奎斯特診斷 (DGX) 2003 Q1 法說會逐字稿

Welcome to the Quest Diagnostics first quarter 2003 conference call.

At the request of the company, this call is being recorded.

The entire contents of this call, including the presentation and question-and-answer session that will follow are the copyrighted property of Quest Diagnostics with all rights reserved.

Any re-distribution, re-transmission, or re-broadcast of this call in any form without the request consent by Quest Diagnostics is prohibited.

Now, I'd like to introduce Laure Park, Vice President of Investor Relations for Quest Diagnostics.

Go ahead.

Thank you, good morning.

I'm here with Ken Freeman, Chairman and Chief Executive Officer of Quest Diagnostics and Bob Hagemann, our Chief Financial Officer.

Ken and Robert will update you on our results before we open up the call to your questions.

Some of our commentary and answers to questions may contain forward-looking statements, based on current expectations.

Results could be materially different from our expectations due to factors that are detailed in our 2002 10-K and subsequent filings as well as from unanticipated events.

Now, here is Ken Freeman.

Thank you, Laurie.

We reported strong financial results, increasing earnings per share 28% in the first quarter.

We also completed the acquisition of Unilab, expanding our presence in California.

Before I review some of the major trends impacting our business and address some questions that may be on your mind, Bob will outline our expectations for the rest of the year and talk about the first quarter results.

Thanks, Ken.

The first quarter produced strong performance.

Revenue increased 15% during the quarter to $1.1 billion.

The first quarter included one month of revenue from Unilab and three months of revenue from AML.

On a pro forma basis, assuming Unilab and AML have been part of Quest Diagnostics since the beginning of 2002, revenues grew 3.2%.

Looking closer, clinical testing volume increased 11.9% over the prior year.

The AML acquisition contributed about 8% of volume growth and Unilab contributed about 5% during the quarter.

Pro forma testing volumes declined 1% in line with our previous guidance, reflecting the impact of severe winter storms and the New Jersey physician strike.

We estimate that these events reduced volume by 1.6%, compared to our earlier estimate of a 1.5 to 2% reduction.

In our February 25th guidance we also indicated that the persistent cold weather across much of the country was further reducing testing volumes.

After analyzing the first quarter results and monitoring volume generated so far in the second quarter, we believe that uncertainty related to the economy also had an impact on our business and may continue to do so as the year progresses.

Our drugs of abuse testing business, which is most directly impacted by economic conditions, declined during the first quarter, reducing company-wide volumes by approximately half a percentage point.

Revenue per acquisition grew 3.6% during the quarter.

This increase reflects favorable test and payer mix.

The inclusion of Unilab in our results for one month of the quarter reduced revenue per acquisition by approximately half a percentage point.

Due to the fact that the Unilab business has lower revenue per acquisition than the rest of the company.

We expect the full year impact of Unilab to reduce reported revenue per acquisition by approximately 1%.

Please note that as required by the accounting rules, we have conformed Unilab's accounting policies to those of Quest Diagnostics.

The effect of this change was to increase the revenue per acquisition Unilab had been reporting by approximately 2%.

With the corresponding increase in bad debt expense.

There is no net changed reported profit or cash flow as a result of these conforming adjustments.

EBITDA margin increased 180 basis points from last year's first quarter to 18.2% of revenues.

The improvement stems principally from increased revenue per acquisition and efficiency gains, resulting from our Six Sigma and standardization efforts.

We continue to be very disciplined in our overall cost management.

Efficiencies in our billing process enabled us to further reduce bad debt expense to 5% of revenues compared to 5.8% a year ago.

DSO's remain at 49 days, compared to 52 days a year ago.

This improvement in bad debt expense and DSO's curd despite the addition of Unilab, which has higher levels of bad debt and DSO's that be the rest of Quest Diagnostics.

Cash from operations was $58 million, compared to $53 million last year.

First quarter cash flow from operations is typically the lowest of the year because of the timing of certain annual payments.

These payments totalled more than $100 million and included variable compensation payouts for our own employees, annual insurance premiums, and other annual payments associated with the crude vacation pay.

During the quarter we re-paid $42 million of the $450 million borrowed in connection with the Unilab acquisition.

The balance sheet remains strong.

Our debt to capital ratio now stands at 35%.

Turning to guidance, for the full year we expect earnings per diluted share to increase to between $4.10 and $4.20.

This includes approximately 10 cents to be contributed by the Unilab acquisition, but excludes any integration charges associated with Unilab.

We also expect revenues to grow approximately 14% to 16%, EBITDA to be approximately 20% of revenues, cash flow from operations to exceed $550 million, and capital expenditures to be between $180 million and $190 million.

The full-year revenue guidance of 14% to 16% growth has several elements as described in footnote 5 to our earnings release.

Approximately 9% of the projected revenue growth is attributable to Unilab, approximately 2% is attributable to the carry-over impact of last year's AML acquisition, and the remainder of the revenue growth -- approximately 3% to 5% -- is from our base business.

Volume is expected to grow 12% to 13%, approximately 10% growth attributable to Unilab and approximately 2% attributable to the carry-over impact of AML.

The remainder of the volume growth -- 0 to 1% -- is from our base business.

Comparing this to our earlier guidance, we have reduced our projections for base business growth by 2%, a portion of which is due to the first quarter performance and the remainder due to the change in our outlook for the rest of the year.

In addition, we have removed 2 points of growth that had been projected to be contributed by additional acquisitions.

We continue to pursue selective acquisitions, but have decided to remove any impact from revenue guidance to provide better clarity.

The estimated revenue per acquisition increased for the base business is now expected to be between 3% and 4%, a 1% increase from previous guidance.

