奎斯特診斷 (DGX) 2004 Q2 法說會逐字稿

Welcome the the Quest Diagnostics second quarter conference call.

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

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

Any redistribution, retransmission or rebroadcast of the 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 Surya Mohapatra, our President and Chief Executive Officer, and Bob Hagemann, our Chief Financial Officer.

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, competitive environment; changes in government regulations; changing relationships with the customers, payers, suppliers and strategic partners; and other factors described in the Quest Diagnostics Incorporated 2003 form 10-K and subsequent filings.

As we have previously indicated, this is the last year in which we will provide quarterly guidance.

To keep everyone focused on the longer-term, after this year, we will begin providing financial guidance for the full-year only.

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

Now here is Surya Mohapatra.

Good morning.

Thank you, Laure.

We reported strong financial results during the second quarter.

Earnings per share grew by 14%.

Revenue grew more than 16 - - 6% reflecting continued improvement in the rate of organic growth.

Margins continue to expand.

Cash flow was strong at over $200 million, and earlier this morning, we announced that the board had extended our share repurchase authorization by $300 million.

I'm encouraged by the continued improvement in organic revenue growth, reflecting our focused efforts and our growing recognition by customers of the value we offer.

At Quest Diagnostics, we have a passion for the patient and our passion for the patient is matched only by our passion for performance.

Now Bob will discuss the quarterly results and guidance.

Bob.

Thanks, Surya.

The second quarter continued to build on the momentum of the past two quarters.

We reported strong earnings growth due to our continued improvement in organic revenue growth, and we met, or exceeded, each element of our guidance.

Revenues grew 6.4%.

Volume increased 2.1% over the prior year and represents the third consecutive quarter of underlying improvement.

We called tha,t in the first quarter, pro forma volume growth adjusted for the favorable impact of leap year and less severe weather was 1%.

Revenue per acquisition grew 3.7% for the quarter.

Improvements in test mix and increases in the number of tests order per requisition continued to be the principle drivers of the increase.

Drugs and abuse testing, which is among our lowest priced services and accounts for about 6% of our volume and 3% of our revenues, grew for the second consecutive quarter after several years of decline.

Our clinical trials testing business continued to report strong growth and contributed about half a point to consolidated revenue growth in the quarter.

Operating income, before the charge for the recently-completed CEO succession, improved 60 basis points as a percentage of revenues.

Principally driven by improvement in bad debt expense.

We expect to continue expanding operating margins through a combination of profitable growth and efficiency gains from our Six Sigma and standardization initiatives.

We are expanding margins at the same time we're investing to ensure our value proposition remains unmatched.

As we disclosed last quarter, we expected to record charges associated with the CEO succession process and the company's debt refinancing.

These charges have been finalized and totaled $13.2 million pretax, or 8 cents per share in the second quarter, $2.9 million was associated with the writeoff of the deferred financing costs, and $10.3 million was related to the acceleration of certain pension obligations in connection with the CEO succession.

We have been able to record the entire charge in the second quarter versus recording it over the remainder of the year as previously anticipated.

It is important to remember that these charges are discrete items and not ongoing costs of doing business.

Cash from operations was strong totaling $207 million during the quarter, compared to $169 million in the prior year.

Days sales outstanding were 47 days, unchanged from a year ago and two days above the first-quarter level.

The increase is temporary and due to lab and billing systems conversions at two of our laboratories.

During the quarter, we repurchased 2.7 million shares of common stock for $226 million at an average price of about $85 per share.

This includes a block of 1.2 million shares we purchased directly from GlaxoSmithKline.

GSK continues to hold just over 20% of our stock.

We have now repurchased a total of 7.2 million shares for $529 million at an average price of $73.54, since initiating our repurchase program in May 2003.

Including the additional $300 million authorization announced this morning, we have $371 million authorized for repurchases.

As we have said before, our first priority, with respect to our excess cash flow, is to invest in growth opportunities to drive long-term shareholder value.

When those opportunities are not available on appropriate terms, we expect to return cash to shareholders beyond the level of dividend payments in the form of stock repurchases.

