奎斯特診斷 (DGX) 2003 Q3 法說會逐字稿

Welcome to the Quest Diagnostics third 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 researched.

Any redistribution, retransmission, or rebroadcast of this call in any form without the express written consent of Quest Diagnostics is strictly prohibited.

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

Go ahead, please.

Thank you, and good morning.

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

We will provide comments about our results as well as major trends before we open up the call for your questions.

Some of our commentary and answers to questions may contain forward-looking statements that are based on current expectations and involve risks and uncertainties that could cause actual results and outcomes to be materially different.

Certain of these risks and uncertainties may include but are not limited to unanticipated expenditures, changing relationships with customers, payers, suppliers, or strategic partners, competitive environment, changes in government regulations, conditions of the economy, and other factors described in the Quest Diagnostics Incorporated 2002 form 10-K and subsequent filings.

A copy of our earnings press release, together with any information that would be required under Regulation G, and the text of our prepared remarks will be available in the pressroom section of our Web site later today, at www.Questdiagnostics.com.

Now, here is Ken Freeman.

Thank you, Laure.

We delivered another quarter of strong financial results and met or exceeded our previous guidance across the board.

Here are some highlights.

We increased earnings per share 29% year-over-year, revenues grew 15%, EBITDA margins improved by nearly 3 percentage points to almost 21%.

We generated strong cash flow of $173 million and repurchased $131 million in common shares during the quarter.

This morning, we announced that our board has taken two actions to return additional value to shareholders.

First, we are initiating a quarterly dividend of 15 cents per share.

Second, we have increased the company's share repurchase authorization by $300 million.

Through September 30, we have purchased $141 million of shares under the initial program, approved by the board in May.

We are focused on providing superior returns.

Taking together, these actions reflect our ongoing confidence in the company's financial strength and our ability to continue generating strong cash flows, while retaining the financial flexibility to invest in growth opportunities.

Now, Bob will provide analysis of our third quarter results.

Thanks, Ken.

Revenues grew 15.3% or 4.6% on a pro forma basis above the upper end of our previous guidance.

These results reflect a slight improvement over the growth rates we reported through the first half of the year.

We continue to believe that our revenue growth rate remains at or above that of the overall industry.

Volume growth measured by the number of requisitions, was 10.8% for the quarter at the upper end of the range we previously provided.

Overall, our business continues to be impacted by economic factors.

Specifically, by the lack of hiring and increased uninsured which has reduced health care utilization.

On a pro forma basis, volume declined 1.5% versus the prior year.

Adjusting for the timing of holidays, which impacted the second quarter, pro forma volume approximated the quarter two level.

Hurricane Isabel and the blackout which occurred during the quarter negatively impacted volume by about a quarter of a percentage point.

Drug abuse testing, the portion of our business most directly impacted by the economy, reduced total company volume comparisons by almost 1%.

We are encouraged by early signs that the actions we are taking to accelerate organic volume growth are working and we expect to see tangible benefits from these actions as we move into next year.

During the third quarter, revenue per requisition increased 5.6% on a pro forma basis above the top end of earlier guidance.

Revenue per requisition grew 3.8% on a reported basis.

Improvements in test and payer mix are the principal drivers of the increases.

Gene-based and esoteric testing continued to grow rapidly during the quarter.

Paced by ongoing strength in testing for HPV and other sexually transmitted diseases and cystic fibrosis.

Over a half a percent of total company revenue growth was contributed by our clinical trial testing business which reflected very strong growth in the quarter.

Most of the increase was due to the completion of clinical trial studies in the third quarter, which previously were expected to be completed in the fourth quarter.

EBITDA margins increased to almost 21%, an improvement of 270 basis points over the prior year.

The increase was driven by our improving mix of business and efficiencies from our six sigma and standardization efforts with the benefits reflected in both cost of services and SG&A.

Cash from operations for the quarter was excellent at $173 million, over $40 million above an exceptionally strong quarter in 2002.

Strong earnings were the principal driver of the increase.

For the full year, we have moved EPS guidance to the upper end of the previous range.

We now expect earnings per share to be between $4.05 and $4.10 an increase of 25 to 27%.

We expect EBITDA to approximate 20% of revenues.

Our full year and quarter four 2003 guidance is detailed further in note six to the press release.

You will also note in our press release, we've indicated that we expect pro forma revenue per requisition to increase 3 to 4% in the fourth quarter of 2003.

This is unchanged from what we anticipated in the full year expectations we previously shared with you and reflects continued improvements in test and payer mix, at a slower rate than we've enjoyed to date.

As we've indicated in the past, we anticipate that increases in revenue per requisition will moderate and beyond this year, approximate our historical levels of 2 to 3%.

Before Ken shares guidance for next year, I want to point out several items to assist you as you build your models.

Starting in 2004, we will speak to operating income measures instead of EBITDA measures.

This quarter, we had begun reporting operating income on the face of our income statement.

Operating income is a GAAP measure.

As such, we will not be required to perform a lengthy reconciliation to net income in the footnotes as we do today for EBITDA.

This year, we expect operating income to approximate 17% of revenues.