But as off-set by the 1% impact of Unilab, which I explained earlier.

Accordingly, reported revenue per acquisition is expected to grow between 2% and 3% consistent with previous guidance.

For the second quarter we are comfortable with the current consensus of analyst earnings expectations of $1.11 per diluted share.

As reported by Thompson First Call, before charges associated with the Unilab acquisition.

We also expect EBITDA to approximate 21% of revenues, revenue growth of approximately 14% with revenue per acquisition growth of between 2% and 3% and volume growth of 11% to 12%.

And on a pro forma basis, assuming Unilab had been part of Quest Diagnostics since January 1, 2002, volume is expected to be flat to down 1%, reflecting continuing softness in demand due to economic conditions.

In comparing the second quarter pro forma volume growth to that reported for the first quarter, adjusted for the winter storms and the physician strike, the timing of the Easter and Passover holidays needs to be considered.

Last year these holidays occurred during the first quarter, while this year they were in the second quarter.

This dynamic has been fully factored into all the guidance we have provided to date.

Before I turn it back to Ken, one last comment on Unilab integration costs, which we expect to be no more than $20 million over the next several years.

As result of changes in the accounting rules, we are required to account for integration charges differently than in the past.

Rather than accruing them all up front when plans are finalized, we are now required to record charges as specific actions are taken.

As a result, integration charges will be recorded in multiple periods and will be fully disclosed when recorded.

Now, I'll turn it over to Ken.

Thanks, Bob.

As indicated, our guidance calls for strong EPS growth for the year, 27% to 30%.

We've moderated revenue growth projections, reflecting softness in quarter one, the impact of current economic conditions and the removal of selected acquisitions from guidance.

We believe we're doing the right things to assure sustainable, long-term competitive advantage.

We continue to enhance our value proposition across our focus areas.

Six Sigma qualities are making a different for customers, policy-holders and shareholders.

Six Sigma and standard operations are changing the culture of our company, improving customer satisfaction and providing substantial cost savings to help drive continuing margin expansion.

We're expanding access and distribution to cover more of the United States.

We're excited to be joining together with Unilab.

It's difficult to imagine building a strong foundation for the future without a strong presence, a leadership position in California, the largest and fastest-growing state in absolute terms.

And, we're driving growth in geographic markets where we are under represented, focusing on Ohio and North Carolina for example.

We continue to bring innovative testing and information technologies to our customers.

During the quarter our gene-based testing revenues continued to grow at a rate greater than 20%.

Internet adoption by physicians continued to grow during the first quarter.

We began deploying our physician portal, E-Max in markets across the country.

This expands our leadership in providing value-added connectivity solutions for our customers.

Our targeted marketing programs continue to bear fruit.

During the quarter in partnership with PHARMACIA, we launched a co-marketing initiative.

Representatives from both companies are working together to educate practitioners and physicians about benefits of IMMUNO cap, a test for upper respiratory disease.

We've begun deploying our rigorous integration process with Unilab and remain committed to achieving a annual run rate of $25 to $30 million in net synergies within two years.

We've already made a number of decisions regarding the way we will operate in California.

We plan to combine operations in the Los Angeles area, specifically the TARZANA and [INAUDIBLE] labs into a new facility nearby.

And we plan to exit our Dublin facility, transitioning the work to San Jose and Sacramento.

The AML integration continues to track as we create full-service esoteric testing capabilities in CHANTILLY, Virginia to help the capabilities in San Juan Capistrano.

Our hospital initiatives continues to gain momentum.

We've evolved quickly from a defensive posture, primarily focused on retaining hospital accounts as the result of the joining together with AML to a growth posture, bringing on new business.

Before we turn it over to you to ask questions, we'll address some specific questions that we believe are of common interest to many of you.

First, let's start with the bottom line.

Why did you lower the upper end of EPS guidance to $4.20?

We lowered the upper end of EPS guidance, driven by a reduction of approximately 1 percentage point in our base business revenue growth projections for the rest of the year.

Second, when will you share general guidance for 2004 and beyond?

We will share general longer-term guidance later this year, most likely during the summer after releasing Q2 earnings.

Third, why has your organic revenue growth rate slowed down, are you losing market share or is there a fundamental change in the industry growth rate?

Our organic revenue growth rate is generally stable, after adjusting for the impact of the severe winter and the strike.

We are not seeing any fundamental changes in the competitive landscape and we are not losing market share.

Although no one has current reliable industry growth rate numbers, we believe that industry-wide revenues will continue to grow about 5% a year, but temporarily may be growing at a slightly lower rate.

That being said, the favorable demographic trends, in terms of the growth of the aging of the population and the growth of the population, and also favorable technology trends, continue and we're bullish about the future.

While healthcare services is largely insulated from the economy, current conditions are impacting our business.

An indication for us is our drugs and abuse testing business.

Which has stabilized toward the end of last year, but resumed its decline in the first quarter.

There is also some antidotal evidence that suggests economic conditions have begun to impact patient behavior, temporarily slowing growth rates in our sector.

People across the country are losing their jobs and their health benefits.

We believe that this is temporarily affecting individual patient behavior in some cases with respect to accessing healthcare services.

Fourth, are you seeing variation in growth rates among geographies?

And did growth pick up in March after the bad weather of January and February?

It's quite typical to see variations in growth rates among geographies.

During the first quarter we did experience stronger growth rates in geographies that were not impacted by the severe weather and strike.

Our rate of growth was higher in March than in January and February, primarily due to improved weather conditions.

Fifth, how are volume trends so far in April?

Through the first 15 days we saw modest improvements in requisition testing volume, however we did feel the impact of the Easter and Passover holidays on volume comparisons toward the end of last week.