Turning to our outlook.

For the full year, we now expect revenue growth to exceed the 7% rate we projected at the end of quarter 1.

Full-year earnings per diluted share are expected to increase to between $4.80 and $4.90 before the second quarter charges, unchanged from our previous guidance.

A reconciliation of the EPS guidance, with and without the charges, is included in footnote 7 of our earnings release.

We continue to expect cash from operations to approximate $700 million, operating income as a percentage of revenues to approximate 18% and capital expenditures to be between 180 and $190 million.

In the third quarter, we expect revenues to grow approximately 6%.

Operating income as a percentage of revenues is expected to exceed 18% and earnings per diluted share are expected to be between $1.25 and $1.30.

Now, I'll turn it over to Surya.

Thanks, Bob.

As you heard from Bob, we had a strong quarter.

We are making progress in driving organic revenue growth.

More simply, we are seeing more doctors, ordering more tests, on behalf of more patients.

There is no single factor that is responsible for driving the improvement.

Finally we are realizing the benefits of a number of concerted efforts we have undertaken and investments we have made.

As Bob mentioned, we continue to invest in our value proposition as a primary driver of growth.

This enables us to differentiate ourselves from competitors and maintain pricing discipline.

The investments we have made in the past are driving the growth today and investments we are making now will position us for growth in the future.

For example, we continue to invest in Six Sigma qualities and more recently, in Six Sigma to improve customer service and efficiency.

And we're also investing in infrastructure, making our PSEs more patient friendly and confidential.

Providing additional training for phlebotomists, standardizing our laboratories, and expanding our ability to serve new providers.

We are training our sales reps to better communicate the medical value of new tests and technologies.

We have seen growth coming from top specialists and from expansion into new geographies where (INAUDIBLE) we have not been a strong competitor.

(INAUDIBLE) testing continues to be the fastest-growing segment of our business growing at approximately 15% compared to last year.

Revenue drivers are the improvement of tests for women's health, which include chlamydia, gonorrhea, HPV, and cystic fibrosis.

Volumes for the (INAUDIBLE) tests ensure colorectal cancer screening tests from entry have shown strong growth.

Similarly in the allergy-testing area, the ImmunoCAP test, according to collaboration with Pharmacia Diagnostics, is gaining physician's acceptance.

Regarding the OvaCheck ovarian cancer blood tests, our clinical evaluation continues.

Customers are utilizing our advanced informational technology products in record numbers and we have added resources to keep up with the rapid deployment skills.

By the end of June, we were transmitting greater than 40% of test results and receiving greater than 30% of test orders via the internet.

This is more than 70% over - - this is up more than 70% over than last year.

When expanding the capabilities of our information technology products, which have sold to physicians and hospitals, we have ordered new tools to the eMax physician portal, we enabled doctors to prescribe drugs electronically, view a person's prescription history, view cumulative lab results and other medical information and share this information with other physicians.

Additionally, our ChartMax (INAUDIBLE) electronic hospital record continues to win acceptance by leading hospitals.

It recently enabled MedPlus, our healthcare IT company, to rank as the number one document management vendor by class, a leading independent healthcare I.D. research firm.

These investments will set us apart from the competition and drive growth.

Now, some brief comments about the industry.

I am excited about our industry and our opportunities.

As you know, demographic and technology trends favor us.

As the population grows and ages, diagnostic testing plays an increasingly important role, not only for diagnosis and treatment, but also for prognosis and prevention.

Every day we read or hear news relating to healthcare.

Medical societies and popular praise are making consumers more knowledgeable about the importance of early diagnosis.

Consumers are getting more involved in their healthcare decisions.

Their first visit is often, not to the doctor's office, but to the internet.

Let me give you a few examples of recent news and what they mean for us.

A recent report from the World Health Organization and the International Diabetes Federation estimates some 3.2 million deaths can be attributed to diabetes each year.

This global figure is 3 times higher than the previous estimate.

Diabetes has become one of the leading causes of premature illness and death.

