nice funnel for for 21 as well and as you all know hospital volumes up and down through 20. They have recovered for us. However, what we do see is a lot of renewed interest of looking at their lab strategies, which includes acquiring their outreach business and includes professional lab service agreements like we just announced in the fourth quarter. That relationship we announced in the fourth quarter with HACSAC, Viridian Health System, is the largest we've ever done. And I can tell you, it took a long time to get there. And I believe the perspective reality of what's happening in the healthcare market this year helped bring that to a conclusion. And I believe that that will happen with a number of dialogues we have going on with hospitals right now. So that's one piece. The second is on other commercial laboratories. Yes, you're right. A number of commercial laboratories that jumped into the COVID testing arena you see it with you know all the capacity we've added in the country however as that starts to be pulled back and they start to see what the prospects are given you know what we're driving as an industry with consolidation with tighter contracts and networks around health plans we believe that you know there still will be a catalyst in the marketplace for us to continue to consolidate. So, yes, there's been a short-term opportunity for a number of labs to take advantage, if you will, of the opportunity to provide COVID-19 testing. But as that starts to change, as we get throughout 21, we believe the realities of what the new world will be with tighter networks, more consolidation will play nicely into our strategy and allow us to acquire more going forward. And obviously, given our cash position and strong balance sheet, we're in a very nice position to continue to do that. And also, Lisa, there's been a lot of discussion around all this additional capacity out there. People have added new systems and potentially, does this prevent a risk for us that these people are going to get into other businesses outside of COVID like Women's Health? We are watching it. Obviously, some hospitals have moved their molecular capacity to COVID and and we help them with some of the other work. But for other commercial laboratories and hospitals to use that capacity to get into competing with us, by way of example, women's health, that's a long stretch. I mean, there's a lot more to getting a client to flip over than the lab capacity. You have to have a sales force. You have to have logistics capabilities. You have to do electronics. You have to work with the physicians. You have to be in a contract with the health plans. So we are watching it, but at the same time, we're a little cautious in the belief that some of this will have a significant effect. At the same time, we're watching it carefully to make sure it doesn't, and we're staying on top of our clients to make sure we serve them well.

Yeah, so if I could add, Steve, just a couple things, Lisa, on your question around our pipeline. At any given point in time, you know, we've got multiple opportunities that we're discussing. I can tell you that, you know, none of the potential sellers that we're speaking to right now are getting and expecting to get paid for that PCR bubble. So fortunately, I could see a mentality that, you know, hey, my value has gone up dramatically because of, COVID testing, but, you know, the people we're talking to right now recognize that that's short-term and that should not be a part of the valuation discussion. And then, you know, while PAMA gets a pause this year, you know, there's still, you know, some risk. But more importantly, as, you know, we've mentioned and I'm sure you've seen, it's not just CMS, but the commercial payers are starting to, you know, put pressure on these high hospital outreach rates you know, recontracting that work that's outside, you know, the patients who are in the hospital, either, you know, admitted or outpatient at independent laboratory rates. So it's not, this pressure is not just coming from Washington, it's coming from the commercial payers as well, and from, quite frankly, patients who, you know, don't like those high prices when they have a high deductible plan. So there's a number of things that are getting the C-suites of large hospital systems with the outreach to think about do they really want to be in this business and will this be a good time to monetize? And so, therefore, I really don't see the pipeline of interest having been impacted over the last 12 months negatively.

Matt LaRue with William Blair. Your line is open.

Hi, good morning. As I think about the various components of your response to COVID-19 and your role in testing, Two things that stick out as step changes from a pre-COVID world are certainly capacity and then consumer engagement. I think the number of patients using Quest Direct has doubled in the last 15 months. So just curious, what can you do as we move to sort of a post-COVID world to leverage that increased consumer-facing presence, consumer engagement, as well as the added capacity that it sounds like you're still bringing on?

