奎斯特診斷 (DGX) 2005 Q4 法說會逐字稿

Welcome to the Quest Diagnostics fourth-quarter and full year 2005 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 sessions that will follow, are the copyrighted property of Quest Diagnostics with all rights reserved.

Any redistribution, retransmission or rebroadcast of this call in any form without the expressed 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 Chairman 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 regulation; changing relationships with customers, payers, suppliers and strategic partners; and other factors described in the Quest Diagnostics Incorporated SEC filings, including the latest Form 10-K.

A copy of our earnings press release is available, and the text of our prepared remarks will be available later today in the quarterly update section of our Website at www.QuestDiagnostics.com.

A downloadable spreadsheet with our results is also available on the Website.

Now, here is Surya Mohapatra.

Thank you, Larry.

We reported strong financial results for the fourth quarter and full year 2005.

For the year, revenues grew over 7%; earnings per share grew 13%; cash flow was $852 million; and this morning, we increased our dividend and expanded our share repurchase authorization, reflecting confidence in our ability to continue generating strong cash flows.

Our clinical testing business is strong.

However, I'm disappointed with the progress of our test kit manufacturing subsidiary, NID.

During the quarter, additional quality issues were identified at NID; we reinstated a voluntary product hold.

These have had significant financial consequences, but it was the right thing to do for our patients.

We are actively working to address the issues at NID.

We have added additional resources and expertise to further strengthen the new management team.

NID is fixable, but there is much more work to be done.

At this time, we are evaluating all possible options for NID and we expect to finalize our plans by the end of the second quarter.

During this past quarter, we drove profitable organic growth by focusing on sales, service and science.

We also completed our acquisition of LabOne.

As we look ahead to 2006, we expect another year of strong performance at Quest Diagnostics with revenue growth of approximately 13% and approximately $800 million of cash from operations.

Now, Bob will review our fourth-quarter financial performance and guidance for 2006.

As we go through the results, I will separately quantify the acquisition of LabOne, the impact of NID and the continuing impact of the hurricanes experienced last quarter.

Consolidated revenues grew approximately 12% for the quarter, with the acquisition of LabOne contributing growth of almost 7%.

A little over half, about 55%, of the LabOne revenues were generated from the risk assessment business, with the remainder classified as clinical testing.

Our clinical testing business, which generates about 93% of our total revenues, grew 8.7% during the quarter on a 5.8% volume increase and a 2.8% increase in revenue per requisition.

LabOne contributed about 3% growth to the clinical testing business, principally reflected in volume.

As you know, the Gulf Coast region has a long way to go before it fully recovers from the hurricanes of 2005.

Although we're seeing some business return in the area, the continuing impact reduced revenues by approximately 0.3% compared to the prior year.

NID, which instituted another product hold during the quarter, had revenues which were $8.4 million less than a year ago and reduced consolidated revenue growth by almost 1%.

Operating income on a consolidated basis was 16.3% of revenues for the quarter compared to 17.2% last year.

The results of NID reduced the operating income percentage by almost 2% compared to the prior year and the LabOne business, which for now produces lower margins than the remainder of our operations, impacted comparison by about 0.5%.

Margins in our clinical testing business showed strong improvement, increasing about 1.5% compared to the prior year.

Dollar top-line growth, efficiencies from increased use of our connectivity solutions, and continued benefits from our Six Sigma efforts are the principal drivers of the improvement.

SG&A is where most of these improvements are reflected, whereas NID and the addition of LabOne are impacting the cost of sales percentage and more than account for the increase there.

While we are actively working to address the issues at NID and return products to market, the latest product hold has caused us to reevaluate the financial outlook for this business.

As a result of our analysis, we concluded that about $16 million of NID's assets needs to be written off, 7.5 million attributable to goodwill with the rest principally related to inventory of products and equipment.

The goodwill write-off, which is recorded in other operating expense, generated no tax benefit and as such reduced earnings per share by $0.04.

The balance of the write-off reduced EPS by another $0.02.

These write-offs coupled with the continuing losses at NID reduced pretax earnings by $29 million and earnings per share by $0.10 during the quarter compared to the prior year.

For the full year, NID reduced pretax earnings compared to the prior year by approximately $50 million or $0.16 per share.

Despite the impact of NID, diluted earnings per share grew to $0.64 in the quarter compared to $0.60 a year ago due to the strong performance of our clinical testing business.