This report is (INAUDIBLE) better pressure on healthcare systems to address the need for timely diagnosis of this preventable disease, and take appropriate measures to reduce morbidity and mortality.

From the New England Journal of Medicine, an important report on PSA(ph) velocity.

This is the rate of change in PSA levels.

A rise in PSA velocity can help doctors identify men at high risk of death from prostate cancer.

The method can also be used for monitoring the effectiveness of treatment.

The concept of velocity may have broader applications for other diagnostic tests.

Again, it highlights the value of regular lab testing and cumulative reporting over time.

From the Medical Journal Population, on guidelines for managing LDL cholesterol levels, experts now want to use more aggressive drug therapy to reduce LDL levels in persons at very high risk of heart attack to 70 mg per deciliter, or below.

The current rate is 100 to 130.

This type of aggressive drug therapy has to be combined with the regular testing to monitor, not only lipid levels, but also other parameters including liver enzymes.

Increasingly, consumers are seeing diagnostic testing as a valued tool to help them in their quest to better understand and manage their personal health risks.

Coming back to Quest Diagnostics, our efforts to drive profitable growth are producing results.

In summary, we had a strong second quarter in which we accelerated revenue and volume growth while we expanded operating margins.

Cash generation was strong and we continue to invest in our future.

And while (INAUDIBLE) have taken advantage of the changing trends in our industry and continue providing continued returns for our shareholders.

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

Operator?

Thank you, at this time, if you do have a question, you can press star 1 on your touch-tone phone.

You will be announced prior to asking your question.

Again, press star 1 on your touch-tone phone.

Our first question comes from Bill Bonello.

Your line is open, sir.

Please state your company name.

Yeah, Bill Bonello with Wachovia Securities.

Just one real simple question.

You mentioned several times continued improvement in organic growth.

I just want to make sure, the 2.1% volume growth that you reported in the quarter, that's all organic, not driven by acquisitions?

That's correct.

That's all organic, Bill.

Okay, great.

Thanks.

Bye.

Next question.

Thank you, our next question comes from Gary Lieberman.

Your line is open, please state your company name.

Thanks.

Morgan Stanley.

Just a quick question.

It looks like your DSOs might have gone up about 2 days sequentially and that ARs might have increased.

Did the ARs increase more than you expected and if so, what drove that?

Yeah, as I mentioned earlier, we had a 2 day increase in DSO's this quarter, principally due to some conversions at 2 of our laboratories.

The - - you know, any time you convert systems you have impact to the timing of getting the bills out the door and the bills also start to look a little different.

We expect that this is a temporary situation.

We'll have those DSO's worked down by the end of the third quarter.

Okay.

Thanks a lot.

Thank you.

Our next question comes from John Szabo.

Thank you, your line is open.

Please state your company name.

John Szabo, CIBC.

Just a quick question.

What, Bob, what was the ending share count for the quarter?

The ending share count was approximately 102 million shares.

Okay.

And then in the guidance for the rest of the year, does that include some level of share repurchase activity?

John, what we've told you in the past is we expect to use our excess cash flow to either do acquisitions or repurchase shares when acquisitions aren't available at an appropriate price.

And the EPS number is really an all-in number, the revenue number that we have given you doesn't anticipate any additional acquisitions at this point, but the EPS number's essentially an all-in number.

All right.

You haven't done an acquisition in - - in a while.

Is that because the returns just aren't available or is there some other reason?

We just want to make sure that we are as disciplined in doing acquisitions as we are in entering into customer contracts and they have to be available at appropriate prices for us.

Okay.

If I could just, one last question on the drugs of abuse business.

You said that it's your lowest priced service.

Could you just give us, sort of, order of magnitude?

Is it 50% less than the average or -- .

Sure.

That's about 6% of our volume and 3% of our revenues.

And, as you said, it's half the company average.

Okay, so it is half.

Great.

Thanks.

Thank you, our next question comes from Tom Gallucci.

Please state your company name.

Merrill Lynch.

Thank you, good morning, everybody.

