奎斯特診斷 (DGX) 2006 Q4 法說會逐字稿

Welcome to the Quest Diagnostics fourth quarter 2006 conference call.

At the request of the company, this call is being recorded. [OPERATOR INSTRUCTIONS] The entire contents of the call, including the presentation and question and answer session that will follow are the copyrighted property of Quest Diagnostics with all rights reserved.

Any redistribution, retransmission or rebroadcast of this call in any form without the 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 am 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 relationships, changing relationships with customers, payers, suppliers and strategic partners, and other factors described in the most recent Quest Diagnostics, Incorporated, Form 10-K and subsequent SEC filings.

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 and supplemental financial analysis are also available on the Website.

Now, here is Surya Mohapatra.

Thank you, Laure.

We reported strong results for the fourth quarter and full-year 2006.

During the year, earnings per share grew 13% despite a reduction of 9% [highly accented] due to accounting changes and special charges.

Revenues grew 15% and cash from operations reached $952 million an increase of $100 million from 2005.

We drew strong organic revenue growth and increased profitability.

Molecular tests [highly accented] continue to grow rapidly led by edge PZ and Chlamydia and gonorrhea testing.

We expanded [highly accented] family of cancer tests, we use blood instead of bone marrow to access leukemia and introduce an important new test to predict breast cancer occurrence.

We completed the acquisition for Focus Diagnostics, [highly accented] testing, and intersection, maker of the InSure colorectal cancer screening test. [highly accented] Industry leading hospital business, and we have met excellent progress in the acquisition of LabOne.

As we look to 2007, we face challenges as a result of increased price competition and the loss of certain contracts.

United healthcare and the PPO of horizon Blue Cross/Blue Shield of New Jersey.

As you recall, we did not accept United Healthcare's [ highly accented], unreasonable demands and [highly accented] provisions.

While it is unfortunate that we could not reach an agreement with United, this was the right long-term business for our company and our shareholders.

Managed care business is extremely important to us.

Every managed care organization has its own goals and objectives.

We walk with them to understand their needs and develop appropriate solutions.

We improve the health of their members and reduce their overall costs.

In this competitive environment, we will maintain our leadership position and we'll take action where necessary to defend it.

While the United contract has attracted a lot of attention, it's important to remember that the rest of our company will continue to grow.

Our focus and our value proposition, putting patients first, providing superior service to physicians as payers, and bringing [highly accented] to the marketplace has served us well in the past and will drive growth in the future.

I will discuss our growth opportunities after Bob reviews our financial performance and 2007 guidance.

Bob?

Thanks, Surya.

Overall, we had strong performance for the quarter and the year driven by our clinical testing business.

Revenues from continuing operations grew 8.5% for the quarter with the acquisitions of LabOne and Focus Diagnostics contributing about 4%.

Our clinical testing business, which accounts for over 90% of our total revenues, grew 6.9% during the quarter, on a volume increase of 1% and an increase in revenue per requisition of 5.9%.

Volume adjusted for acquisitions was actually below the prior year by about half a point.

The volume decrease was principally driven by ending two very low priced relationships, one for lab management, and one for drug screening, which account for an almost 2% decrease.

Essentially none of the volume change was associated with the United contract.

As we retained virtually all of the United volume during the fourth quarter.

The increase in revenue per acquisition continues to be primarily driven by a shift to a higher price test mix, and an increase in the number of tests ordered per requisition.

Operating income as a percentage of revenues was 18% for the quarter, and comparable to the prior year before the impact of FAS 123R which reduced margins in the quarter by 0.2%.

The impact is less than in the first three-quarters of the year because we reduced our accrual associated with our long-term performance plan due to our revised outlook for 2007.

Clinical testing margins continued to expand or were offset by lower margins in our clinical trial testing business and increased investment in our health care IT subsidiary Med Plus.

The LabOne acquisition, which anniversaried this quarter, had a negligible impact on year-over-year margin compares.

We remain on track to realize the $40 million in annual synergies committed to, most of which will be realized in 2007.

During the quarter, we recorded a noncash charge of $10 million or $0.03 per share to write down an investment.

The charge is reflected below operating income in other expense net.

Diluted earnings per share from continuing operations increased to $0.77, the growth in earnings was driven principle by the stronger performance in our clinical testing business, partially offset by the investment write-down and the performance of our nonclinical testing businesses.