As Bob explained earlier, these holidays occurred in quarter two this year and will negatively impact Q2 year-over-year volume comparisons by approximately 1%.

The timing of holidays does impact volume comparisons, typically the impact is relatively small, but in the current environment this impact is important to discuss.

This may seem like a nuance, but the impact is real.

Six, your full-year guidance implies growth will pick up later in the year -- why?

We do expect volume growth to accelerate in the second half of the year, albeit modestly, between 1% and 2%.

We remain focused on executing our organic growth initiatives, including geographic expansion, introduction of new tests and technologies, targeting specific market segments for growth, and driving customer loyalty through Six Sigma quality.

Seven -- why have you taken the revenue impact of additional acquisitions to zero from previous guidance of 2%?

We are removing the impact of selective acquisitions from our guidance for clarity.

We continue to aggressively explore acquisition opportunities on many fronts and there is no shortage of candidates.

But we will not compromise our ground rules just to hit a number.

Eight -- if you complete any selected acquisitions, will they be additive to the full-year EPS guidance of $4.10 to $4.20 per share?

No, they will not be additive to this year's guidance.

We have now removed any revenue impact from our top line guidance and we continue to expect that any bottom line benefit from such transactions would be small in the current year and not change our earnings guidance.

Ninth -- are you making any adjustments to your cost structure in light of revised volume projections?

Other than in California, we do not have any current plans to reduce laboratory testing capacity.

We continuously review our capacity utilization and continue the long-standing discipline of maintaining a tight rein on costs.

Taking a moment to summarize: We had another quarter of strong earnings performance.

We remain on track to achieving another year of exceptional earnings growth through a combination of continuing efficiency gains, effective integration of Unilab and AML and a focus on driving profitable revenue growth, despite economic conditions.

And we are well-positioned to provide superior returns to our shareholders over the long-term.

We'll now open up the call for your questions.

Operator?

Yes, at this time we are ready to begin the q-and-a.

Your first question comes from David Lewis of Thomas Weisel Partners.

Good morning.

Ken, if we could drill down more on the volume utilization.

You mentioned 100 basis point recollection reduction in your core business, which percent is drugs abuse and what percent is other economic conditions you refer to?

The drugs abuse testing business in the first quarter impacted comparisons by about a half a point, approximately half a point.

As we look at the rest of the quarter as we mentioned, a number of factors came into play, certainly severe storms and the strike had a significant impact.

We also believe that the economic uncertainty did have an impact, it's based on antidotal evidence as individuals continue to lose jobs and felt the impact of maybe having a job on the top of the list, more so than saying healthcare was at the top of their list in terms of what they wanted to engage it.

Sounds like 50 basis points of drugs abuse and 50 basis points of antidotal, economic issues?

Is that fair?

Certainly if you want to be that granular in terms of the math, you could draw that conclusion, but you could infer in the other half of the percent, there might be impacts for cold weather as well.

We were really able to drive quantitatively was the impact of severe winter storms on a daily basis as well as the impact of the strike.

And David, just to be perfectly clear on our guidance, the fact that we brought down the volume growth for the remainder of the year by about a point certainly drugs of abuse testing is a component of that, but not the primary driver.

So the primary driver is this other economic and weather?

It's not weather beyond the rest -- for the year, for quarter two, three, and four, but it's very much driven by continuing uncertainties relating to the economy.

I want to highlight for you, as we strive to provide estimates for you in terms of projections for the year, the economic conditions are uncertain today.

People are losing their jobs in this country, people are becoming uninsured and we believe that's having a temporary impact -- and I must emphasize the word temporary impact on the [INAUDIBLE] statement.

It's a modest impact, not a huge impact, but a temporary impact as the fundamentals for our industry remain in tact moving forward.

So in the back half of the year, are you forecasting any economic recovery to make current guidance?

We are not forecasting any significant change in the economic conditions to make guidance.

Okay, then in terms of the acquisition, obviously pulling on acquisitions provides greater clarity.

Does it also suggest that potentially there are not as many acquisitions to make?

Is that the principle driver here?

Not in the least.

We want to disvalue any assumption as to that.

The inventory of potential acquisition candidates has never been larger.

However we felt for clarity purposes that to make things less confusing potentially for our investors to make it clearer, we should pull the impact of potential selected acquisitions out of our guidance.

We see more deterioration however in the possibilities.

We also feel the need to not feel that any pressure whatsoever to compromise our ground rules in any way to hit a number, if you will.

Okay, then just on price, price has been a lot stronger than in your historical guidance of 2 to 3%, is this the result of a more favorable make-shift or is this potentially the type of business you're losing during weather is lower-margin business on average, actually helping price?

The predominant factor is test and payer mix by far.

There's a bit of general pricing improvement as well, but at a lower rate.

The impact of weather -- yes, there's a potential for a small impact.

The people who are sickest will figure out a way to get to the doctor potentially in the worst storms, more so than somebody in there for an annual physical, and that might have a very small impact, might have a very small impact on revenue per requisition, but I would say it's very immaterial.

Thank you.

The next question comes from Bill Bonello.

I'm wondering what your guidance preassumes in uses of free cash flow, if it does not assume acquisitions?

Bill, at this point the guidance that we've put forth anticipates that we'll continue to use our excess cash flow to retire the debt that we took on in connection with Unilab.

Yeah, obviously we ton evaluate the best way to deploy our cash flow to maximize the return for shareholders, and as Ken said, we still see numerous growth opportunities available for us to invest in.

But with that said, we realize that something along the lines of share re-purchase or even potentially a dividend are also ways to deploy our cash.