The principal difference between EBITDA and operating income is depreciation expense which has historical resulted in EBITDA running roughly 3 percentage points above operating income as a percentage of revenues.

While we continue to believe that EBITDA is a meaningful metric, we are reducing our use of non-GAAP measures and will not provide EBITDA guidance in 2004.

However, we will provide the necessary information to enable you to calculate EBITDA from our financial statements.

We plan to file an 8-K next week that will contain voluntary disclosures of quarterly income statements for 2002 and 2003 in the new format to assist you in your comparisons.

Now, I will turn it over to Ken.

Thanks, Bob.

As we look to the future, we see ongoing strong financial performance as we remain focused on execution.

We are at a stage in our development where our growth will become more dependent on distinguishing ourselves through improvements in our quality and service, our science and our technology.

We will continue to generate strong cash flow which we can put to work in a number of ways for our shareholders.

For the full year of 2004, we expect solid growth in earnings per share of between 12% and 15%, before charges associated with the Unilab integration.

Note that we are not assuming any significant improvement in economic conditions in the coming year.

Revenues are expected to increase approximately 5% excluding the impact of additional acquisitions.

This increase is expected to be driven by improvements in revenue per requisition, modest volume growth, and approximately a 1.5% carry-over from the Unilab acquisition.

Operating income as a percentage of revenues is expected to approach 18%.

Cash from operations is expected to exceed $600 million and capital expenditures are expected to be between 180 and $190 million.

On our year end earnings call, we will provide specific guidance for the first quarter of 2004.

Between now and then as do you your preliminary cycling for 2004, keep in mind that the first quarter of 2003 included Unilab revenues for March only typically the strongest month of the quarter.

In addition, the first quarter is subject to unpredictable weather, as we saw earlier this year.

Now, before we open up the call for your questions, let's answer some specific questions that we think will be of interest to all of you.

I'll take the first few and then hand it over to Surya.

First, how did you arrive at the 12 to 15% EPS growth rate as guidance for 2004?

Let's look at the drivers of EPS growth starting with revenues.

We believe that our industry is currently growing at the rate of approximately 3% to 4% and will also do so in 2004.

We expect to continue growing our revenues at or above the industry growth rate as we have in the past.

We expect volume comparisons next year to benefit from the growth initiatives we have put in place this year.

On the cost side, we anticipate additionally efficiencies from our six sigma and standardization initiative, as well as the integration of Unilab, which are expected to drive further improvements in operating income.

Keep in mind that six sigma, and our ability to successfully integrate acquisitions have become core competencies of ours.

The AML integration is complete.

The Unilab integration is on track.

And we expect to generate substantial cash.

We will use a significant portion of free cash flow to repurchase shares or fund small to medium-sized acquisitions.

Our projected EPS growth in 2004 of 12 to 15% is an all-in number including the impact of organic revenue growth, increased efficiencies and cash investments in share repurchases or acquisitions.

Second, why did you declare a dividend and increase share repurchases?

At this stage in our company's evolution, we view the dividend and share repurchase programs as appropriate additional ways to return value to shareholders beyond share price appreciation.

We generate a significant amount of cash, enabling us to fund the dividend and repurchases while retaining financial flexibility to invest for growth.

Paying a dividend and repurchasing shares will not restrict our ability to pursue growth opportunities.

Third, what is the likelihood that we will see a Medicare lab co-pay?

We remain hopeful that Congress will not enact a lab co-pay provision.

To do so would place an additional financial burden on senior citizens, and would pose an excessive administrative burden for providers.

The industry continues to work to educate Congressional conferees and their staffs about the value of laboratory testing as Congress continues to search for ways to fund the pharmaceutical benefit for seniors.

Now, Surya will address questions relating to business operations.

Surya Mohapatia, Ph.D.: Thank you, Ken.

What reference from encouraging early signs that suggest volume growth accelerate in 2004.

What are these positive indications?

We feel see several positive indicators.

Let's review some of them.

Our current sales force is becoming more productive in gaining business, as measured by their performance against sales quotas.

At the same time, of course, we remain as confident as ever to pricing discipline, being paid appropriately for the services we provide.

The entire organization is focused on improving customer loyalty using six sigma quality techniques.

We continue to attract new customers.

At the same time, we are doing a better job of retaining existing customers.

And we are expanding our investment in medical and scientific expertise, as an important way to differentiate ourselves from the competition.

We continue to put MDs and Ph.D.s in leadership positions throughout the company.

And we recently recruited well known MDs from academic institutions to lead our expanded methodology efforts across the country and the development of new coagulation testing services.

Question five.

Have the industry's competitive dynamics changed?

We have not seen any significant change in the competitive landscape overall.

We believe we are growing at or above the industry growth rate and have been doing so for some time.

While we have seen some insourcing by physician office and hospital labs of selected routine tests, this is nothing new.

Keep in mind that our industry has always been highly competitive.

New [inaudible] entering and exiting on a regular basis.

We are committed to grow our organic revenues at or above the industry rate of growth.

Question six.

What is the growth potential for new test offerings, particularly in the areas of the colorectal and ovarian cancer?

Bringing new tests to market that improve the health of patients is a key element of our growth strategy.