Discontinued operations, mainly NID produced a $0.01 loss in the quarter, principally associated with legal expenses.

Cash from operations was strong at $306 million for the quarter, and comparable to the prior year.

Full-year cash from operations of $952 million was $100 million above last year.

During the quarter, we made capital expenditures of $60 million, and repurchased $196 million of common stock.

Days sales outstanding rounded to 48 days, down almost a day from last quarter, reflecting the resumption of Medicare payments which had temporarily stopped at the end of the third quarter.

Now, I'll discuss the estimated impact of contract changes and our outlook for 2007.

We are only about three weeks into our status as a noncontractor provider to United and it will take some time, possibly into the second quarter, before we can narrow the estimated range of the impact on our financial results.

United accounted for approximately 7% of our revenues in 2006, with some markets having concentrations as high as 15 to 20%.

Although not the best barometer for what we ultimately expect, through the first three weeks of January we estimate that about half of the United business has moved to various contracted providers.

United has threatened positions with penalties if they are still sending lab work to an out-of-network provider as of March 1st.

This is unprecedented and clearly inappropriate, and influencing physician behavior.

We will not be able to determine how much volume may ultimately move until after March.

Additionally, United has been aggressively communicating to its members that they will be faced higher co-pays and deductibles if they use an out of network lab.

While these actions may cause a significant portion of the work to move to contracted labs, if there is a deterioration in the service levels that patients and physicians have become accustomed to, it's not clear how long those service failures will be tolerated.

Additionally, given how soon it is after the contract change, we have not seen how United plans to reimburse us in each of the markets and for each of the plans where we do perform testing.

Although in most cases we're entitled to reimbursement from United, sometimes at rates in excess of what we were previously reimbursed, we expect United to challenge our rights in certain cases, leading to disputes which will take time to resolve and which could result in a temporary increase in DSOs.

We plan to aggressively assert and defend our rights through appropriate reimbursement.

We have also been notified that as of April 1 we will no longer be a contracted provider on the Horizon Blue Cross/Blue Shield of New Jersey PPO contract.

This contract accounts for about 1% of our revenues and we believe it was lost on the on the basis of price.

Our current expectations is that these contract changes will reduce our revenue growth in 2007 by between 7% and 10%.

Most of that resulting from the direct loss of previously contracted work, and some of it associated with the loss of other work from physicians who choose to consolidate their testing with a single laboratory.

Given that we expect a decrease in volume, we have developed cost reduction plans which will be implemented based upon a weekly analysis of volume levels.

We have already taken actions which will reduce our cost structure by over $100 million annually, and will continue adjusting our costs to match with volume levels.

Additionally, while we were always looking for ways to become more efficient, we are taking a closer look at what additional structural cost reductions can be made.

As we adjust our cost structure, top priorities will be maintaining the differentiated level of service we provide to our patients and physicians and remaining position to capitalize on growth opportunities.

As you have heard me say before, all cost is variable in the long term.

With that, comes the understanding that certain costs can be acted on faster than others.

About 60% of our operating costs can be considered variable in the near term, immediate to six months out with the remainder more structural in nature and taking longer to address.

Therefore, the profit impact of any lost business will be greatest during the six months or so following its loss.

The extent to which we will need to reduce structural costs which in part will be driven by how quickly we replace lost business will determine how long it will take to complete all of our cost actions.

With that said, providing precise estimates for 2007 is challenging.

Our estimates are based upon the market intelligence we have gathered, operational plans we have developed, and actual volume levels for the past three weeks.

We plan to update full-year guidance each quarter or possibly more frequently if we make major revisions to our estimates.

Our current guidance for results from continuing operations in 2007 is as follows.

We expect revenues to approximate $6 to $6.2 billion, this anticipates that the contract changes mentioned earlier will reduce revenue growth by 7% to 10%.

Revenue guidance excludes the impact of potential acquisitions.

We expect operating income as a percentage of revenues to be between 16.5% and 17.5%.

The impact of the revenue loss associated with contract changes is estimated to reduce 2007 margins by 1% to 2%.

To help you initially reset your models, we're giving full year estimates for net interest and amortization expense of approximately $90 million and $13 million, respectively.

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

We expect cash from operations to approximate $800 million, which reflects a reduction of $150 to $200 million related to contract changes.

This reduction includes a one-time amount of approximately $50 million related to anticipated delays in billing and collections with United and its members, which will temporarily increase DSOs by several days.