A couple of quick questions if I could.

First, just a follow-up on the billing system conversions.

Is there a timeline for any others that are coming up in the next few quarters or is that relatively isolated right now?

Tom, at this point, we are not anticipating any major systems conversions for the remainder of this year.

They're all going to be next year at this time.

Currently we've got about 2/3 of our sites on the standard platform and any major conversions beyond this year will be taking place in the '05 timeframe.

Okay.

And then on - - just wondering if we could get some more color on your efforts in terms of, you know, getting into new markets and the competitive landscape, generally speaking.

I know you also won a contract, I think, down in Florida if there is any color, maybe to offer there as well.

Tom, first of all, as far as the competitive environment is concerned, you know, the industry, I mean, is fragmented, but there is no significant change in the competitive landscape.

You know, the in-sourcing continues in some hospitals and some physicians office laboratories.

The hospital average remains the same as before.

Some are getting in and some are getting out and (INAUDIBLE) organizing and the GPO's, obviously, they're trying to maximize value for their members.

But we have a very strong value proposition and what we do, is to walk very closely with them and understand the requirements.

And actually we bring value.

A number of organizations recognize the value we bring to their members and that's the example, in Florida, Blue Cross/Blue Shield.

We're very excited about this contract, it'sa privilege to solve the millions of members of Florida, Blue Cross/Blue Shield.

And it is the first contract in which another organization has announced that they have given to us based on quality and service.

So, the investment in Six Sigma quality, the investment in science and innovations are paying off, and we ask for a fair price for our high quality of service.

Now, there are some small labs getting reincarnated just to live for 2 or 3 years and getting sold.

And, as we know, there are a number of laboratories are available for purchase, but we will not, we're not really buy, if it is not, if it doesn't have the proper valuation.

Now going back to the new geographies, both Carolina and Ohio we're growing.

And we can grow faster .

And - - but it is slowing growth, and as you know, that I'm really impatient as far as growth is concerned.

We want to grow faster and quicker, but I'm very encouraged by the investment we have put and the results we have seen.

Maybe if I could just ask one more, Bob.

I know there has been a lot of talk, obviously, about potential changes in accounting for a contingent converts.

Could you let us know what your position is there?

With respect to the potential change in accounting?

Yeah, I mean, you have a convert that is out there, and what are your options if the changes go through or - - ?

Well, obviously, you know, when November rolls around at that point there is the ability for investors to put that to us.

We also have the ability at that point to call the security if we so choose.

And, you know, frankly I think we'll be monitoring that.

We certainly have the ability to, you know, mitigate any dilution associated with those shares at this point.

What is going on to happen with the the security is all going to be a function of what the share price is at the point that - - that - - that put comes up.

Great.

Thank you.

Thank you.

Ricky Goldwasser.

Your line is open.

State your company name.

Hi, good morning, this is Ricky Goldwasser from UBS.

Can you tell us what was the impact off product mix shift on your price growth.

Ricky, the vast major in improvement was driven by improvements in tests and improvements in the number of tests ordered per acquisition.

So that was the - - those are the drivers.

Okay.

And then our market checks (INAUDIBLE) to increase for (INAUDIBLE) Quest sales force in some marketS.

Not only the markets that you mentioned in North Carolina and Ohio, but some other markets as well.

Can you give us some more colors on your activities?

Yeah, Ricky.

What we do - - we do a very thorough territory planning.

And based on the requirement of a particular territory, we shift the resources to that particular territory.

And one of the things we are seeing now is that by training the salespeople and having lower turnover, we are making the salespeople more productive.

And, you know, this business - - this target business, we have to maintain the customers we have, and we sell updates to those customers and we bring new customers trough getting new accounts.

And there is no specific reason, which is better than the others, but we constantly look at the territories and we plan our salespeople to address those demands.

So when you look at your organic growth, as reported this quarter, is the majority of this coming from getting the new accounts or are you just seeing improved trends with existing physician offices?

It's all of the above.

And there is not one that is having more of an impact?