While gene-based testing is the fastest growing part of our business it is important to remember that not every exciting new test needs to be gene-based.

For example, the ImmunoCAP biology testing, and important cardiovascular tests such as cardio CRP and lipoprotein subparticle analysis are not gene-based yet they are making a significant difference for patients and bringing in new revenues.

In the area of colorectal cancer screening, the new InSure immunochemical test has the potential to drive improved patients acceptance and save lives.

This test is being well received by doctors and insurers and for good reason.

It offers 89% sensitivity.

This is significantly better than the traditional fecal occult blood test.

In addition it does not require patients to handle or ship specimens overnight as other testing methods require.

Sample collection is significantly less intrusive for patients than all other colorectal cancer tests which is what we believe will drive usage by patients.

A recent study showed that InSure improved specimen compliance by nearly 70% compared to the traditional fecal test.

A long leading clinician has said, the best test is the one that is used by patients.

Turning to ovarian cancer screening, we are excited about introducing the ground-breaking blood test, developed by Colologic and the National Cancer Institute.

Initially this test will be targeted at women who are at high risk.

We believe this represents 5 to 10 million patients.

Keep in mind that this will be the first ever [PROTUMICS] test.

We have been very deliberate in making certain that it meets all of our reverse medical and scientific requirements before we launch.

We are currently finalizing our validation studies and anticipate availability by the end of the year.

Now, I will turn it back to Ken to wrap up.

Putting it all together, we are at a stage in our company's evolution where growth will be driven more by improvements in our quality and service, our science and our technology, rather than large acquisitions.

And shareholder returns will be driven by a combination of share price appreciation and returning cash to shareholders through share repurchases and cash dividends.

Quest Diagnostics is very well positioned to provide superior returns for shareholders today and tomorrow.

We'll now up for questions.

Operator?

Thank you.

At this time we are ready to begin the question and answer session.

If you would like to ask a question, please press star one.

You will be announced prior to asking your question.

To withdraw your question, please press star two.

Once again, to ask a question, please press star one.

One moment, please.

Bill Bonello, your line is open.

Yes, just a couple of questions.

Can you give us, just so we can figure out on share count, can you give us a little more specificity in terms of when you repurchased the shares that you have already announced that you repurchased?

Bill, most of those repurchases took place pretty evenly over the third quarter.

As you know, at the end of the second quarter, we had repurchased $10 million worth of shares, and we added $131 million throughout the third quarter.

But pretty evenly over the quarter.

Okay.

So just in terms of thinking about the impact of dilution from options going forward, I mean there was not a dramatic reduction in the share count quarter-over-quarter.

Does it take, you know, 100-plus million of share repurchase to offset the impact of options?

To offset the dilutive impact of the annual option grants, you're probably talking share repurchases in the range of 1.5 to 2 million shares per year.

Okay.

Perfect.

And then two, you touched a little bit on that you had already indicated that pricing or revenue per requisition would not go up at the rate that it has been going up beginning in the fourth quarter.

But can you give a little bit more color on specifically why that is?

Are there new contracts that kick into effect?

Is there something -- you know, what was driving pricing in Q3 that won't be there in Q4?

Bill, nothing specific as it relates to contracts.

We expect continued improvement in tests and payer mix, but at a slower rate than we've enjoyed to date.

There are some practical limits as to how long the payer mix shift can continue.

And certainly, that's got to slow down over time.

And also, gene-based testing has grown rapidly to represent over a half a billion dollars of business for us on an annual basis.

It does remain the fastest-growing piece of our business.

But that rate naturally slows down as it becomes a bigger and bigger piece of our business.

But as we go forward, we expect to see continued improvements in payer mix, test mix, and tests per req, to continue to drive the increases in revenue per requisition.

Great.

Thank you very much.

David Lewis of Thomas Weisel Partners.

Your line is open.

Good morning.

Bob, I wonder if we dive more granular into this issue of pricing for 2004?

Can you discuss the relationship between drugs of abuse declines and potential pricing benefits?

It seems that has been one of the principal drivers in better pricing is that DOA has been declining.

Is that the principal trend that's driving pricing declines for next year?

The fact that DOA may come back?

No, it is not.

That is certainly one element of the payer mix, as well as the test mix that has helped us this year.

But it is certainly not that the biggest piece by any means.

Can you quantify the impact, Bob?

I can't for you at this time.

I would call it modest.

Although it has been helping us this year.

Yeah, one way you can start getting at it David, is that today, drugs abuse testing is about 3% of our total revenues and about 6% of our requisitions.

At one point, Ken, that number was 8 to 10%?

That is correct.

As we've seen the decline in the drugs abuse testing business over the last really couple of years driven by the economy primarily, we have seen it become a smaller piece of the business.

And we are not anticipating any significant rebound in that business next year.

Okay.

Perfect.

That's very helpful.

And then heading into the fourth quarter, obviously you've moving the guidance to the higher end of the range and you mentioned a clinical trial contract here in the fourth quarter that usually does come in the fourth.

Just trying to look.

It looks like revenues and volumes are better for the fourth quarter but profitability is slightly lower than what we're anticipating.

Is that conservatism or is there something going on in the fourth quarter that we may be missing?