Capital expenditures are expected to approximate $200 million.

Consistent with our past practice, we intend to deploy excess cash first into growth opportunities, and secondarily into share repurchases.

And lastly, we expect diluted earnings per common share to be between $2.70 and $3.

This estimate reflects a $0.50 to $0.80 reduction due to the anticipated impact of contract changes discussed earlier.

These estimates are before any special charges, including charges related to potential restructuring activities.

Before I turn it back to Surya, one final comment.

While contract losses and intensified pricing pressure will impact performance in 2007, we fully expect to return to growing revenues and earnings in 2008.

We will do this by continuing to provide a differentiated service offering at competitive prices and driving efficiency in our business.

In addition, we plan to use our strong cash flow and solid balance sheet to fund expansion into other profitable, high-growth areas.

Now, I'll turn it back to Surya.

Thanks, Bob.

A lab test is not a commodity, someone's's life depends on the results.

Our job is to provide accurate and timely results to physicians and ensure that our patients are treated with care and compassion.

We are in the medical business and our reputation is based on solid quality, convenience and innovation.

That is how we distinguish ourselves every day.

In the past, we have seen business move to the competition on price and return based on service and quality.

We have improved the overall patient experience at Quest Diagnostics, we have 2000 of our own conveniently located patient service centers with specially trained [highly accented] to provide a unique patient experience.

At Quest Diagnostics patients are served at our patient service centers within 20 minutes on average, and even faster where we have deployed our automated appointment scheduling.

One [highly accented] was so pleased with this benefit for their members that we [highly accented] the rollout of their request.

We continue to deliver superior service to physicians and hospitals.

Our extensive logistic network ensures timely and reliable pickups of specimens by our own couriers.

Our more than 500MD's and Ph.D.'s and our Six Sigma culture help us deliver accurate results on time and provide consultations to physicians on difficult or unusual cases.

Our emphasis on bringing new tests and technologies to market helps doctors manage their patients better and is driving growth today.

These include gene breast tests for women's health, such as HPV and endocrinologist tests using [tandem aspects].

During 2006, gene breast unnecessary testing generated more than $1 billion in revenues and is growing at greater than 10% per year.

We have strengthened our relationship with [FARIA], formally [highly accented] diagnostics, the leader in allergy testing.

UniLab testing is growing in double-digits and we have extended our exclusive [arrangement]. [highly accented] has aggressively piloted the use of our proprietary InSure colorectal cancer screening test to its members and employees, saving lives and reducing costs through early detection.

We are continuing to spruce new tests and technology to drive growth for tomorrow.

We are working on an exciting new genetic test to determine carriers of genetic [highly accented] that causes [highly accented] Fragile X Syndrome.

The most common form of mental retardation.

The test, expected to be ready in a few months, will enable broad based screening for Fragile X.

Our Focus Diagnostics has introduced a genetic test to identify multiple sclerosis patients who may benefited from an important drug [highly accented] This is another example of personalized medicine and increased role that diagnostics is playing.

Another exciting development is digital pathology.

We have begun to use advanced digital scanning devices that allow us to share images over the web.

This, too, will allow us to accelerate growth in [highly accented] pathologies throughout our collaborations with hospital-based pathologist.

According to innovation in Healthcare IT, we continue to announce our Care360 patient center physician portal.

Currently, more than 100,000 physicians across the U.S. use Care 360.

We are delivering approximately 90% of test results and receiving about half of all test orders over the Internet.

Several mental health plans are piloting e-prescribing using Care 360.

Only this week, Anthem, a division of Well Point announced it is partnering with General Motors to drive e-prescribing to doctors in Ohio using Care 360.

Treating patients with care and compassion, providing physicians and payers with superior service and bringing technology and medicine to the marketplace quickly, these are the proven [highly accented] that distinguish our company and drive growth, and we will resist any efforts to turn our existing business into a commodity.

We also see increased opportunities to bring our experience and expertise in diagnostic testing to international markets.

We have recently been awarded a contract in Ireland, the government contracted with us to reduce their backlog inside [oncology] testing.

While this is a small win, we are encouraged because the quality and service we provide in the U.S. are being recognized internationally.

Technologies enable testing to be brought from closer to the patient, whether in the physician's office or at the patient's bedside.