The acquisition of LabOne was neutral to EPS in the quarter. $0.01 of the EPS improvement resulted from the reevaluation of certain tax contingencies, which reduced the tax rate in the fourth quarter and brought the full year rate to 40%.

Full year rate of 40% is in line with what we expect going forward.

We continue to generate significant amounts of cash.

Cash from operations was $303 million for the quarter and $852 million for the full year.

It compares to last year's totals of $264 million and $799 million respectively.

Day sales outstanding improved to 46 days from 47 days a year ago despite the acquisition of LabOne, which added 1 day to the 2005 figure.

Capital expenditures were $46 million for the quarter and $224 million for the full year.

During the quarter, we repurchased 4 million common shares for $200 million at an average price of $49.47.

For the year, we repurchased a total of 7.8 million shares for $390 million.

Also during the quarter, we raised $900 million in a very successful bond offering to complete the LabOne acquisition.

Our capital structure and strong cash generation coupled with the positive outlook for performance has us well-positioned to raise further capital to fund additional growth opportunities.

Turning to 2006 guidance.

We expect revenues to grow between 12.5 and 13.5% with approximately 8% from LabOne.

This excludes the impact of potential additional acquisitions.

We expect operating income as a percentage of revenues to approximate 17%.

This includes the impact of adopting SFAS 123R as of January 1, which is estimated to reduce margins by approximately 1%.

To help you initially reset your models, we're giving you full year estimates for net interest and amortization expense of $100 million and $10 million respectively.

We will not be updating guidance for these components throughout the year.

We expect cash from operations to approximate $800 million and capital expenditures to be between 225 and $245 million.

Please note, with the adoption of SFAS 123R, the tax benefits associated with the exercise of stock options will no longer be added to cash from operations but will be presented as a component of financing activities.

In 2005, these tax benefits served to increase cash from operations by $34 million.

Lastly, after the estimated $0.20 per share cost of adopting SFAS 123R, we expect diluted earnings per common share to be between $2.75 and $2.85.

LabOne, which we expect to generate about $30 million in annualized synergies by the end of 2007, will be modestly accretive to earnings in 2006.

Continuing weakness in the performance of NID and some lingering impact of the Gulf Coast hurricanes is included in this guidance.

The guidance excludes potential charges related to the integration of LabOne and the possible restructuring of NID.

Now, I will turn it back to Surya.

2005 was a successful year.

We grew our business both organically and through acquisitions.

We increased our profitability, and we generated significant amount of cash, most of which we have returned to shareholders.

We continue to enhance our value proposition with our focus on patients, growth and people.

We want patients to think of Quest Diagnostics when they need lab tests.

We continue to raise our standards for delivering customer service.

This year, nearly 9,000 front-line employees and managers received in-depth customer service training.

Patients are noticing the improvement, driving up the patient satisfaction scores.

We are also expanding our efforts to educate patients about the benefits of diagnostic testing as a critical part of preventive healthcare.

We are partnering with the American Cancer Society in connection with this Great American Health Check program, which encourages people to take an online health risk assessment and ask their doctors about the range of simple screening tests, such as those for colorectal, prostate, and cervical cancer.

We drove both organic and acquired growth during 2005.

An important aspect of driving organic growth is building a robust pipeline of innovative new products.

We're seeing double-digit growth in tests ranging from bladder cancer to digestive diseases.

In addition, we continue to see strong growth from HPV cervical cancer testing, InSure colorectal screening and ImmunoCAP allergy testing.

We have made great progress in developing new tests for diagnosing and monitoring cancer.

We became the first national laboratory to develop and launch a very important new test using technology licensed from Arcturus to help physicians identify cancers of unknown primary origin.

Understanding where the cancer started is a vital piece of information for appropriate treatment by oncologists.

We developed and launched the first tool in a family of new blood tests that will reduce and can replace the need for leukemia and lymphoma patients to undergo painful bone marrow biopsies.

These steps are based on technology licensed from MD Anderson Cancer Center.

We are also encouraged by the initial results of our efforts to educate doctors about CellSearch, a prognostic test from Veridex.

This test counts circulating tumor cells in blood samples and provides information about the effectiveness of treatments for metastatic breast cancer.

We're collaborating with managed care organizations to help reduce healthcare costs and improve patient outcomes.

We have proven capabilities in laboratory network management.

Several managed care organizations use our QuestNet offering to reduce out-of-network laboratory charges.