We have no plans for either at this time, but how best to deploy our cash is a topic that we regularly review with the board of directors.

And just to come back on one more point about the guidance and the acquisitions -- we've pulled it out of the top line, which has impacted us about 2% in terms of revenues, bull all along we've anticipated any earnings impact associated with the acquisitions would be very, very small and therefore that's why we're not doing anything with respect to our earnings guidance.

And certainly it's not having any significant impact on what we would plan on doing with our cash at this point.

Okay, thanks a lot.

The next question comes from Kemp Dolliver of SG Cowen Securities.

Thanks and good morning.

Is it fair to say that the integration benefits from Unilab are going to be most closely tied to the timing of the combinations of the labs in northern and southern California?

And can you give us a sense to the time table for the integration process, thank you.

Yeah, Kemp, with respect to the Unilab integration, we've said that we expect to realize $25 to $30 million in run rate synergies within the next two years or so.

We're going to get that by reducing redundant capacity, whether it be labs, patient service centers or labs, obviously overlapping personnel.

The others are contracts and test sendouts, as well as the fact Unilab had private company costs.

Some of those are going to be dependent upon how quickly we can actually move volume from one lab to another and consolidate it, but other costs, such as the public company cost and some of the supply contracts and test send-outs, we'll be able to get sooner rather than others.

And you should expect that there will be some modest synergies this year, which is baked into our guidance and reflected in the 10% creation we expect from the Unilab transaction.

And that the majority of it is going to start to come in next year and the year after.

Okay, that's super.

Also, can you discuss a little more detail your comments regarding increasing your presence in Ohio and North Carolina?

We are not prepared to give you specific details today, Kemp, other than to say let's take as an example the state of North Carolina.

We have put in place a sales force, we've put in place a patient service center network, and logistics to support providing high-quality testing in that state.

And nothing on Ohio?

No specific comments beyond you could probably do a duplicate of what I just said about North Carolina.

Okay, that's great, thank you.

The next question comes from Tom Gallucci of Merrill Lynch.

Good morning, thank you.

A couple of questions if I could.

First, on the economic impact -- is there a difference that you're seeing between the routine or the esoteric -- would it be bigger in the routine area potentially?

I guess what was your mix in the quarter, was it slanted one way or the other?

Tom, during the quarter, esoteric made up about 15% of our top line and we did see continued strong growth in our gene-based testing, which continued up over 20% year-over-year in strong continued growth in our esoteric testing as well.

Obviously with that strong growth, the decrease that we saw was most strongly felt in our routine testing business area.

I might build on this going back to something I said in response to David Lewis's question earlier.

I'd say not a material difference, but certainly when we think about individuals and their attitudes to healthcare, when there's uncertain economics and uncertain world conditions, people start thinking their job is the number one issue perhaps and what's goning to happen in the world, and healthcare maybe goes down the list one or two notches from being number one, unless you have a critical condition.

If somebody has a critical condition of course, it remains number one and you might expect you might infer someone with a critical condition typically may need the more exotic, specialized tests, but I want to emphasize again, I don't think it's a material difference, given the kind of economy we're in today in terms of growth rate comparisons.

Right.

If I could switch gears, you said that the acquisition environment is I guess you said never been better, but you don't want any pressure to compromise your ground rules -- can you describe maybe -- is it the number of acquisition opportunities that are out there that have never been better, but is there a difference in the quality or price sellers are looking for or some other aspect of it that maybe there's a lot of opportunity, but it's a matter of getting things done that take a longer time?

Yeah, Tom, what I would say is this, certainly the inventory of possible opportunities for acquisition has never been longer in terms of the number of opportunities that are out there.

Certainly we adhere to our ground rules as you know in compliance with the law, reasonably well-run and accretive for shareholders in the first year, and those are near and dear to us.

As we reflected on the guidance we gave you earlier at the end of January, we decided to reduce confusion, to reduce any potential confusion in terms of what we might be doing moving forward.

It would be better for clarity purposes to just pull it out, that doesn't signal anything in terms of our plans for acquisition.

We remain committed to, in part growing our company through continuing selected acquisitions, and we'll do them when they make sense for everybody, particularly for shareholders.

Okay, if I could ask one last one.

A lot of talk on the top line and the volume so far.

You raised your EBITDA margin expectations to the higher end of the range I guess.

Can you give more color there, if you could?

Thank you.

That's principally a function of the fact that we continue to see very good progress with respect to our Six Sigma and standardization efforts.

And additionally, the top line in terms of revenue per requisition is slightly improved.

We've realized some significant benefits this year as result of standardization and Six Sigma, some of that's showing up in our bad debt expense at 5%.

It's continuing to ratchet down from where it was and keep in mind we have a long-term goal of less than 4% there.

But additionally, any time that the volume isn't where we would necessarily like it to be, we're constantly looking at our costs and making sure they're totally aligned with the anticipated volume that we have coming in the door.

Thank you.

The next question comes from John Nicolson of Sanz Point Partners.

Thank you, my question's already been answered.

The next question comes from Al Kildowny.

Good morning.

I wonder -- I don't know if you provided it, but can you provide the percentage of pap tests being performed under CYTOLOGY in the quarter?

Our conversion rate of monolayer pap tests was 84%, our exit and average rate for the quarter.

Great.

And are you able to comment on any plans you might have to promote HPV testing in combination with [INAUDIBLE] detail [INAUDIBLE] as a primary screening tool?

We believe cancer testing, including AP, is an important area for growth.

We believe it's growing faster than the overall market and we're well positioned to capitalize on this growth.

As it relates to specifically on the DNA pap, Quest Diagnostics, along with any other company in the impact to us, we really need to wait to evaluate physician ordering patterns.