We are actively exploring opportunities in this area and intend to capitalize on this strength to augment our laboratory testing business.

In closing, 2006 was a year of outstanding performance, 2007 will bring challenges and we are prepared to deal with them.

In the end, we will emerge as a stronger company.

In 2008 we expect to drive both top and bottom-line growth.

We are committed to our longer-term goals to grow revenues organically at the level of the industry growth rate,[inaudible] acquisitions, to expand margins to 30% and to further strengthen our leadership position.

And I'm excited about the success of our company.

We'll now take your questions.

Operator?

Hello?

Yes, sir.

We are ready to take questions.

Thank you. [OPERATOR INSTRUCTIONS ] Our first question comes from Bill Bonello of Wachovia.

Good morning, guys, just a couple of questions.

Just one on the quarter, I want to make sure I understand something.

Are you saying, Bob, that EPS would have been $0.80 in the quarter without the charge?

You could actually do that math and get there.

The charge cost us $0.03 and we recorded 77.

I wanted to make sure, so $0.77 is net of that charge?

Absolutely.

Okay.

And then on the guidance, you gave a lot of color on your thinking, I appreciate that.

I'm just trying to get some sense of what could make the revenue end up being either better or worse than the guidance.

And you touched on sort of your ability to retain United business and get paid on that.

Is it fair to say that the guidance assumes that you will not be retaining much United business and that you won't be getting much of a premium on the business that you do retain so that if you do better than that, that would be upside to the guidance?

Or do you assume some retention in premium pricing?

Bill, we're assuming that the majority actually the vast majority of the United business moves.

Now, given that for the business we retain, there will be cases where we get higher reimbursement than we've historically gotten.

We also expect there's going on some business where we struggle to get reimbursement and may not be reimbursed at all.

And net-net what we're looking at is an average reimbursement at least for the way we've modeled this, consistent with the average reimbursement we had last year.

Okay.

Okay.

That's very helpful.

And then in terms of the pricing environment, outside of the two contracts that you mentioned, are you sort of getting feedback from national account managers and/or regional sales people had your competitors are sort of across the board now going out and competing more aggressively on price?

I mean, what's your sense of how much United and Horizon are kind of a one-off opportunistic situation versus ability to do that with other contracts?

Yes.

Bill, every managed care organization is different and every contract is different.

But what we are seeing here is where the competitor who is bidding on a significant lower price, asking for exclusivity and longer-term and more importantly, guaranteeing leakage, this is the way it used to be brought in the '90s, then we have a payout as protected themselves by having $200 million transaction costs, have gone out of their way to take choice away from the physicians and the employees and the employer and basically turning a PPO product to an HMO.

So we see the competitive pressure and we also are monitoring the competitive environment.

And what we feel that for the next six to 12 months, this is going to play out and at the end of the day that these contracts are not profitable and the service is going to be affected.

So we will continuing providing the service, we will be competitive in pricing and we'll take some strategic action to defend our position.

But we'll always provide the service that is required for the patients and the payers and the doctors.

Okay.

But it sound like from all of that, then, that we shouldn't necessarily be shocked if over the course of the next year there's sort of more volatility around additional contracts, that would at least be within the realm of sort of how you see your competitor operating?

That's what we assume, that this is not the first one, it's not going to be the second one and at least for the six to 12 months, this is going to be a very highly competitive price environment.

Okay.

That's very helpful.

I'll jump back in the queue.

Thank you.

Our next question comes from Bill Bonello with Wachovia.

That was just Bill Bonello.

I'm sorry, it's Tom Galluci with Merrill Lynch.

Good morning, thanks.

Maybe just following up on some of those comments you were just making.

So if we think about United losing the vast majority of that, so call it 6% or 7%, I guess and Horizon you say is another 1%, you've got that for a couple of months for the year and you're taking out 7% to 10% of revenue, that incremental sort of revenue that you would expect, are those contracts that you have identified that you think are at risk, or is it just spillover business from the doctors?

Could you give a little bit more color there what's opposite top of those contracts?

It's Bob.

We expect to lose most of the combined 8% in revenues associated with UHC and Horizon.

Right.

And some pull-through.

So far, when we looked at the first three weeks or so, our total volume has been impacted by about 5% associated with the UHC contract.

Almost 4% of that or about half of the UHC, almost 4% is associated with UHC, about half of their volume.

There's just over 1% that I'd label as pull-through so far.