Despite the recognized value of diagnostic testing, an important report by the Lewin Group shows that lab tests are underutilized for critical diseases, such as diabetes, cardiovascular disease and colorectal cancer, resulting in adverse outcomes and higher healthcare costs.

We facilitate the appropriate utilization of diagnostic testing through our Care360 patients' entry portal, which can help health plans and doctors monitor compliance with clinical guidelines.

In addition, Care360 enables physicians to order lab tests and view results and order prescriptions electronically.

We are committed to improving the health of our employees and reducing healthcare costs for them and for our Company.

Through our HealthyQuest initiative, we provide the employees with the opportunity to lose weight, quit smoking and generally pursue healthier lifestyles.

We offer to all of our employees and their spouses at no charge our Blueprint for Wellness product, a comprehensive health risk assessment which includes the panel of lab tests.

Employees, who utilize the product, receive a discount from the Company on their healthcare premiums.

We received a lot of positive feedback from employees, particularly many who identified health concerns that might otherwise have gone undetected.

The idea behind HealthyQuest is simple.

Healthier people make better and more creative employees.

Of course, we also believe that early detections will lower healthcare costs for everyone.

In summary, our clinical testing business is strong and growing.

We further strengthened our business with the acquisition of LabOne.

We are addressing the NID issues.

We are enhancing our value proposition with our focus on patients, growth, and people.

We see opportunities to continue to grow our revenues and profits in 2006.

We will now take your questions.

Operator?

(Operator Instructions).

Ricky Goldwasser, UBS.

A couple of questions around the guidance.

I guess the first one, does guidance include the additional 600 million in share buybacks that you announced earlier this morning?

And also, if you can just give us a little bit more color as to what are the assumptions you're baking in for the progress with NID into the guidance?

Back in the third quarter, you said it's going to cost $0.05 in the fourth quarter.

If you can give us some of the similar breakdown to the progress throughout calendar '06.

Thank you.

This is Bob.

The EPS guidance for '06, we need you to think of it as an all-in number.

We're going to deploy our excess cash flow that we have either at the growth opportunities or through share repurchases.

We typically don't give specific guidance on share repurchases.

I think it's really a function of what growth opportunities are available to us at a particular time because it will be the excess cash flow that we deploy into share repurchases.

But, either way, the excess cash flow is going to be deployed into growing earnings and the EPS number is an all-in number.

With respect to NID, you should expect that the NID performance in '06 is not going to be significantly different than the performance we saw in '05.

In fact, it could be somewhat worse.

As we said, we're looking at all the possible options with respect to that business.

We're doing the things that we can right now to adjust the cost structure, while at the same time assuring that we've got good, quality product there and we're doing what we can to get product to market.

But we don't expect that the fix there is going to be something that we can do very quickly, and we expect to see continued impact of NID in '06.

So, should we assume factored into the 2.95 to 3.05 excluding option expensing -- should we assume taking the $0.04 that you had authorizing loss in NID in the quarter and annualizing them and assume kind of set at $0.16 of an impact is factored in?

And a follow-up question there is, why do you think that after kind of being out of the market for the full year '06 for 4 quarters, you can actually go back and gain back market share that you probably have been losing over the last 2 quarters?

Why not just bend out the business?

Well a couple things.

First, with respect to NID, your estimates are not far off at this point.

We're not expecting the run rate from operations to significantly improve in '06.

Secondly with respect to the second part of your question, NID has some products that are very important to a number of customers.

And we think it's important to fully evaluate all of our options there, including doing what we need to to turn this business around but also evaluating whether or not the effort and the time and the cost of turning it around is really worth it.

This is Surya.

We're disappointed with NID's progress.

But, I believe that as a diagnostic testing company that selective product strategy is complementary to the lab test.

As the lab test goes from the central lab to the patient Website, NID gives us a platform and we're looking into the future.

But, as Bob said, we are evaluating all options.

As we go forward, we're going to make the decision by the end of second quarter.

I assume you are then going to just communicate it to us as far as what are the next steps?

As we have more information to communicate, we will be updating the market.

Absolutely.

Tom Gallucci, Merrill Lynch.

I was wondering if I could just maybe follow-up with one or two questions on NID and then ask about the LabOne integration.

Just as a follow-up to Ricky, when are the customers getting those products?

Now?

Or are they just going without them?

Are there alternatives -- would be the first part.

There are alternatives for some of these.

Some of them are looking towards that.

So, really it depends on a test-by-test basis.