From a prosper inspective, we will be educating physicians on what the new FDA approval means obviously, as a point of reference the FDA approval obviously was only within the last 30 days and at this point in time we have not yet received the packaging insert or the data used by the FDA to make their decision.

Lastly, quickly, are you able to comment at all on your process in evaluating the second thin layer pap test technology for use in your labs?

At this point in time we have put in place a team to operationalize the activities.

As we indicated in the press release, we will be piloting it in a couple of our regional laboratories and you should expect we will have it in operation in these laboratories by mid-year and we will begin at that point to offer choice to physicians for monolayer pap testing.

Great, thank you.

The next question comes from Angie Sanfillippo of Piper Jaffrey.

Good morning, it would seem that Easter falling in Q2 of this year created an easy comp for Q1.

How should I think about how maybe that positively impacted volume in Q1?

Angie, with respect to the impact of the timing of the holidays, as Ken mentioned, it impacts the comps in Q2 by about a point, versus the prior year.

Likewise, it impacted the comps in the opposite direction by about a point in Q1, so quarter one was benefited by that timing, just like quarter two is hurt by that timing.

When you look at Q2 versus Q1, there's actually a 2% swing in terms of volume growth.

Okay.

And in terms of pricing in the quarter, can you give us what percent was true price and what percent was mix shift?

We don't typically share the specifics.

What I would say to you, Angie, though, is very much the payer and test mix drove the majority of the improvement and the general pricing did improve, however the bigger drivers were test and payer mix, the majority was test and payer mix.

Okay, my last question, can you comment on what you're seeing on the acquisition front in terms of pricing?

What has happened to multiples?

Do you think as we get further out from the Unilab and even the DIANON deals that multiples will come down and deals will be easier to do?

Angie, with respect to the multiples and the prices that we pay for acquisitions -- to a large degree, they're a function of where evaluations are in the industry at any one point in time and obviously one of our starting points is how we and others that are publicly traded are being valued and obviously as Ken said, we're looking to do transactions that meet all three of our ground rules, including the fact that they've got to be accretive for shareholders and generate positive returns.

So over time, evaluations do move, but they generally tend to move with the industry overall.

Okay, thank you very much.

The next question comes from John Szabo of CIBC World Markets.

Good morning.

Just a question about -- what makes you think that some of this weakness is economic-related beyond the drugs of abuse, which you can obviously measure?

Are there specific ant dots you can pass along to us that make you draw that conclusion or is this more of your interpretation of the situation?

As we look at the aggregate of what's going on out there, I'm not prepared to share specific stories with you, however, if we look at membership among the various managed care plans and we look at what's happening to participation rates with managed care and the number of uninsured, we do see a trend develop, which says memberships are declining and have been for a period of time as we've gone through the economic times that we're going through, and the number of uninsured have gone up.

Those indicators would suggest that there would be a slight decline in the use of laboratory services, potentially as individuals focus more on whether they have a job or not and bring food to the table as opposed to taking care of their health as their number one priority, unless they have a critical health condition.

Okay, have there been any sort of plan designs that you're aware of that may have also affected the sensitivity of the consumer to testing -- was that a factor at all?

John, that's a good question.

It would appear that plan design, while it may be a factor, is a lesser factor as a person impacted by a plan design, obviously still at this point has a job and has health insurance.

Also, looking at comments made by the managed care players, they say they're not seeing an impact also from changes in plan design.

So to answer it, while there may be a lesser -- impact, there's definitely a lesser impact than the increase in uninsured and the membership declines.

Okay, thanks.

The next question comes from Gary Leibermann of Morgan Stanley.

Thanks.

If we could stay with the managed care theme for a second.

A lot of discussion about more difficult negotiations between employers and managed care companies going into the rate environment in say '04 -- what, if anything, have you seen or indications do you have of how that may impact you or your negotiations with managed care companies changing at all, becoming more difficult.

Any detail there?

Gary, our negotiation with managed care have always been very, very challenging.

Our managed care customers are highly valued and strong negotiators and have been forever in our business.

Keeping in mind that we're only about 3% of their spending, it's important to keep that as perspective, as well as the fact that we can prevent significant costs later on in the providing of healthcare if we can help folks avoid costly surgery and other procedures later on.

So our value proposition at Quest Diagnostics is all about providing the capability through the full array of quality servicemen you and access and distribution, to allow us to be priced competitively to enjoy the business from managed care.

We don't see today dramatic changes either way in what has historically been and will continue to be a highly-competitive environment in dealing with managed care.

Certainly, Quest Net is also an opportunity for us in dealing with some of the managed care companies to help them manage their overall spending.

Keeping in mind that typically maybe 30% to 40% of the typical spending a large managed care company might have, goes to the contracted providers and the rest is what's called leakage, provided by uncontracted providers at retail prices.

We think that will play an ever more important role as we continue our dialogue with managed care in future years.

Thanks.

Just one follow-up.

Not sure if you gave it or not, but if you could give the percent of your revenue classified as esoteric and the percent of routine.

Approximately 15% would be classified as esoteric and that's using the exact same methodology as at the end of the year.

Thanks.

The next question comes from Sandy Draper of Sun Trust Robinson Humphrey.

Good morning, thank you.

Two quick questions.

One, I may have missed it.

Did you give a target, Ken, for bad debt for by the end of the year?

We did not give specific guidance for bad debt for this year.

What we have said is we believe that over the long-term we'll be able to drive bad debt down below 4%.

Okay, do you think -- will you expect any sequential change with a full quarter of Unilab.

Do you expect it to bounce up higher than the current quarters or is that not going to be a significant issue short-term?