No, it's not really a matter of profitability being lower than we had been anticipating.

It is very much where it was earlier.

The one little tweak that we had was the fact that the clinical trials business closed some contracts in the third quarter that we anticipated previously in the fourth.

But when you look at the earnings projections for the fourth quarter they're essentially unchanged and overall, we've taken the full year guidance up to the upper end of that range.

Okay.

And lastly, for next year, you're talking once again about $180 million or more in Capex.

Bob, can you just give us the principal breakouts of Capex and what material shifts given the company's refocusing you may see in Capex for 2004 that you didn't see in 2003?

You won't see any material shifts.

Capex next year, we expect to be somewhat below 4% of revenues.

Very consistent with the percentage of revenues that we're spending this year.

And when you think about our capital spending, think about a third of it roughly going into information technology.

Think about a third of it going into equipment, laboratory testing equipment in the labs, which we're constantly upgrading.

And think about a third of it or so going into facilities-related items.

Great.

Thank you very much.

Tom Gallucci of Merrill Lynch, your line is open.

Good morning, thank you.

Just a couple of questions, if I could.

First, Ken, before I think you said that for EPS guidance it was kind of an all-in number and obviously you upped the share repurchase program amount today.

How much of that is actually in expectations?

Can you quantify a little bit further what you think you would do in terms of share repurchases?

I think at the end of last quarter you said were you going to do about $100 million or so for the rest of this year so we're ahead of that pace, I guess.

We're not prepared to give you specific guidance on the amount of share repurchases that we have in the fourth quarter.

Although in terms of preparing our guidance, we do anticipate that the amount of share repurchases in Q4 will be below the level that we've had in Q3.

And we expect that it won't be significant.

As you look towards next year, 2004, we are anticipating that we'll use the majority of our free cash flow to either repurchase shares, or do small to medium-sized acquisitions after we pay the dividend, and after we do any mandatory debt repayments.

Is there much material mandatory debt repayments or --

No, we're talking about roughly 20% of the $300-plus million that we have outstanding on the term loan so think about it as in the $60 million range.

Okay.

And then just, because you mentioned it there on the acquisition environment, maybe can you give us an update on what you're seeing out there?

In terms of the acquisition environment, Tom, there continue to be alternative opportunities for building additional acquisitions into our company.

We continue to be steadfast in our use of our three ground rules in terms of compliance, reasonably well run, and being an appropriate value to drive benefits for shareholders in the first year.

And you know that we're very disciplined not only in pricing discipline with our customers but also on the buy side when we consider acquisitions.

So there is no shortage of possibilities and we continue to be very rigorous in the way we drive our business development process.

And then finally, if I can just ask one other one, Surya, and I think you also, Ken, had mentioned some of the initiative that were you doing that were you seeing encouraging signs.

Can you talk about some of those initiatives in more color on the volume side of things?

Thank you.

Surya Mohapatia, Ph.D.: Yeah, Tom, one of the interesting things we are seeing that our pipeline is now much more dense than before.

And we are really using a very vigorous way of measuring sales productivity and as you know, that we have a very focused effort on hospitals and physicians, and also the specialty sales force.

Along with that also our activities in the new geography is showing some results so hopefully in '04 all those things are coming together and we are very encouraged with our actions with the sales people, they are having in the marketplace.

Robert Willoughby of Banc of America Securities, you may ask your question.

Just two questions, Bob, a clarification.

I think you said in the fourth quarter, you expect share repurchase activity to be immaterial.

You know, why would that be in the absence of acquisitions?

And secondarily, just in terms of looking at the acquisition pipeline, Ken, can you comment in terms of maybe a breakdown, give a little bit more color in terms of regional labs versus outreach programs versus esoteric opportunities.

Can you give any type of color on that front, what kinds of opportunities are out there?

Bob, I'll get the share repurchase piece first and then I will hand it over to Ken.

In the fourth quarter, we do anticipate continuing to repurchase shares but for purposes of the guidance, as I said, we expect it to be at a lower rate than the third quarter.

Okay.

Keep in mind since we're just doing it in a quarter, it doesn't have that much of an impact on the weighted average shares.

Okay.

In terms of the acquisition environment, if we go to the pieces, Robert, certainly we see opportunities across the three areas you've mentioned.

There are opportunities in terms of regional laboratories around the country, there are opportunities as it relates to outreach programs, and there are also opportunities as it relates to esoteric testing.

And you can assume that we are evaluating and constantly evaluate all the various possibilities in a very rigorous way.

That's great.

Thank you.

Ricky Goldwasser of UBS you may ask -- your line is open.

Hi, good morning.

Can you talk a little bit about what you're seeing on the AML business, and you can quantify to us whether you've kind of lost business there, and also, does your guidance for next year assumed continued customer attrition on the AML side?

Surya Mohapatia, Ph.D.: AML attrition is complete and we have made our synergy target.

There is no significant loss of customers.

We anticipated the transition to be complete, and I don't see, also, any changes in next year.

And in fact, both the companies are now working together under a combined plan, which we put together last year.

All right.

And as we've indicated the 2004 number is an all-in number.

Surya, in your comments before, were you talking about the fact that the sales force is more proactive now and more productive in getting new business, can you comment on the ratio of lost and new business?