Some customers had some inventory in their facilities.

So, it really varies.

At this point in time as Bob had mentioned, we're really working diligently on this and we do realize that to retain customers, we do need to work to get the product back into market.

Maybe for the benefit of everyone, could you explain exactly what the problem is?

Because you're kind of talking about people having inventory.

But yet, you are taking the products off the market.

So, that inventory must be I guess good, but you don't feel comfortable enough to ship new inventory.

So, what's really the issue that's difficult to get your hands around here?

There's a number of issues out there -- a number of quality issues, including issues in the areas of GMP; procedures for design, control, and validation recordkeeping and reporting.

So it's a multitude of issues.

But the tests that they would have in the marketplace are working okay?

We have not brought product back.

We certainly don't believe there is anything out in the marketplace that would adversely impact patients.

Then on LabOne, maybe if you could just talk a little bit about -- where are we, what are you actually doing on the ground in terms of the integration process today -- some more detail -- and then where do we stand generally with customer retention?

And perhaps if you can at all talk about the Health Alliance customer, which is obviously an important one for them.

The final thing, I know LabOne opened a new lab I think during the third quarter and where does that stand?

This is Surya.

First of all, we are excited about LabOne.

You know we completed the acquisition in this quarter, and we have started the integration as we said that we are expecting $30 million synergies.

And it's going to take 2 years, this year and next year.

The integration team is working; the synergy lab is open.

And we are working with the Health Alliance to resolve some of the open items we have.

But we're pretty excited, and we have started talking to the life insurance people.

I met with some of the key executives -- State Farm and Allstate.

It's interesting actually how we could help the insurance business by using some of our assets and at the same time how LabOne can help us to improve our core business by using their biomedical services and call centers.

So the strategy remains intact.

Adam Feinstein, Lehman Brothers.

Maybe just a follow-up just to a statement you had just made.

You gave us the revenues and we put it back into the revenues for the risk assessment business for the quarter.

So how do we think about the growth?

Obviously, that was in a full quarter of revenues.

So can you just help us think about the growth there?

And then Surya, you had just mentioned that you think there's things you guys can be doing there.

That business has not been growing for LabOne over the last couple of years.

So with some of the issues in that business, I would just be curious to get some more details in terms of what strategy you were referring to in terms of ways to step up the growth.

I will let Bob talk about guidance, and I will come back what we're doing to grow the business.

To put in perspective that risk assessment business, which is a little over half of LabOne's business, grew at about 3% in '05.

There's testing in association with the risk assessment business, and that actually was off but was more than offset by growth in paramedical services and teleunderwriting in some of the other areas.

We're not expecting a significant improvement in that growth in '06.

But we are expecting that over time, we're going to be able to accelerate that growth for some of the reasons that Surya talked about before and is probably going to elaborate on now.

Again, we're not expecting significant growth there in '06, but we do expect that that's a business where we can accelerate its growth beyond '06 after we have completed our integration.

You know although the number of licenses/applicants are not moving as fast, but the number of tests that is required for each applicant is improving.

So that's number one.

Number two, as the life insurance companies are trying to save costs, a number of these customers about outsourcing some of their activities -- like paramedical services, like the physician's reports and the call center -- and that business is growing.

One of the exciting things for me is that Tom Grant and his team remain and working with us, and we are looking forward to doing some pilots, where the life insurance candidates can use some of our patient service centers to do the clinical and that will reduce the time it takes to close the deal.

So, those are the strategic reasons why we wanted to have this acquisition, and we are progressing to doing the pilots.

Just another follow-up question here.

Can you just talk a little bit about managed care and what's going on there?

There was a lot of talk last quarter about the UnitedHealth Care RFP process and also with WellChoice getting bought by WellPoint -- just any updates there.

Do you guys anticipate maintaining that business?

So just any thoughts, that would be great.

First of all, managed care organized are the single most important customer for us, and we have long-term relationships with the managed care organizations.

We work with them, not only to reduce their costs but also improve healthcare.

But, they are also tough negotiators.

And all long what we have emphasized that we bring our value propositions, whether it is Six Sigma quality, whether there is access of distribution, whether there is a new test or whether it is our IT technology.

They want to bring value to their customers, and we want to bring the value proposition to them so that they can differentiate themselves.

Now a lot of discussion about United contract, which is basically a request to reduce their expenses, which is what I call the out of network.

We use a product called QuestNet.