Again, Sandy, we're not providing specific guidance with respect to bad debt, but as I stated earlier, Unilab's bad debt is higher than that of Quest Diagnostics.

Several points higher.

And it did impact us a little bit in the first quarter, but keep in mind Unilab was in there for only one month in the first quarter and we'll have a slightly bigger impact as we get into the second quarter and third.

But also keep in mind that that is one of the areas that we believe is a synergy opportunity for us as we start to deploy our billing practices at Unilab.

We believe we'll be able to significantly drive down their bad debt expense.

Great.

And the second question -- on the pricing side, typically, acquisitions don't have a material impact on price.

Is it you know -- looking at Unilab, is it because of the size of Unilab or just that they had such a small percentage of higher margin, higher price tests that you're seeing a meaningful impact to your overall pricing?

It's principally the impact of their payer mix, which is a little different than ours, and as a result, they carried a lower average revenue per requisition, but keep in mind they also had very strong EBITDA margin percentages.

And with you expect on the payer mix -- is that something that as part of Quest now, you're goning to be really focusing on those payers and trying to work on the pricing as you've done over the past couple years?

Certainly you should expect we'll practice pricer discipline, but mayer mix is not something we can necessarily influence.

It's more driven by geography and the markets in which the companies are operating in.

And you should expect that California is a highly-competitive market and that's one of the reasons that you see the average price per acquisition lower there than for the average across the cop.

Great, thanks.

The next question comes from Debra Lawson, Solomon Smith Barney.

Hi, I have a couple questions.

First of all, can you give us an indication of on drugs of abuse at this point, what percentage of your testing volume it represents presently?

Then I have a couple other little ones.

Drug abuse testing volume as a percent of the total is in the zone of 7-8%.

Okay.

And obviously a much smaller percentage of our revenues.

Right, and what would you say two years ago or whenever it sort of was at its height what percentage of testing did it represent at that point?

It was approaching double that in terms of revenues several years ago.

Okay.

All right.

And just two other things, one is that you did say on the acquisition front you weren't looking for them to be additive and clearly you've taken them out of the guidance and what-not.

But is -- but you may do some, but you said you wouldn't expect them to be additive.

Is that because the things you're seeing are just from a size stand-point, just not material?

Is that what you're indicating?

Essentially what we said was we were anticipating about 2% or so in revenue growth from acquisitions. 2% is a relatively small number and we did not expect it to drive earnings in any one year significantly.

Okay.

And then lastly, can you just comment on any trends you're seeing with regard to co-pays and irritability to collect them, you know, is it becoming -- especially with the economic environment -- becoming harder or just give us color on that front?

And that's it, thanks.

Sure, Debra.

Interestingly enough, in the laboratory environment there's relatively low incidents of co-pays with managed care carriers.

We are more likely to see the co-pay with the physician office visit or with pharmaceuticals.

So it's a relatively small component for us.

As to billing and collection, because it's a small component, it's really not having an impact on our cash flows or bad debt expense.

Typically you're in-net provider, so there's another issue there of a deductible.

There's relatively low incidents of co-pays in the laboratory space.

Typically if we're billing for out of network business, that's at a much higher price than contracted business.

Right, okay.

I want to come back briefly on the acquisition question, just to make sure we're all clear here.

We see no shortage of opportunities to acquire companies, our ability to acquire companies is not diminished in any way, shape, or form, and we're not signaling anything in that direction by taking the revenue growth out of guidance.

What we want to do for you is provide clarity and to put -- we got a lot of feed back suggesting that having revenue growth from acquisitions that were not yet conspiracy mated in our guidance would confuse people potentially and we want to be as clear as we can.

We believe we can continue growth of business organically and inorganically.

It's all about timing, all about size of acquisitions and making sure the ground rules are met, but there's no shortage of enthusiasm, commitment, or opportunity out there today as it relates to acquisitions.

Okay, great, thanks.

The next question comes from Ricky Goldwasser of UBS Warburg.

Good morning.

Is your new volume guidance based on margin April volume trends that you've seen?

And in addition, we're hearing there's another strike planned in New Jersey in mid-May and is this included in the guidance?

Ricky, as Ken mentioned earlier and as I mentioned as well in looking at our volume subsequent to the close of the quarter, we saw some improvement, but we were impacted by the holidays, but.net, we continue to believe that the economy is having an impact on our overall business, and that was the principle reason for bringing down that base business volume growth.

There is some discussion of a possible strike again by physicians in the New Jersey area.

We do not have anything specifically factored into our guidance for any additional strikes that may occur, either in New Jersey or potentially anywhere else in the country.

Okay, so I guess again, just to get more clarity on my question, I understand that you've seen some pickup in volumes at the second half of March and April, so you're not seeing deterioration or a negative 1 percent.

So is what you're seeing is in the flat to positive 1% range or are you trying to be overly conservative and say April is actually better than that, but we want to be conservative, so we're telling you flat to 1%.

We're trying to call it as we see it and give you our best view as to where we think volume is heading at this point.

Okay.

And as part of the AML business, have you seen any customer tradition from hospital clients shifting away from Quest and moving to other competitors, other private competitors?

Ricky, we've seen some movement, but nothing out of the ordinary.

Typically when you acquire a company, you'll find that there's a potential for some attrition of clients.

We've been very focused on retaining our hospital clients we've brought on board after acquiring AML and had very good success in aggregate in doing so, and as we move forward, we are moving much more aggressively today towards growing the business, going from preserving to growing.

With our dedicated hospital sales force that's now been in place for about six months.

And we're seeing good signs, good progress.

But as you know, typically when you do an acquisition, there is the risk of potential breakage, particularly if the company you acquire may have built itself in part as being a non-competitor with hospitals.