Yeah, thanks for the question, and we're very bullish on our consumer strategy. As you all know, we have five strategies for growth, one of which is the consumer strategy, and our direct-to-consumer business that we've built over the last several years has done quite well, and we do believe that the pandemic has now been an accelerator for that. We're providing COVID-19 testing, through that platform. We're going to look at using it for consumer genetics. And, you know, as I said in my interactive comments, an interesting part of the pandemic is brought to the forefront, the strong role of testing and overall health care. And QuestMain has been out there more than ever. And our brand has been built. And our brand is really second to none in our industry. And We coupled that with our service performance. And so we have this strong foundation coupled with the change in the marketplace. And we do believe, you know, there's going to be a continuation of a number of consumers that are engaged, that will engage differently with healthcare delivery systems. And now they engage with the physician, with telehealth. We have a very strong presence with telehealth providers and with integrated delivery systems that offer a telehealth option. But at the same time, a lot of A lot of patients as well and consumers will want to receive their basic health checks and testing online as they buy so much else in their lives. And so we're very well positioned with replication, with capabilities. And so we are investing in that in a significant way, more so than we would have if we did not have the pandemic. And so we think about the growth drivers going forward. And we'll talk about this some more on Investor Day. We're very bullish about the opportunity we have in front of us around our Quest Direct, but also the consumer opportunity in general.

Dan Leonard with Wells Fargo. Your line is open.

Thank you. Just one quick one on the deal side. Possible you could frame for us the hack and sack opportunity, the contribution to growth in 2021 and the first hack guide. Thank you.

Mark, you want to take that?

Yeah, so we don't typically announce the revenue impact of deals like this. And again, I want to remind you, this is organic. So this is not something we bought. We worked with Hackensack and demonstrated to them that we can perform the same work they do in their lab at a better cost, better value. And for a system that size, there's significant lab spend. So this is is going to be quite impactful and beneficial to them. And we see that as a, you know, opportunity, obviously, to also get other clients who, you know, will get their attention to see, hey, if Hackensack, you know, thinks that this will work well, you know, in addition to some of the other hospital systems that we've won over the last couple of years. So we're very, very excited about it. It is a large deal. It's the largest deal we've ever done. It will be, you know, material to our growth. And, you know, we talked a couple years ago at our investor day, and we'll likely give an update on this, but, you know, we thought we could get more than 100 basis points and, you know, somewhere between 100 to 200 basis points of growth every year from our PLS business. And certainly this one is a large contributor to that and might even give us an opportunity to exceed that. You know, very large deal, but, you know, we're not going to. We haven't had a historical precedent of calling out the exact revenue, but it will be, you know, noticeable and material as we go into 2021 and beyond.

Ricky Goldwasser with Morgan Stanley. Your line is open.

Yeah, hi. Hi, good morning. So, I mean, clearly there's a lot of uncertainty around second half and the trajectory of the comeback of a more normalized utilization level. But if we step away from the timing and just think about the margin trajectory, how should we think about core margin trajectory from where they were, let's say, in the fourth quarter to where they can expand to as utilization comes back? to a more normalized level. So again, the question is more about the margin trajectory as it relates to utilization, not about the timing. And then my second question is more about sort of market demand. So how do you think about changes in physician behavior patterns? You know, we're seeing telehealth becoming more integrated into the workflow. So do you think that there's going to be any impact on longer-term lab testing demand curve