We have been using it of course several years, and we have proven capability.

The discussions we have with United is, how do we use the QuestNet so that they can reduce the total expenses, which is -- there's a lot of leakage and lot of hospital contract there.

Now, as managed care organize and consolidate, obviously, our relationship with them becomes more and more and more important.

But, at the end of the day, you know, the business is local and we have to maintain good relationships with our doctors and patients and the organizations so that people can recognize our value and that's the basis of our negotiation.

Then just with the WellChoice business, any anticipated changes there?

I don't know of any changes.

You guys have a contract.

I guess how long does that contract last for?

A matter of policy, we don't talk about specifics on contracts.

But usually contracts are several years in length. (multiple speakers) then we have several coming up.

Next question, please.

Robert Willoughby, Banc of America Securities.

Maybe I was disconnect here, but you played through a lot of challenges in the fourth quarter in terms of NID, hurricanes, maybe LabOne contribution here that might not have been as strong.

But you turned in a strong quarter, but I don't quite understand the '06 guidance, which seems to be more of a step down.

NID will continue to be an issue.

LabOne's contribution I guess is a concern.

But still, I would've thought the guidance would've been a little bit stronger.

Is there something else from an operating standpoint that we're just not seeing or focused on here that is keeping you from showing some stronger clinical lab-type results where the business was strong?

I think we are anticipating that we're going to have strong results on the clinical lab business.

There's a lot going on in both this quarter and in the guidance next year.

Remember there's $0.20 a share impact as a result of the new equity accounting that's impacting margins by a full point.

The other thing to keep in mind is that LabOne has historically had lower margins than we have.

And including them for the full year next year is going to reduce margins by about 0.5 point.

Although, we do expect them to be modestly accretive next year.

Unfortunately, NID is continuing to have an impact on us, not necessarily a year-over-year impact but it's continuing to be a drag on operating margins by about 1 point in '06.

Does the guidance at all reflect any diagnostic imaging contribution for '06?

It does not reflect anything specific relative to that.

And does not include any further acquisitions at the top line.

I just wanted to add one thing.

It is true that this quarter had a lot of noise, whether it's NID, hurricanes, LabOne or 123R.

But I feel pretty excited about the core business.

As you know, we have invested significantly in ourselves or within science.

We're growing organically.

Also, we have been a very patient buyer.

That's why it took us 3 years to acquire a company like LabOne.

But when I look to the future and I know that NID is an issue but that will pass.

But the most important thing is that we have a very strong foundation of clinical testing business, so we are producing a lot of cash and we are looking at how to really grow this Company as we move forward.

Surya, does the Canadian market offer any opportunity to you?

Not at the moment.

It's a single payer organization as you know.

We really would like to have a little bit of flexibility in our revenue sources.

Steve Hamill, Piper Jaffray.

I was wondering first with regard to NID if I go back through my notes, you had a full product hold in June.

And by October, my recollection is that about half of those products had been reintroduced.

Where do you now stand in terms of what percentage of the product line is actually being marketed?

At this point, we are in the midst of a complete product hold.

So there is no product being shipped at the moment.

Can you help us understand why you would have thought you could bring it back to market in October and now have had to pull it?

Because it seemed like most of the issues here were GMP, packaging type of issues as opposed to assay performance issues, which it would have seemed fairly solvable.

Certainly, we did not anticipate instituting another product hold back in October when we talked to you about NID.

As a result of the process they put in place, they did identify additional quality issues that we felt needed to be addressed before we could continue shipping product -- hence, the additional product hold in December.

Just to add, we have the quality initiatives.

But, as you know like any other IVD companies, every batch has to be examined.

They have found other issues, and it had financial consequences but that's the right thing to do for our patients.

You're absolutely right; this can be fixed.

There are issues, which can be identified, and we have added new management.

We have an outside adviser advising us.

However, it's also up to us.

While we balance a number of factors, we need to also look at what are the other options available to us.

And that is the reason why we are evaluating all options, starting from turning this business around and gaining some of our customers to completely shutting it down if we cannot run the business profitably and we cannot produce products with high quality.

But when you make a move like writing off goodwill, it seems to me that the interpretation for the street has got be either that you're not sure you can fix these product problems or you are not sure you can get the customers back once you have.

How would you describe that?

Let me answer that.

The write-off of goodwill is really driven by technical accounting requirements, which require you to look at the forecasted cash flows of the business and see whether or not they support the goodwill balance that you have on the books.