No, and in fact it's coming across the region and it's a mixture of new and upselling of the new accounts.

Thank you.

Thank you, Kevin Berg, you may ask your question.

Please state your company name.

Credit Suisse First Boston.

Thanks.

In terms of the pricing, you just mentioned that it was mainly based on number of rec - - more tests per acquisitions as well as mix.

So in terms of sort of the pure unit pricing with managed care, you know, in our conversations with managed care it seems like they are loathe to raise prices for lab tests.

Is that sort of what you guys are seeing as well?

As we've said before, managed care are very difficult negotiators.

But we believe we have a very strong value proposition and what we have seen in terms of pure price is modest increases there.

And that's consistent with what we have seen in prior periods as well.

Is that consistent with your thoughts on a go-forward basis as well?

Yes.

You know, it's a combination of cap related contract versus peoples salaries and use of total package we bring and it's a balanced view of what we do for cap related contracts and what we do for future service.

What we have said over time is we believe the improvements in revenue per requisition are going be in the 2 to 3% range, principally driven by improvements in test mix and increases in test per requisition.

And then in terms of longer-term volume, what are your expectations there and what -- the drivers there, is it gaining market?

I guess two questions.

Do you picture to gain market share?

And what do you expect the market to be growing at there?

We have not given specific guidance for the components of revenue growth.

We expect to grow revenues at or above the industry average over time.

As I said, we expect to see revenue increases, revenue per rec increases moderate, but still be in the 2 to 3% range.

And then I guess finally, in terms of the acquisition marketplace or other assets, what would you most be looking for right now in terms of strategic - a strategic acquisition?

Well, I think with respect to acquisitions, we're always looking for opportunities to further round out that leading access and distribution that we have got, and make it more convenient for patients to get into our laboratories.

There are a number of opportunities out there and, again, it's just a matter of making sure they're available to us at the right price.

Okay.

Thanks a lot.

Thank you.

David Lewis, you may ask your question.

Please state your company name.

Good morning, TWP.

A couple of quick questions.

In terms of the sales changes, obviously improving the sales force and obviously other infrastructure, it sounds like you're getting a lot of questions here this morning.

Can you give us any metrics in terms of net sale ads, net PSC ads, net phlebotomy ads, any kind of more specific numbers?

Well, why don't we do this?

In terms of PSC ads, we have added patient service centers.

And actually, with respect to phlebotomists, we have added over 1000 phlebotomists this year to be able to deal with the increased volume that we're seeing coming out of physician's offices, as well as assuring that we keep raising the bar with respect to what the patient wait times can be there to improve service levels.

The PSCs and the phlebotomists are a very important element of our access and distribution which we see as a key differentiator for us.

So, Bob.

Speaking on the CapEx, obviously, you're increasing if you're increasing 1000 phlebotomists, you must have increased some, you know, net PSCs and you have the same kind of CapEx guidance.

I'm wondering if it's the same CapEx guidance, spending seems to be improving.

Where are you taking that CapEx from to invest in this infrastructure?

Well, keep in mind that PSCs are not capital intensive.

These are relatively small facilities that we lease and the capital that goes into them is relatively minimal.

So, that is not driving our capital spending in any big way.

Okay.

In term of - - you mentioned, Surya, the importance of electronic requisition, both the mission and the receipt.

You talked about 40% and 30% respectful.

Surya, are there targets that Quest has for the end of '04 and the end of 2005 for those businesses?

Well, you know, David, as I have told you that we have a backlog of a lot of customers and we are deploying it as quickly as we can.

When you try to change people's behaviors, it's not the instruments, but also, the training.

And I think what is really exciting is that we took this step 2 or 3 years ago that IT is going to play an important role in our business, and we are a healthcare service business, and now you see all the emphasis by the government and the legislators to really reduce error and increase efficiency.

And we don't have any specific targets.

For I know that we go to, we will provide as quickly as possibility to the doctors so that eventually we want all of our doctors on the internet.

But that's going to take a couple of years.

What if I ask it another way?

They're able to get the same-day results if they're on our internet based reporting products.