But we've come through that and we are very bullish in moving forward and growing the hospital business.

I'd also like to just add onto something Bob said earlier as well.

As we look to the rest of the year, as you know our guidance implied for the rest of the year in terms of volume growth is about 0 to 1%.

If you look beyond the impact of the first half in terms of volume growth.

And in driving that, certainly it's our focus on execution.

In the base business.

All right, and it's all about driving our product segmentation, our market segmentation, our geographic segmentation as we move forward.

Another question relates to the thin layer products, I think you mentioned it was 80 % in the first quarter.

Was it at about 80% also in the fourth quarter, if I'm not mistaken, are you seeing some slowdown in conversion there?

And also, what percentage did it contribute to pricing growth?

I understand -- Ken, you said you're not goning to give much information, but I know in the past you said 50% of price growth was product mixture, 50% organic, so is it still 50/50, and if so, of that percentage, what percent Yang is really thin prep?

Ricky, as we've indicated in the past several quarters, over 50% of the revenue per requisition improvement came in improvements in test and payer mix.

The current quarter is consistent with that trend line with over 50% coming from improvements in test and payer mix.

As we have in the past, we won't this quarter give any specific tests that's driving at any specific amount.

You can trust that our continued focus on the higher-end gene-based and esoteric tests and focus on hospitals and physician specialists and their testing needs is helping to drive partial of the route improvements in route requisition.

As to your initial question on monolayer pap testing conversion, in the fourth quarter our exit rate was approximately 80% as well.

The current quarter is at about that same rate.

I don't think that in light of with the weather and other items going on during the quarter that I would draw any conclusions on slowdowns and pap rate conversion.

Ricky, one other thing on the contribution to the price, associated with the thin layer -- over the last several years we had seen a rapid ramp-up and as that starts to mature and slow down, obviously the contribution that it has towards increasing prices is much smaller than it had been in the past.

Okay, and lastly, maybe you've commented about already, in terms of Cap Ex, there's an increase compared to the spend in '02.

Is it related to upgrades until the Unilab facilities?

Not any specific upgrades per say.

The fact that we've added about $400 million in business means that we're going to have additional capital requirements, but there are no specific items built into this year's guidance.

And yeah, we'll be evaluating that, but again, in terms of Cap Ex, it's historically run for us about 4% of revenues over the last several years as we've been investing in our business and I'd expect it to look like that for this year and next year at least.

Great, thank you.

The next question comes from Bob Willoughby of Bank of America.

Thank you.

Ken, can you provide any detail on specific changes in the organic gross strategy?

I think your efforts to date really have not been rewarded much in the way of returns.

It's not clear to me what's changed to position yourself better for internal growth.

Bob we are moving forward with the programs that we have put in place over the course of the last 12 to 18 months and they're just now in the mode of going from being put in place to starting to drive bearing fruit.

An example of an initiative as an example that's bearing significant fruit is our genomic and esoteric representing sales representatives.

They've been in place over a year.

We've recently expanded toward the hospital business as well and they're driving substantial growth.

In addition, it's important to look at organic revenue as opposed to organic volume.

Because the bottom line for us is the revenue line and we've been growing roughly consistent with the rate of industry growth.

I'd like us to be growing more rapidly and the initiatives we have in place -- including Six Sigma quality that drives customer loyalty and satisfaction, including our genomic and esoteric sales representatives, including our hospital sales force that's only been on the ground for the last six months as a dedicated group, and geographic expansion selectively internally, which we've been engaging in for the last three months.

Some are at early stages, some advanced stages.

Those at advanced stages are generating positive results that anyone would be proud of.

Now the other initiatives are at earlier stages in their life cycle and moving ahead smartly.

Keep in mind in terms of organic growth, we are growing this company in revenue terms consistent with the rate of up growth of the market and are working to drive time prove that growth rate to grow at a rate slightly more than the marketplace.

And all the while, we're driving significant margin expansion.

You announced a new marketing manager I guess a few weeks back, was there some discontent with the previous person in that job or --

There was no discontent per say.

We don't typically comment on specific individuals leaving our company, but I would say this, the individual coming into the job is Bob Peters, who is continuing the every illusion of our company as we drive our capabilities to grow organically and inorganically.

Bob brings over 20 years of experience, significant sales experience and operations experience.

He's a great collaborator, has great track record in the lab business for driving profitability growth and we're excited about the value add.

He'll be able to build on the foundation that's already in place.

Thank you.

The next question comes from Matt Rippergur of JP Morgan.

Three questions specifically about the Unilab deal.

First, have you seen any customer attrition with that deal to date?

Secondly, how is the vest picture of the northern California properties going?

And third, specifically about the commercial pricing for Unilab -- when do you plan, or when are you going to be able to contractually be able to increase the pricing of the Unilab business to a level more comparable to yours?

Thank you.

First, in terms of attrition of customers at Unilab, we have not seen anything out of the ordinary course of business.

So there's no significant attrition whatsoever from Unilab today.

In addition, in terms of the contracting environment, keep in mind as Bob said earlier, it's a slightly different environment in terms of mix of payers in California than other parts, particularly the more frequent use of capitated managed care contracts.

We expect the environment to continue and we expect it to be a competitive environment as well.

So, we will expect in California to see a continuation of the lower revenue per requisition than we see in other parts of the country typically.

We do see the opportunity however with our richer capabilities in esoteric and speciality testing compared to what Unilab was able to bring to the party so there may be some opportunities moving forward to enhance revenue per requisition.

Keep in mind it's a highly competitive market in California.

To the second element, Bob I turn to you.

With respect to the transaction of the business or invest picture of business in California, we expect to transition that business over time.