And certainly, we have anticipated that some of the customers will not be coming back.

And the outlook for NID at least financially is significantly different than it was just before this most recent product hold.

So, as a result, we were required to write down the goodwill.

Now, that is all of the goodwill that NID had on their books.

It was about $7.5 million, which we wrote down.

Then if I can ask, what's the status in terms of discussions with the Health Alliance in Cincinnati?

How long will it probably take before there's an official decision as to whether or not they remain committed to Quest and LabOne?

We don't discuss any individual contract or any individual customers.

They are one of the most important customers, and we have number of discussions and we are working with them.

(technical difficulty) We have no indication at this point that they are not going to continue to work on with us.

One last one.

Have you had any recent QuestNet wins that you could mention?

Say that again, please.

Have you had any recent QuestNet wins that you could mention with any payers?

Oh, QuestNet wins.

Some of the largest QuestNet opportunities that are in place have been in place for several years.

Movement onto them, keep in mind it's something that both the health plan -- the health plan really has to be committed to making the changes.

John Emerich, Iron Works Capital.

Just one left.

If we are on this call a year from now again and you were able to get a little bit more operating leverage from your sales growth than you're currently forecasting for '06, where do you think it would most likely have come from -- from the cost of goods sold or the operating expense?

I think you'll see it in potentially both areas.

Certainly, there is a fair amount of fixed costs embedded in our business.

If we were to grow faster than we are talking about now, I think you'd see benefits in both SG&A and cost of sales as a percentage of revenues.

Kemp Dolliver, SG Cowen.

First with regard to the options expense, how will that run through the income statement?

Will it be mainly cost of service or G&A or even a blend?

You'll see a blend.

Since obviously we don't give guidance on cost of sales of SG&A, I can't give you specifically the components of it.

But it will show up in both areas.

Principally, it's a function of where the employees that are receiving these awards sit in terms of their costs in either SG&A or cost of sales.

But it will impact both.

If I have heard you correctly, I think you mentioned in this quarter that you had some G&A benefits that offset some of the pressures you had in cost of sales.

What things broke your way in G&A this quarter?

I wouldn't necessarily label them breaking our way.

I think it's more a function of the things that we've been doing consistently to make our operations more efficient as well as the growth that we've seen in the top line.

If you looked at the SG&A percentage over the year, you saw improvement in all of the quarters.

And we continue to see that in the fourth quarter.

The impacts of NID, particularly the write-off and the addition of LabOne coming into the last few months impacted the cost of sales line -- one, because of where we had to take the charges for NID and two, just because of the way that LabOne's cost structure is set up.

Did any of this impact anything, such as you know management compensation accruals or the like?

In the fourth quarter?

Yes.

No.

Okay.

Your final question is, we've read that there have been some issues with the Baltimore lab and there have been inspections.

You've gone back to them with some fixes, and they've come back in.

At least the last thing we are aware of is they plan to come back in on an unannounced basis at some point.

Could you just tell us what's been going on there from your perspective and whether the state has come back in yet?

At this point in time, we are working -- we're cooperating with the state and with CAP related to this and have put in place the appropriate changes and are just waiting for final resolution.

You know the complaint there is about -- again that procedural issue how to deal with customer complaints.

In terms of your record-keeping and response to customer complaints?

That is all a process.

At this point in time, all of the employees in Baltimore have gone through additional training.

The process has been strengthened, with the laboratory manager or director having significant control over the process.

Gary Lieberman, Morgan Stanley.

It seems like you guys remain pretty committed to primarily doing share repurchases with your free cash flow.

Can you talk a little bit about what other things you are weighing that against in terms of I guess the acquisition environment?

And also any desire to expand internationally or what the ability -- or what your current desire is to expand some of the services domestically that you've talked about in the past?

I will start and I know Surya is going to want to follow up on this.

But, as we've said before, our first priority for our excess cash is to invest it in growth.

When growth opportunities are not available at appropriate prices -- because we are very disciplined as it relates to acquisitions as well -- we will deploy that cash into share repurchases generally.

And you saw that even though we can put it in acquisition in the fourth quarter, we also did some significant share repurchases in the fourth quarter because the cash flow is very strong.

Regards to the use of cash apart from the growth, you know when you look at how much money we can put to enhance our organic growth, whether it's investment in science or expanding salespeople or training salespeople, we look at those things and we have been very successful in investing money in ourselves or within science.