Yeah.

Well the problem, let me ask it another way.

Is there a (INAUDIBLE) that (INAUDIBLE) traction towards an incremental IT spend, has what type of return on invested capital, so every dollar spent on IT returns what to Quest, do you think?

You know, Dave, that's a difficult question to answer.

Because it's really - it's a core element of our business here.

But any time we looked at any capital spending, whether it be IT or anything else, we need to make sure it generates an appropriate return and it's at least returning in excess of our cost of capital.

So you should assure that, be assured that any of our IT investments are doing the same thing.

Yeah.

Okay.

To build on, and one thing, David, sometimes we increase our cost in one segment but the benefit shows up somewhere else.

For example the internet orders and results.

We may be increasing our costs in IT, but the benefits comes in bad debt and physician retention.

So over this year we can tell you what the total return, but by quarter or unit is going to be difficult.

Okay, this is the last question and I'll jump back in the queue.

In terms of HPV testing, Surya, you mentioned that as a driver.

As that testing, you know, grows over time, are you doing any additional metrics trying to track what regions are stronger than others, or whether the testing is still reflex versus primary screening.

Any goal to track that any trench you can share with us there?

Well, Laure's anxious to answer that question - - .

Well, David, as you would expect, we manage our business through metrics and we do track trends on various tests on a business unit level and do zero analysis.

And this has been only about a year since the pronouncements went out there, and our sales force is actively educating physicians about the benefits of HPV as a part of primary screening.

And we are seeing nice growth in our HPV volume.

It's up strong this year and is actually one of our leading tests that's helping to drive part of our improvements in gene based testing.

So, to your point, we track it, we're educating it and we are seeing improvements.

Okay.

Thank you very much.

Your line is open.

Please state your company name.

Robert Willoughby, Banc of America.

On the share repurchase, the block the you did about GLAXO, out of curiosity, did they come to you or do did you go to them to see if there was any opportunities to shake them out of some stock?

They indicated to us they would be in the market to sell some of their shares, and we have an ongoing dialogue with them, and that's important for us because we want to be in a position to manage any of that overhang that is there, and that's essentially what we did this time.

Okay.

Thank you.

Kemp Dolliver, your line is open.

Please state your company name.

SG Cowen.

Thank you.

What is the product mix of your esoteric and gene based test to the total testing mix?

Kemp, our mix remains consistent with the last quarter.

The gene base is at approximately, think of it 11 to 12% of our top line.

And gene based plus esoteric is around 17% of our top line.

All right, and in terms of your performance this year, you have, I think, if I remember correctly, at least the last 2 quarters, modestly increased your revenue outlook.

Could you just briefly discuss, you know what, you have seen relative to your expectations with regard to what, you know, with regard to growth.

Growth overall on a revenue basis?

Well, it's really more a matter of what parts of the business are doing better than you had initially dialed into the guidance?

Yeah, essentially if you go back and you look at each of the last three quarters or so, we have seen nice steady growth in the underlying business.

At the end of the fourth quarter, or for the fourth quarter, when you take out all the noise and you normalize that, we grew in the 3.5 to 4% range for the core business.

In the first quarter, that moved up to a little over 5% and in the second quarter, it approached 6%.

And basically, what we're seeing is increases in the number of accounts that we serve and increases in volume from those accounts.

So, it's generally an across-the-board increase and it's a function of some of the things we have been doing over the last year: improving service levels, improving the training for the sales organization, and adding selectively to the sales force in markets where it makes sense for us.

And last question on that.

I assume drugs of abuse, in terms of their overall impact, the upturn there has really been really very immaterial to that growth, correct?

It's very modest.

Again, keep in mind that that business is about 6% of our total volume and 3% of our revenue.

That - - their volumes were up about 5% in the quarter.

It contributed to less than .2 of a percent to the overall growth.

Thank you very much.

Our next question comes from Michael Maguire, please state your company name.

Thanks, Mike Maguire from Leerink Swann.

Just a quick question on the 2004 guidance.