Ricky, we don't typically comment on -- in that level of detail.

You can assume that we're continuing to drive -- the bringing in of new business, also additional business from existing customers.

And through utilizing our six sigma techniques we also work very hard to remove the obstacles that would cause a customer to potentially leave us.

So initiatives on all fronts to drive growth in volumes and appropriate pricing of course for the company.

So would you say that that ratio is improving?

Directionally, yes.

Surya Mohapatia, Ph.D.: You know, we expect it from customers to leave us, because the reason why they went to AML is a very different reason than why they will stay with Quest Diagnostics.

But all those things were taken into account when we did the [inaudible] planning.

So we are very happy that could keep more customers than we anticipated before we acquire AML.

And lastly, on the cost of services side, the cost of services were a little bit higher than what we were expecting and obviously that's a function of volumes.

But can you provide us a little more detail of what composed the increase on the cost of services?

What were the different items or the big items?

Ricky, there's no single big item in there.

As we've said on earlier calls, we are continuing to invest in client connectivity solutions.

Today, we have over 20% of our orders and over 25% of our results going over the Internet.

We are continuing to install these client connectivity solutions at a rapid pace.

And the install costs end up in cost of sales.

Now, we are seeing benefits, though, outside of cost of sales as a result of that.

As we're reducing the manual keying that is typically involved, and at the same time, we are reducing missing information which drives bad debt, and also drives the cost of the billing operation.

And lastly, as you think about cost of sales, we also indicated that we had been adding phlebotomists in both our PSCs and doctor's offices as physicians are doing actually less draws in their office and asking us to do more of that.

So on one hand that adds some costs for us but on the other hand it reduces costs in other areas.

We are getting more complete requisitions so we have less missing information.

And again, lower billing and bad debt costs.

And in addition, we're getting fewer specimens where the quantity is not sufficient for us to perform the test.

Simply because we're having our trained phlebotomist do the draws and in the end that helps reduce rework as well.

But overall when you look at our margins which is the way we look at them in total, we look at operating margin, they've shown significant improvement.

EBITDA and operating income have both improved almost three full percentage points over the prior year in the third quarter and we see continued opportunities to expand margins going forward.

Thank you.

Gary Lieberman of Morgan Stanley your line is open.

Gary Lieberman, CFA: Thanks.

Talking about the lab co-pay a little bit.

Can you give us any idea of what the impact to earnings would be if it actually goes through in 2004?

We haven't provided any specific quantification, Gary but what I would like to highlight for you is that our 2004 EPS guidance is an all-in number no matter what happens with Medicare legislation.

As I mentioned in my prepared remarks we are very hopeful that the co-pay will not come to pass literally in Congress.

We are at the same time however, have put in place appropriate plans if there were to be one that would come forward.

But again, we are hopeful it won't happen at all.

Gary Lieberman, CFA: Can you elaborate on that a little bit?

Because it would seem like either it's in the number or it's not in the number.

So can you just talk a little bit about if it's not in the number, what are some of the other mechanisms that you would use to offset it, if that's what you're saying.

Let's just look at some of the core starting points for us, Gary.

Keep in mind that Medicare for us is in the zone of about 14% of revenues.

That we have a long history of complying with Medicare rules and regulations, the most significant of which in the last many years was the implementation of medical necessity documentation.

And through that era, back in the '97, '98 timeframe, we were able to improve our bad debt performance and DSOs at the very time that the Congress had really enacted a dramatic change in how we would be paid by Medicare, way beyond a co-pay impact.

This was just being reimbursed for specific tests where physicians had to change their behavior to enable us to be able to bill and collect.

So as we look to our numbers for 2004 and as we've constructed them we've built these numbers and are sharing them with you as guidance, as if they are all-in numbers.

No matter what happens with Medicare legislation.

And as I said before, we are hopeful it will not come to pass.

And we are prepared if a co-pay does come to pass.

However, to implement using six sigma and the other techniques at hand, in a way that will ensure that we provide -- that we are able to deliver these kind of performance that we shared with you this morning.

Gary Lieberman, CFA: Okay.

I guess I'm still a little confused.

So if it doesn't go through, I guess we could expect EPS to be higher than guidance?

We assume that Medicare will probably do something.

As it relates to the labs and most other providers in our -- in the world of health care not just labs but all players.

And we felt that for today, the best way we could move forward is to provide you a number that we believe is a number that we can deliver under any scenario that Congress might enact, whether it be a Medicare or some other avenue for controlling reimbursement or reducing reimbursement from the laboratories.

Gary Lieberman, CFA: Okay.

And Bob, just a question, if you could elaborate a little bit on what is the -- in the non-operating expense item.

Are you talking about the new line that we've added to our P&L at this point?

If you look at that, there are non-operating expenses, I assume you are talking about the other income expense net, which for the quarter was about $100,000 or so?

Gary Lieberman, CFA: I'm actually referring to the one below that, the $14.8 million.

That's a total of the four numbers above.

The net interest expense, the minority income, the equity earnings, and the other items.

Gary Lieberman, CFA: That clears it up.

Thanks a lot.