However, that acquired growth is -- you know we are a patient buyer, we are a very disciplined acquirer and it has to be opportunistic.

But it also has to meet our ground rules.

First, operator has to be a strategic fit.

When we buy a company, not only is that company is going to help us to grow our core business but also how that business -- that acquired business can grow using our assets.

It must be well-run, compliant with the law and has to make economic sense.

So we look at acquisitions, whether it's technology or this Company almost every week.

And at the same time, we also drive organic growth.

I'm very pleased the way we are actually balancing both the organic growth and acquired growth.

Let me just ask a quick follow-up on your bad debts.

You've done a good job, an excellent job over the past couple years of continuing to bring down your doubtful accounts.

Can you talk about the decrease in the quarter?

Was it continued I guess better data collection, or did LabOne have anything to do with bringing it down?

Where do you think going forward you sort of think where you will push against the limit for where do you think going lower?

Just quickly, LabOne had a negligible impact, maybe 0.10% or so on the bad debt.

They did have a lower bad debt.

But as I noted, they have higher DSOs that sort of will work its way out though over time as we integrate those operations.

But, the other thing you need to keep in mind is that there's a bit of normal variation from quarter to quarter, given 0.01% or 0.02% in any particular quarter.

Our long-term goal is still to get bad debt below 4% on a sustainable level.

This year for the full year, we're at about 4.2%, which is a continued improvement from where we were last year which was lower than the year before that.

And the goal is to keep driving it down so that we get it below 4%.

We don't have a specific target to give you.

I tell people it's kind of like a goal score.

The closer you get to par, the tougher it is to shave a few more strokes off.

But we're still working to improve it.

(Operator Instructions).

Michael Maguire, Susquehanna.

Just a couple of quick follow-ups.

On the LabOne synergies, could you give us some sense at least in terms of where on the margin side those may be coming out?

Is there anything that you can do over the next year or two to materially impact the gross margin line?

Or is this predominantly coming out of SG&A leverage?

Again, I would tell you for our business, don't focus so much on either cost of sales or SG&A.

Focus on operating income as a percentage of revenues.

That's how we manage the business.

We are trying to drive overall profitability.

Where it comes from isn't necessarily that important.

What I would tell you though is there are opportunities on both the SG&A side and the cost of sales side as we start to integrate LabOne.

Certainly, since they were a public company, there's public company costs that goes away.

Obviously, a lot of that shows up in the SG&A line.

Then as we start looking at the consolidation of the laboratories, a lot of that is going to come from the cost of sales line.

But I can't tell you at this point how to weight those two.

I certainly appreciate the operating income focus.

It would seem as though it's perhaps a little bit easier to get the savings out of the SG&A line initially.

So just curious if the 30 million is I guess back-end loaded and is going to require some more investments to get to lab consolidations, etc.

Or maybe it's a roughly even split or just trying to get some sense there.

Well certainly, the earlier synergies come in the SG&A area -- the public company costs, duplicate management, things like that, some of the sales force.

Think about the areas where synergies come from.

As I said, public company costs, then you have infrastructure overlap, whether it be patient service centers, couriers, sales force.

Those are some things that you can go after relatively early.

And then you get into lab consolidation, which takes longer, because you have system conversions that you need to go through.

And that does take time and require some capital typically.

Then just one quick follow-up just on the managed care side.

I know you probably can't address United specifically.

But over the last 0.5 year or year, how has your pricing experience been in terms of managed care?

I know there's a focus on leakage.

But in terms of your current pricing leverage with the managed care organizations in '05 perhaps going into '06, just some general commentary there.

When you think about price for us, we typically report it in terms of revenue per acquisition.

And you need to keep in mind that it's a function of a number of things as we've talked about in the past.

It's a function of the number of tests ordered per requisition.

It's a function of the payer mix.

It's a function of the test mix, whether it's esoteric or routine.

It's also a function of pure price.

Over the last several years, the principal driver of the improvements in revenue per requisition, which have been around 2 to 3% have been increases in test mix and increases in the number of tests per requisition with what I would label as very modest pure price increases.

And that's pretty much what we've seen this year is modest pure price increases.

Art Henderson, Jefferies & Company.

Just a quick follow-up.

How much of your revenue -- your clinical testing revenue now comes from esoteric tests?

Gene-based and esoteric tests represents about 17 to 18%.

Gene-based for the full year was actually -- exceeded 660 million.