As the revenue and top line number continues to increase relative to your initial expectation, could you just provide some additional detail about the operating income margin?

And, you know, perhaps - - I would have expected that to increase a little bit in line with the additional, um, revenue guidance increase.

I just wanted to see if there is anything there that could be potentially offsetting the benefit to the margin line.

Nothing specific.

Keep in mind that the current guidance is actually very consistent with our previous guidance.

We have raised revenues very modestly.

But frankly not enough to warrant a change in any of the other metrics.

Business has been performing very consistently with what we have said.

Keep in mind for the full year, we are expecting to expand operating margins by about a full point.

And we're doing that while continuing to make investments in the business, as Surya referred to earlier.

Thanks.

And of that full point year-over-year, is there just core efficiencies that you're utilizing from the business, is there some additional acquisition synergies that you're capturing as Unilab continues to be blended into the full company?

Yeah.

We have a piece of the Unilab synergies that we have realized to date.

But that's not a significant driver of the margin improvement; the - - some of the improvement is coming from reduced bad debt, which we have been realizing the benefit there year-over-year.

And it's really coming from a combination of top line growth and the efficiencies that we're gaining from standardizing our operations and continuing to deploy Six Sigma across the business.

And it's something that we expect to continue.

As we've said in the past, we expect that operating income, as a percentage of revenues, over time is going to get into the 20% range and be sustainable there.

Great.

Thank you.

Our final question comes from Kevin Gail.

Please state your company name.

Of Radcliffe Funds.

Part of my question has been asked.

But just to go back to routine versus esoteric testing, could you address where you see more acquisition opportunities?

Is it that it's more for the routine or esoteric?

And what the differential margin is on those different types of tests currently.

Well, you know, first of all, we look at the acquisition pipeline, both esoteric and routine and also platform technology.

As you know, the esoteric tests have higher margins than the routine tests, but the routine acquisition, it will help us around the geographic expansion.

But we are always looking for companies that can add value to us and provide us this sustainable channel of value rather than just acquiring companies for acquisitions sake.

Right.

And keep in mind acquisitions of routine businesses can also be very beneficial to the profit margins.

When you consider the fact that, in many cases, we're able to buy essentially a book of business without having to buy a lot of infrastructure.

So, in running that business through your existing infrastructures sometimes you can enjoy very nice incremental margins on that.

Okay.

And back to the question with the coco (ph)and the effects on dilution.

If you could address then the importance that you put on the copay, and the real benefit s of the tax benefit on the convert.

I'm sorry, the benefit of the tax?

Yeah, the tax - - the burns on the copay side of that convert versus the contingent conversion which is just, you know - - .

There is a tax benefit.

It's actually a cash-flow benefit more than a benefit that is flowing through the P&L at this point, and we have realized some substantial tax savings as a result of that.

I think ultimately, if that instrument is either converted or taken out, how much of that cash benefit from the tax deferral we receive is going to be a function of what price we take that out at.

Right -- For example.

Okay.

I was just kind of addressing, you know, you had mentioned it depending on where the stock price is based on, and how you manage a dilution.

I wanted to see, you know, if that was also a factor that you were considering on the copay side of things.

Yes, it is.

Okay.

Great.

Thank you.

Once again, if you do have a question, please press star 1 on your touch-tone phone.

We have Scott Wilkins.

Your line is open.

Please state your company and time.

Thank you, UBS Asset Management.

Just a question, Bob, on the gross margin line as a percent of sales, it was flat year-over-year I think after 4 quarters of expansion.

And I'm just trying to understand that given your comments that core pricing seems to be up slightly, you know, esoterics grew well ahead of the corporate average, and you said also the DOA only had a modest impact in the quarter.

So what is weighing on the margin given all of those dynamics?

Keep in mind we don't focus on just the gross margin number.

We're really focusing on the operating income margin.

And some of the things we're doing right now, for example, rapidly deploying the connectivity in physician's offices.

That install cost, which is sort of a cost bubble as we see it, shows up in cost-of-sales.