David Zembeliss of Blaylock & Partners, your line is open.

Hi, I'm curious to know a little bit how you derived a 60 cent annual dividend.

Is it based on some sort of trailing cash flow or a certain payout ratio?

And also if you could talk a little bit about to what extent your guidance for next year incorporates benefits from changes in business models like the thin prep imaging system.

David, I will start with the dividend.

First of all, in thinking about the size of it we wanted to one, make sure that we could provide what would be viewed by most folks hopefully as a meaningful dividend.

The 60 cents per year or 15 cents a quarter is roughly a 1% yield on our stock today.

That compares to what is on average less than a half a percent yield for S&P health care companies.

And when we look at companies that have initiated a dividend over the last year or so, roughly two-thirds of them launched dividends that were yielding less than 1%.

So in terms of it being a meaningful number, we felt by those benchmarks, that it would certainly be meaningful.

We also, though, had an objective of retaining financial flexibility as Ken talked about.

The dividend represents approximately 15% or so of our free cash flow.

We don't expect it to have any impact on our credit rating.

We're operating well within our capital structure guidelines.

In fact, we're actually better than the most conservative end of them.

And we still have lots of flexibility to pursue growth opportunities and repurchase shares.

And that was essentially the thinking behind the 60 cents per year.

On the productivity side, I guess a way to look at 2004 is that we're assuming that we'll be able to use six sigma and other tools to expand and improve our efficiencies.

As it relates specifically to automated cytology platforms, we are currently evaluating the focal point platform but have no immediate plans related to either platforms.

One other follow-up just on the clinical trial side, you guys have had in the past a Glaxo contract that pays whether or not they use your services.

To what extent do your fourth quarter and '04 estimates include that kind of revenue item?

And to what extent are you also assuming that there will be costs related with those services, or if it's just paid out of the contract?

At this point, we are not anticipating any significant minimum required payments at all.

The volumes under that contract with Glaxo are doing very nicely and in the past, actually, last year, in the fourth quarter, we did have one of those catchup payments by Glaxo, which impacts the comparisons certainly this year in Q4 when we get to it.

But no minimum payments of any size at all anticipated this year.

Okay.

Thank you.

Tom Stern of Chieftan Capital Management.

Your line is open.

Hi, it's actually Colin Moran.

Ken, you gave the pro forma volume growth could you give the organic volume growth in the quarter?

We have not attempted to provide what I will call organic, simply because it is merely impossible to calculate.

The reason for that is when do you an acquisition, particularly in a service business like this, volumes start moving around between the facilities that service that business, and it is very, very difficult to tell whether or not the increase in volume in one facility is as a result of new volume growth, or the fact that work has moved from another facility that you've recently acquired.

Therefore, we have used pro forma as what we believe is the best measure of really how you're doing organically because what it does is it level sets the base and you're comparing off of that new higher base as you're measuring growth.

Okay.

In terms of your '04 guidance can you give us a sense of what your bad debt expense assumption is?

We're not providing specific guidance on bad debt for '04 at this point.

But you should expect that we anticipate continued improvements in our bad debt over time.

And we have a long-term goal of driving bad debt down to around 4% or so of revenues.

Okay.

And then how much did drugs of abuse testing affect volume in the quarter?

Nearly 1% in terms of the overall comparisons.

Thanks.

Matt Ripperger of JP Morgan.

Your line is open.

Yes, I have three questions.

The first question is related to the electronic connectivity data that you provided earlier 20% of your orders and 25% of your results.

I believe both of those percentages are up materially sequentially.

I wondered if first of all see if you can confirm that.

And secondly, have you seen any change in the back office billings percentage of your workforce as a percent of electronic claims increases?

First in terms of the statistics, for the third quarter, if you include California, which we now are able to do, including the acquisition of Unilab, our orders are greater than 20% the results are about 25%.

And if you go back to excluding California, you would see on an apples to apples to what we said previously that the numbers were in the zone of 23% on the orders and 28% on results.

So we continue to see adoption.

Our customers are giving us very positive feedback on our connectivity capabilities.

In terms of the back office billing, I'll ask Bob to respond.

Yes, we are seeing benefits in terms of increased efficiencies in both the billing area and the specimen processing area as a result of requisitions coming in electronically, because we're eliminating keying, and obviously, that requires folks to be sitting there doing that.

Not only is it helping us on the cost side, but it's improving overall quality in terms of accuracy because of the fact that these are coming in electronically with a lot of edits built in upfront.

And for the doctors who are submitting claims electronically, have you seen any change in the pull through volume that you can get related -- not related specifically to that commercial contract?

Surya Mohapatia, Ph.D.: Yeah, actually, what it is doing is actually improve can the stickiness of our customers with us.

Yeah, the end then drives more physician loyalty and in the end, will drive more business towards our company.

Okay.

And the second question I had is in the past you commented on the North Carolina and Ohio market.

I wanted to see if you could just provide an update in terms of how your expansion is going in those two markets.

We have no specific comment to share with you today.

We continue to work aggressively to establish a presence in those two marketplaces.

And as we move forward, we're hopeful to continue to build a business there, certainly if were you to ask me and I've said this several times in the past on other issues as well, I would like us to see us go a bit faster than we are going currently but we're making progress and we are standing fast with our principles in terms of how we compete in a marketplace.