Based upon some of your comments that you made regarding opportunities in cancer testing, where would you expect to kind of see that percentage next year at this time?

We can't speculate about percentage.

But actually with the addition of LabOne and their risk assessment revenues, the percentage could be flat -- will be probably flat to maybe slightly downward just because of the mathematics of the addition of the LabOne business into the calculation.

Keep in mind too when you think about esoteric tests, things don't necessarily stay esoteric forever.

Over time, they tend to become routine.

So you see a constant shift into esoteric and then out of esoteric over time.

Basically what grows the esoteric as a percentage of your revenues is the pace with which you are introducing new tests.

On just one -- not to beat a horse on this NID situation, but I get the sense that there is potentially still more skeletons in this closet that maybe you haven't seen just yet.

I guess I felt that way the last quarter, and it's kind of proven that it has been worse than what you had originally thought.

And I just wonder as you look to the next couple of quarters to the point at which you decide what you are going to do, are you confident that it's not going to be worse than what we've seen this quarter?

Or given what you said about what's in the guidance, I mean is there some more downside here?

Are there things that you are still coming across as we speak?

To put it in perspective, we indicated that we expected NID to have about a $0.04 or $0.05 negative drain to us in this fourth quarter.

Excluding the write-offs that we had to take which were triggered by an event, the operating performance was actually in line, maybe a little bit better than we had anticipated.

We weren't anticipating there to be much improvement in the operations.

We're not expecting it to be much improvement going forward at least for the first part of the year.

Are there potential costs associated with us taking actions at NID, which are not in the guidance?

Yes.

We indicated that there are no restructuring costs associated with NID in our guidance.

I think if there is something big to come, that would be it.

Just out of curiosity, how much of a distraction is this for you guys?

Then you mentioned that there is some customers that really value some of the NID products.

I'm just wondering if you decide to exit this, are you concerned that those customers -- it's going to have an impact on the larger part of your business.

You know, first of all, this is a complicated situation.

As you would expect, we have to balance a number of factors in the context of the impact on patients, the customers and employees.

It is more frustrating, rather than it's a distraction because obviously we have capable management at different levels and NID has been an innovator in their field.

They have a lot of customers, and they have a small but worldwide business.

But the core business continues, and we have a number of managers who really are dedicating to NID.

But the core remains the focus.

No matter what we do with NID, I wouldn't expect it to have a significant impact on the core business.

But your point about impacting existing customers -- i.e., NID customers -- is something that we need to consider as we go through this process and evaluate what we want to do there.

We did have a few more questions.

David Macdonald, SunTrust.

Just one quick follow-up on that.

I was wondering if you could give a sense of what percentage of customers who use NID are also using the core business.

Then I guess what I don't kind of get is if you don't expect the core business to really be meaningfully negatively impacted if you were to shut down NID, I guess kind of what is the advantage of continuing to kind of grind through this and get products back to market?

David, with respect to the customer overlap, there is some certainly but I don't expect that it is substantial in a lot of areas.

In fact, NID sells to the vet business as well, so there is some overlap but I don't know that it is that significant.

With respect to why we're not just shutting it down, as you heard us before, they have some products that we think are very important for patient care that we would like to be able to get back into the market if we can.

There are some customers that are continuing to ask for product, and it also having a products company fits in with our longer-term strategy that we have.

One follow-up.

Is it fair to say if we're able to get NID turned around and kind of back out to market, it would be with a little bit of a skinnier product portfolio?

Most probably.

We have time for one further question.

Anton Hie, Jefferies & Company.

Thanks for squeezing me in.

CMS has proposed restricting the use of the 88305 CPT code to two units of service per patient per day.

That's a general pathology procedure, and I wonder if you could talk a little bit about what the exposure might be there.

And more importantly, this seems draconian and medically dangerous potentially.

I wonder if we could talk about the industry response to this proposal.

It's very early.

As you've indicated, this is something we are looking at and we will work more broadly to educate CMS and others about why it is appropriate oftentimes to use a CPT code more than once, not just on the AP side for that specific code but also on the clinical side as well.

So it's something that we are working through.

As to quantification, I don't have any quantification that I am able to share.

How would you characterize your GI pathology business though as far as it?

I can't get into that level of specificity this year.

Coming out of CMS is very new and we need to work through the whole process.

Thank you for participating in the Quest Diagnostics fourth-quarter and full year 2005 conference call.

A transcript of prepared remarks on this call will be posted later today on Quest

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