Additionally as we ramp up the number of phlebotomist's we have on board, that shows up in cost-of-sales as well.

Those investments then pay dividends that show up elsewhere in the P&L, and a good piece of the bad debt improvement that you're seeing is as a result of improved billing information that we get now from having more electronic orders, as well as better information that we get from our phlebotomists as more of the volume comes to our phlebotomists as opposed to the physician offices.

So we try to manage it in total, and not necessarily one particular line, and we may be making investments in one area that pay off elsewhere.

Is it at all possible to estimate the impact that those investments may have had on the margin in the quarter.

The only reason I'm asking is that I just want to make sure pricing trends aren't having an adverse impact on your business.

No, in fact the pricing trends as you can have seen there were positive and that was certainly a contributor to the overall growth and margin expansion that we had.

Any way to just sort of apportion how much of the - - is going toward these investments?

There is some, but I am not in position to break it out for you at this point.

Again, yeah, I think it's going to vary quarter by quarter and there are going to be some periods where we actually opportunistically make some investments to position us for the longer term.

So, quarter-by-quarter, I think, is very difficult.

But, again, what we're doing is making investments that are intended to expand the margin.

Okay.

Thank you.

Greg Layton, your line is open.

Please state your company name.

J.P. Morgan.

Thanks.

Early on you mentioned that the clinical trials testing contributed a half percent of consolidated growth.

Could you just remind me how large that business is for you, and then also on a go-forward basis, is this an area of investment for Quest?

Well that, first of all, that business is about 3%, maybe a little less of our total revenues.

And it showed very substantial growth in the quarter in excess of 20%.

Another thing to keep in mind, though, is that business carries a lower margin than our core of business.

So, as you see that expand and grow more rapidly, it does compress a little bit the total consolidated margins as a percentage, but it actually expands them in terms of dollars.

That's lower - - .

It's a business that we consider a business that is worth investing in, and we have been, and continue to do so.

I'm sorry, that's - - it carries a lower operating margin?

Yes, it does.

Okay, and then just lastly, I'm not sure if you really commented on this, but do you have any sort of expectations for the proportion of your cervical cancer citeology business that will be Tripath versus Sitach?

Well, we really want to provide choice to our doctors and cervical cancer (INAUDIBLE) is an important area for us.

We are now rolling out the Tripath product (INAUDIBLE) to our business units and we'll give the choice to the doctors and the patients.

At the end of the day, that's our job and we we want to make sure that the clinicians are properly educated, along with the HPV screening.

But in your mind, it's a passive option that you're providing rather than your trying to drive business.

You don't have formal expectations for what that share would be within Quest.

No.

That's not true.

As the industry leader, it is our responsibility to introduce alternative technology, and when we take a product to distribute, we take it very seriously and we put a extra effort to make sure this alternative technology is available to the clinicians.

And it's up to the clinicians to really select.

Okay.

Terrific.

Thank you.

Kemp Dolliver, your line is open.

Please state your company name.

Yes, SG Cowen.

A quick follow up on a different topic.

It looks like the tax rate, after adjusting for the one-time expenses, was a little lower than it's been in recent quarters.

Could you talk about what drove that?

Kemp, it's - - I think it's about a 10th of a point lower and I mean essentially all we are doing is trying to periodically adjust the tax rates to where we think it's going to be for the full year, and that's essentially it.

I mean, when it moves, you know, a 10th or 2/10 of a point, it's really not much.

We do our best to try and nail it at the beginning of the year, but that's very difficult to do.

Thank you.

Thank you for participating in the Quest Diagnostics second quarter 2004 conference call.

A transcript of prepared remarks on this call will be posted later today on Quest Diagnostics's website at www.Questdiagnostic.com.

Investors in the U.S. may listen to the replay on this call dialing 800-294-0997.

The replay will open today at 10:30 a.m. eastern time and will continue through 11:00 p.m. on August 20, 2004.

Investors outside the U.S. may dial 402-220-9755.

No password is required for either number.

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

The call will also be available to the media and individual investors at Quest Diagnostics's website..

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

Goodbye