There's been no business transition through the end of the first quarter, although we do expect to have it completed by the end of the third quarter, and any transition of business is already built into our guidance for the remainder of the year at this point.

Thanks very much.

The next question comes from Alan Brockstein.

I was wondering if you could explain your bad debt expense.

What is the source, since it's not deductibles?

What exactly is the source and why is the weak economy not affecting those payments?

Well, that's a great question, Alan, and in our business, bad debt is not typically associated with the inability of people to pay.

Like in many other industries.

Bad debt in our business is principally driven by missing billing information.

We rely on physicians and others that send work to us to supply us with all the information we need to bill -- whether it be a diagnosis code, the patient's name, address, insurance information, etcetera.

And it's the level of missing information on those requisitions that principally drives bad debt for us.

Back in the early days, when we were first spun off, that missing information was approximately 15%, or 1 out of 6 requisitions that came in the door had inadequate information to properly Bill.

We've since driven that down to below 5% and we've seen a corresponding change in bad debt expense over that period of time from 10% back in 1995 to around 5% today.

And so, as such, the bad debt is not principally driven by the economy, more driven by our process in educating physicians around the importance of that information and then doing what we can to collect that information when we don't get it initially.

Okay, can you refresh my memory -- have you guys ever taken a significant charge to AR?

Not as a public company, we have not.

Okay, thank you.

The next question comes from Quentin Lai of Robert W. Baird.

Good morning.

I was wondering about genetic testing.

Is that mainly goning to be some of the new tests that we're talking about for accelerating growth in the back half of the year?

We expect the gene-based testing will continue to grow at rates similar to what we experienced in the first quarter and have experienced for the last several quarters.

And it's coupled with the fact that new tests that have been coming to the market, as they continue to mature and become more widely adopted, as well as introduction of new tests.

So there's no change in the pace of introduction or the approach as we go through the next several quarters, compared to what we've been doing over the last several.

And keep in mind, when a new test is introduced, it takes a period of time for it to ramp up to acceptance in the marketplace.

Examples of tests that we're seeing some increase in improvement in acceptance in the physician marketplace is really cardio CRP, [HOMOCYSTEINE] and others in the cardiovascular area for example.

These are tests that we've had in our test menu for several years, but only with the increase in the education of the physician marketplace are we seeing the rapid increase in acceptance of the.

That's great.

Last week I saw a release that Nichols is putting out a cystic fibrosis bio-chip and they'll start screening in July.

How long will it take to have that new technology based on the new platform rolled out to all your labs?

You're referring to the collaboration that we have with thermo bio-star for the CF portrait bio-chip technology.

We're now in the final stages of production validation and we expect to be completely transitions to this platform at our San Juan Capistrano facility through the remainder of 2003.

Right now from a testing in our network, we do cystic fibrosis testing at our Nichols institutes in San Juan Capistrano and at Chantilly, Virginia.

At this point we're not planning to move it to all of our facilities.

What it will do, though, is improve turn around time for patients on this critical test.

Thank you.

The next question comes from Peter Holemens.

My question's been answered, thank you.

The next question comes from Wade King of Wells Fargo.

Good morning, thanks for the detail.

A couple follow-up questions.

Can you comment on where you categorize cervical cancer tests?

Do they fall in your routine, esoteric category, and if it is in the route teen category for you, is that an exception to the rule as it relates to what kind of growth you've seen recently?

Cervical cancer testing is included within our routine testing.

We have never categorized monolayer pap testing as an esoteric test.

As for others, you'll need to contact the individual companies.

With you consider the growth rate you've seen in monolayer testing to be higher than the routine test slower growth that you commented on earlier?

We believe the anatomic [INAUDIBLE] section of the marketplace is growing faster than the overall laboratory testing industry.

Including cervical cancer and the home [YACHTOPATHOLOGY] and the like.

Secondly, can you comment on the percentage of HPV tests that you are processing -- what percentage of those are now out of the thin prep file versus done independently.

Right now, from an HPV perspective, approximately 50% of our monolayer requisitions in come in indicating if the results are inconclusive to automatically reflex to an HPV.

Obviously ASCIS represents the 3% to 5% overall pap tests and we would have a consistent rate on what we're using the HPV for.

And of your total HPV [INAUDIBLE], there have been data points put out that's as much as 70% of it is performed currently out -- is that consistent with what you're seeing?

We have not historically provided that level of detail.

Okay, all right.

Additionally, could I ask you -- given there is only one monolayer test that offers approval for HPV testing out of a liquid-based [CRYSTALLING] sample -- if a physician asked you to perform a HPV test in the future out of a alternative monolayer test without FDA approval, will you perform that or will you only perform a test out of an FDA-approved monolayer.

If there's no approval, there will be no test performed.

Okay, thank you, sir.

Lastly, can you comment -- we recently attended a research forum focused on breast SITOLOGY and certainly Sitek is pursuing this vigorously.

Have you seen pickup in your volume relating to breast testing in relation to the efforts done in the research reason and the growing clinical arena?

we've seen no significant pickup.

Very good.

Thank you very much.

Thank you for participating in the Quest Diagnostics first quarter 2003 conference call.

Investors in the United States may listen to a replay of this call by dialing 888-56 l-0616.

The replay will open today at 10:00 a.m.

Eastern time and will continue through 5:00 p.m. on May 31st.

Investors outside the United States may dial 402-998-1519.

No pass code is required for either number.

In addition, registered analysts may access an on-line replay of the call through street events at www.streetevents.com.

The call will also be available to the media and individual investors at www.questdiagnostics.com.

The on-line replay will be available 24 hours a day beginning at noon.