Great.

Allen Brockstein of Pedra Capital.

You may ask -- your line is open.

Yes, throughout this year, we've talked about the decline in doctor's visits may be affecting diagnostic test ordering but have you guys gathered any more information about plan design changes that you might be able to share with us?

Has there been any evidence of co-pay changes or higher deductibles having an effect as well?

As we've said previously it's very difficult to specifically measure those impacts.

As we're moving into the new plan enrollment season we will begin to see what changes are being put in place for 2004.

At this point in time consistent with what we've said earlier, there are a very limited number of plans that directly have a co-pay for laboratory services.

Where plan design does tend to impact us is changes in co-pays as it relates to physician office visit, as it's a physician office visit that drives the work to us.

We also have some anecdotal evidence that suggests the implementation of a co-pay with physician offices in a plan can have an impact certainly on the physician office frequency, visit frequency and hence the lab testing.

But as individuals get used to the notion of paying a co-pay, and before they go to the physician, if there are increases in co-pay amounts associated with that, that the impact would be significantly less than the institution of a co-pay in the first place when somebody goes to a doctor's office.

Okay.

Thank you very much.

John Szabo of CIBC World Markets, your line is open.

Good morning.

Thank you.

I had a quick question about the InSure test.

How do you see the overall size of that market?

And do you see the test as a replacement for the fecal occult blood test or would that be used sort of in conjunction with that other test?

I think obviously the first thing is to look at, when you're looking at colorectal cancer is right now there's a very limited number of people that should be tested actually are tested, probably only 25% of the population that should be tested is being tested.

Initially, obviously you would tend to look to conversion of existing fecal occult users over to InSure.

It's easier to use and has better sensitivity.

So that is a good first place to look.

Surya Mohapatia, Ph.D.: Just to build on that, Laure.

The most important thing here to know, that there are approximately 147,000 people who will be diagnosed with colorectal cancer and 50,000 people will die and the most important thing is that this is a curable disease.

And this is none invasive, less than $100 and this is going to have higher patient compliance, so we think apart from the good business it's also going to be good medicine.

And is that test sensitive enough that the survivability is relatively high?

In other words is it catching it early enough?

Surya Mohapatia, Ph.D.: If you catch it early enough, 90% of the time you can cure it and the sensitivity at the moment is 89%.

And did that contribute positively to the quarter?

I think you started selling that in -- or offering in August, is that right?

It's very early days, adoption of new tests does take a little bit of time.

The evidence coming back from physicians is very positive as an alternative to or a replacement for the FOBT tests but it's early days, we'll see this continuing to build over the coming quarters.

Okay.

Great.

Thanks.

Just one other question on the drugs of abuse testing which you know has continued to negatively impact your volumes.

Is it fair to say that it's about as low as it can go as a percentage of the revenue?

Or can you give us just an idea of where it is at right now?

I suppose anything can go lower or higher but certainly at this point it's about 3% of our revenues.

We are committed to the business.

It's a cash generating business.

It's a profitable business.

But it's one certainly that has felt serious challenges due to the economy.

If the economy improves, and some day, it will, remember as we've shared our guidance for you with 2004, we're assuming for 2004 no significant improvement in economic conditions in the new year, but if and when the economy improves, we think the drugs of abuse business will improve with it as the level of hiring increases.

Certainly, the drivers long-term are favorable for this business as well as the fact that as you look at this, we also engage with more than half of the Fortune 500 in the business.

And employers are taking an ever-increasing role in health care.

And we think that's an important strategic reason to continue our leadership in drugs of abuse testing.

And John, we continue to closely watch the capacity and the cost in that business, and we will make adjustments necessary to assure that it remains profitable.

Okay, Bob, on that point, is there relatively less operating leverage in that business?

In other words, if it were to swing to a positive, would there be less incremental profit than maybe in some of your other businesses?

The short answer to that is yes, simply because it's a less profitable business overall.

Okay.

But it still has operating leverage?

Yes.

Okay.

All right.

Thank you.

Bill Bonello of Wachovia Securities, your line is open.

Yeah, hey I just wanted to revisit I guess a point that were you talking about earlier because I'm still not crystal clear on what you're saying regarding the Medicare lab co-pay.

Just so I understand, Ken, are you saying that even if there is a 20% Medicare lab co-pay, you still anticipate earning EPS or having EPS growth of 12 to 15% in 2004?

Yes.

Thank you.

David Zembeliss of Blaylock & Partners, your line is open.

One quick follow-up to that, Ken, is it fair to say that the range of 12 to 15% would be able to include at the high end lack of a co-pay and at the low end, sort of risk adjusted opportunity to offset the co-pay?

And the second question really, more detail if you could talk a little bit about your hospital business, part of the acquisition of AML, you talked about really being able to target the hospitals differently than you had in the past.

If you could talk a little bit about how that's going, what kind of metrics you're looking at and you know, how that contributes to corporate growth, is it above average grower, or is the idea to get it back to average for 2004?

On your first question, I have to say I think we're splitting hairs here.