um because of that i don't know if it's the experiences early in the year could shed some light on that yeah sure mark you want to take the first part of it for a second yeah so ricky obviously the you know size of the revenue was generated from coved which more than offset the base business has materially impacted our margins and expanded them greatly relative to our historical margins So as we progress, and we'll talk more about this at Investor Day, but we progress into a future where COVID testing is still around for a while. As Steve said, we don't expect it to go away completely, certainly by 2022. It's going to be less material to our top line and to our margin. So where will our base business be? Once we get back to the pre-pandemic levels of 2019, I would expect our base business to be, you know, slightly higher margin than it was pre-pandemic. Because as you look at, you know, our Inmigrate program, which we continue to drive even during the pandemic, and you look at the offsets of the pay-fors that we usually talk about, including wage inflation and price erosion, you know, given the pause on PAMA this year, And given, you know, the fact that we've done really well in other price concessions, despite, you know, significant increases in our SWB that was warranted during the pandemic, you know, as we wanted to reward our employees for their incredible contributions in getting us up and running, operating well through it, and obviously driving strong company results. And when I net all those together, that level of business should be more profitable. And then going forward from that, when we get back to the growth that you saw in 2019 and you saw in the first two months of 2020 and our ability to leverage that growth, I would expect to see margin expansion on the base business. But of course, that will be partially offset for a period of time as the COVID revenues and margins fall down. So You know, longer term, the good news is, you know, we were on a good path on growth and margin expansion pre-pandemic, and we will, you know, we'll get back there. But for a while, it'll be somewhat masked by the COVID decline that's inevitable, you know, over the next certainly 18 months or so.

Yeah, and a question about physicians, Ricky. We're watching this carefully because we do believe that going back to an earlier question about the consumer activity, that there will be a transition here now going forward with physicians serving the market in a different way. As we said before, about half the physicians have either sold their practices to integrated delivery systems or have strong affiliations with integrated delivery systems. And that will be consistent going forward. But the other half of of the market we believe there will be a growing percentage of that portion of physicians that are served by telehealth and we have a very strong position with those telehealth providers and that was before the pandemic and those telehealth providers are not going to work work with handfuls of laboratories we'll work with a few and then we'll have a real tight for lab network as you would expect And as you would expect, Quest would be one of those options. So we feel good about that. Second is you see more consolidation going on in physicians and you see what's happening, you know, particularly with one of the health insurance companies, Optum, acquiring physicians and a number of those physician practices are our customers. You think about that consolidation and think about their role and think about where they add value bringing all those physicians together. We believe there will be an opportunity for us to work with a consolidator like Optum to provide lab services more broadly and really reduce the variation they have with all their physicians. And just one last point to show that this world is moving to a tighter network of lab providers. In the fourth quarter of last year, UnitedHealthcare actually announced the removal of out-of-network benefit for some of their fully insured members. And so it's just another example of a major health plan tightening up the network. So we think the physician side will change, and there will be a different way of providing physician services to patients going forward. And that trend, we believe, is a good trend and will provide tailwind for us to consolidate the market.

Aaron Wright with Credit Suisse.

Your line is open.

Hey, Aaron.

Hey, thanks. Thanks so much for sweeping the end. Just to follow up on that competitive landscape and consolidation, so it sounds like you don't expect there to be any sort of meaningful impact on your opportunity around consolidation, just even given the dramatically expanded installed bases, PCR instruments across the U.S. over the past year. I mean, I would assume that customers do want to monetize those investments to some extent, and I'm just curious what you're seeing in terms of market share shifting outside of maybe COVID testing that you're seeing already, if that's happening at all. I mean, it sounds like everything still remains an opportunity from an M&A perspective and consolidation standpoint. And then my second question is just on how should we be thinking about the long-term dynamics as it relates to COVID testing? It will obviously diminish with the vaccine rollout, but Could it evolve into something more similar to, like, flu testing in future years? And can you remind us of the flu testing exposure you do have?