I don't have my ouija board in front of me here this morning to be able to really get at it, other than to reassert the response I just provided with Bill.

In terms of the hospital business, we're very committed to the business.

We have integrated the AML business with our existing hospital business, today it's an important component of our company, we're the leading provider of reference testing for hospitals, we've over the course of since acquiring AML, we've reconfigured our sales organization.

We have driven additional science expertise into the business as well, and as we look to the future we see the hospital business as one of several significant market segments where we see opportunities to grow the business at a rate that we will all be proud of.

Surya Mohapatia, Ph.D.: Just to add.

The hospital business becomes the platform for all the new techniques, so there is coagulation, or whether it is a blood cancer or almost all the esoteric test goes there.

So we use that platform to introduce new products and gain market acceptance and as you know we provided [CDs] of products starting from just a reference to lab management to also providing consultation to the hospital how to improve quality.

Okay.

And is that business largely billed back to the hospitals or is it still largely split between billing patients directly or billing the hospital?

It's all billed directly to the hospital.

When you are working with a hospital, you need to bill the hospital directly and if they need to bill others, it's up to them.

So as a percentage of your business this year and next year, what should we be thinking about?

The annual revenues of the hospital business are approximately -- in the 10 to 15% range.

And you should expect that they'll continue in that range.

Is it likely to be ticking up as a percentage of the business, whatever that base is?

We expect it to remain in that range.

And as you've heard, that we've got a particular focus on it, so we would hope that it would move up towards the upper end of that range.

Thank you.

Our last question comes from Yvette Cotta of Argus Partners.

Your line is open.

It's actually Matt Butan from Argus Partners.

A couple of questions.

In terms of cash flow and your cash flow guidance for '04, looks like you're talking about more or less flattish growth and maybe if you can comment on that.

And then in terms of EBITDA, and I know you're moving and operating income but if you take a look, you're looking at a 100 basis point increase year-over-year I guess from 20 to 21%.

Maybe if you could comment on how much of that improvement if you can quantify maybe some of the expectations for additional merger synergies and six sigma.

On the clinical trial side you said half a point was from accelerated volumes.

Was it all accelerated volumes in the quarter or was a component of that expected in Q3 and then maybe give an early read on HPV conversion and what was your thin prep conversion in the quarter in terms of penetration?

Matt, I'll start with the first few.

We're still writing the list of questions here.

But with respect to cash flow, we expect it to be continued strong next year, over $600 million in cash from operations.

Keep in mind that over the last several years, we've enjoyed the ability to continue driving down DSOs at a pretty dramatic pace.

And with the DSOs in the high 40 day range the opportunity to continue driving them down and effectively harvesting cash from the balance sheet becomes more difficult and certainly isn't the same size opportunity that it was in the past.

Additionally, we are not anticipating the type of stock option exercises that we enjoyed over the last several years.

And that is an element that goes into the tax benefits that we see show up in the cash flow statement.

But overall, the cash flow continues to be strong.

And you know, barring any changes in the DSOs, it's growing commensurate with the earnings.

And in terms of EBITDA or operating margin, as we're now going to talk about it, we see it moving near 18% next year.

We expect it to be right around 17% this year.

And we are seeing continued benefits from not only top line growth, and a continuation in the improving mix of business, but benefits from six sigma and standardization, which are really impacting just about every aspect of the business.

We do expect to see some additional synergies from the Unilab acquisition next year.

As we told you, we expect in the range of $25 million or so of synergies there.

We are realizing very little of that this year.

Next year, as we start to bring facilities and operations together, we will begin realizing more of that.

But we don't expect to have the full annualized amount in place until the year 2005.

The clinical trials component and prep conversion and HPV?

The clinical trials piece, as I said earlier, the uptick that we saw in the third quarter compared to the prior year is principally as a result of moving the completion of certain studies out of the fourth quarter into the third quarter.

Okay.

The other questions you have were on HPV and thin prep, we'll start with thin prep.

Our conversion for the quarter, excluding Unilab was 85%, including Unilab, it's 82%.

That is an uptick from the last quarter.

We continue to believe that we will see additional conversion there.

On the HPV side, as we've indicated that has been one of our strong growers on the gene-based side.

And we continue to see good growth on that side.

Okay.

And then on bad debt, you saw sequential flat, flattening of bad debt improvement.

Are you seeing any issues with higher default rates, you know, kind of --

No, we are not.

We continue to monitor our receivables and our bad debt by payer type very closely.

And we are not seeing any significant changes in any category as relates to uncollectability at this point.

Thank you.

At this time, we have no further questions.

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

A transcript of prepared remarks of this call will be posted later today on our Web site at www.Questdiagnostics.com.

Investors in the U.S. may listen to a replay of this call by dialing 800-664-4219.

The replay will open today at 10:30 a.m. eastern time and will continue through 12:00 p.m. on November 21, 2003 to investors in the U.S. by dialing 888-562-7244.

Investors outside the U.S. may dial 402-220-6038.

No password is required.

In addition, registered analysts and investors may access an online replay of the call through StreetEvents at www.streetevents.com.

This call will also be available to the media and individual investors on our Web site.

The online replay will be available 24 hours a day, beginning at noon.

Goodbye.