Sure. So, you know, as I said earlier, we believe that hospitals will be now increasingly looking at their options to become more efficient given the pressure the pandemic's put on many of them. And we're encouraged by, you know, the level of discussions we've had and know the deals we've closed as an example that this is happening so we think that's good on the commercial laboratory side we believe that you know some have gotten into the covid testing opportunity it's provided somewhat of a an opportunity for them to get through this year but as you know the dust settles and testing volumes go down you know the reality of what we talk about dynamically doesn't change and we think there would be many of those that would be looking at their options And we do believe that COVID testing will continue into 22. We believe that this will be a virus that we'll have to manage. So it will be more flu-like and something that will be behind us in the end of 21. And it's hard for us to scale at this time what that will be. But you should not think that this is going to be a testing opportunity that will go away at the end of this year, but we do believe they'll be with us in 22 as well. And as far as the flu, we talked about prior to Ernie's call that we have offered a combination panel that when a patient presents itself with symptoms, the physician wants to rule out the flu and also COVID. And so we have seen, you know, that be accepted. But as you all know, the incidence of flu this year is down considerably because of all our behaviors in the United States. So that has changed somewhat. Sean or Mark, you want to add something to food testing in general and exposure to answer the final point of the question? Yeah, I don't have anything to add, Sean.

Our last question comes from Brian Tankler with Jefferies. Your line is open.

Hey, good morning, and thanks for speaking with me. And I guess just one quick question, Mark, as I think about capital deployment, obviously you're generating a lot of cash, and it sounds like the hospital acquisition opportunities are the pipelines there, but maybe a little slowing coming through. So how should we be thinking about your willingness to buy back more aggressively in the front end, and how should we be thinking about just other capital deployment opportunities, whether it's internal on the CapEx side for growth?

Sure. So we are investing quite a bit internally. As you may have seen or you'll see in our capital spend for 2020, we ended up $418 million, which was above the initial range. A lot of that was related directly to the COVID capital that was necessary. But we certainly have not stepped back on investing internally because we think it's the best way to drive returns. A lot of that obviously is related to our Invigorate program. You know, we are moving all of our new assay tests to a single platform. We continue to move forward on that. And then a big piece of the 2020 and the first half of 2021 is was really the quest in our new facility. Although we started operating in early January, which we still have some final fit out and equipment to put in and that'll drive some of the spending in the first half. So we absolutely have a high priority on internal capital and will continue to do so. You can see we got it to 200 million in the first half, which is, you know, about 50% of what we spent in 2020. as we step back a little bit from COVID capital, but we have some continued spending on Clifton and then also the normal priorities in which we spend. On share buybacks, as I mentioned, I will give a lot more color on the investor day. The reason for that is, you know, we do have some things that we're monitoring around potential cash deployment. We'll have greater clarity on as we move over the next couple weeks. We also wanted to get a little more of 2021 Q1, you know, behind us to see how that performance continues and what our expectations, you know, for Q2 look like at that point because every day, every couple weeks, every month certainly gives us, you know, better line of sight into expectations. But, you know, by us seeking and getting approval and announcing a billion-dollar increase in our authorization, certainly you correctly are taking that as a signal. And as I said, specifically in my prepared remarks, that we're going to do more share buybacks than we have done historically. And I'll remind you that our capital allocation strategy, which we have not changed to this point, is to give a majority of our free cash flow back to our shareholders, to our dividend and our Share repurchases, we suspended them for 20, 24 period of time. But even with the 250, you know, we spent in Q4 and the increase in dividend over time, you know, we're behind that 50%. So we have some catch up to do.

Let me just add to that the performance we had in 2020 and the performance that we're indicating with our guidance in 21 is affording us an opportunity to invest in our growth strategies. And that includes what we've talked about on this call, working on the relationships with health plans or gaining traction with presenting our lab strategy view to health systems, hospital health systems, what we're doing around advanced diagnostics. And then finally, what was asked about earlier around the consumer opportunity in front of us. So Implied in the guidance is an increase in investment for those growth drivers to accelerate growth of our base business within 21, but as we enter 22 as well. So if there are no further questions, I'd like to thank everyone for, again, joining us on this call. We appreciate your continued support and interest, and you have a great day. Take care.

Thank you for participating in the Quest Diagnostics fourth quarter and full year 2020 conference call. A transcript of prepared remarks on this call will be posted later today on Quest Diagnostics website at www.questdiagnostics.com.