We expect that UHC's going to ramp up their efforts to get more of the work to move to them.

Obviously on March 1st the penalties for physicians that have been threatened kick in.

And the Horizon contract end on the 1st of April, we expect some pull-through associated with that as well.

It seems like in some ways you're being fairly conservative on what you lose on those contracts but we don't have anything built in here for any other contract losses necessarily?

No.

In fact, Bill, we have some built in for contract wins to offset some of this.

If you look at the revenue guidance, we're saying that it's actually down 7% to 10% from where it otherwise would have been.

But essentially it's flat to down about 4% in what we're reporting, which implies that the rest of the business is growing at about 6% or so, and that anticipates that we will be winning some other contracts.

As contracts come up, it's not all bad, because as they come up for us, they come up for other people as well, and that's an opportunity to win contracts.

Which sort of led, I was going to ask Surya, you mentioned in your prepared remarks that you would take some actions to defend yourself.

Does that mean retaining business you've got or maybe going after other business in other areas of the country and maybe yourself looking to expand in some newer markets.

Both.

We are going to retain the business we have and great relationships with managed care organizations and go after some contracts we don't have.

Then maybe if I could ask you one more accounting sort of related question, Bob.

Since you sort of have a lot of guesswork it sounds like to do on the pricing that you're going to get from United, how are you going to go about booking that revenue and would we see increased bad debt expense?

How does that technically work?

Tom, it's -- first I can tell you it won't be easy necessarily.

As we get work, we'll bill it to United as we would have in the past.

We have to then wait to see what comes back on the EOB at that point.

And then evaluate the reimbursement, determine whether or not we'll be actually appealing any denials on behalf of the patient.

We then have to determine how those appeals are going to be treated and evaluate how we'll then deal with any patient responsibility that's out there.

With that said, all complexity attached to it, we have a pretty good view as to what we believe our rights are in even of the states and for each of the plans, we're going to be looking at this in a very, very detailed fashion, building it from the ground up.

From an accounting perspective I feel very good about us being able to, once we understand how much work we get and from what plans and from what states, being able to appropriately account for it.

The real challenge is trying to figure out how much in which states and which plans we're going to get.

That's the complexity here.

Okay.

Great, thank you very much.

Our next question comes from Ricky Goldwasser with UBS.

Yes, good morning.

I have some follow-up questions just to clarify, maybe I missed the answers.

I guess the first question is you've said that in the last three weeks you lost about 50% of the United business.

How much business have you lost so far from other contracts?

As I said, right now we're looking at volumes associated with the UHC contract, which are down about, in total, 5% over the prior year.

About 4% of that is attributable to UHC work, which has moved to other contracted providers, and just about a little over 1% I would label as pull-through associated with that work.

Okay.

And is the guidance off your revenue guidance, so kind of the low end of the guidance, what are the assumptions there for -- what's the percentage of pull-through business?

Ricky, as opposed to giving you a specific percentage on the pull-through, what I would tell you is if you assume that the 7% to 10% impact that we mentioned assumes that the majority of the UHC and the Horizon work has moved, then the rest of it is really the pull-through.

Okay.

And on the 450, it's only the UHC?

Well, it's a combination.

I think, again, it's -- there's always going to be a combination of direct work that's moved, and some pull-through associated with it, and as you look at the ranges, it's really a function not so much of varying the pull-through but varying the amount that we retain on each of the contracts.

Can you just clarify that?

Because in terms of when I look at the United impact, I think you know obviously United is kind of a straightforward business because you're saying that United is going to physicians and basically trying to make them switch.

Or encouraging them to switch.

But the question then is really what's going to happen a few months from now if physicians switch, will they decide to try other labs and send them the rest of the business?

Ricky, as I've said, in some cases we expect that that will happen, physicians will look to consolidate all of their work.

Our hope is that given the value proposition, the service levels that we provide, the patient experience that we have, even if they do move their United work, they'll keep the rest of the work with us.

Really that's what we're going to be fighting to retain.

As well as as much of the United work as possible.

And so going back to my question, if that's what you're factoring into the 450?

There is some anticipated pull-through in both the 450 and the 650.

So at both ends of the range.

It would be silly for us to assume that there would be no pull-through.

Particularly when we've already seen some of it occur.

Okay.

As far as the bad debt expense assumptions?

We are not giving specific guidance on bad debt, but that's built into the operating margin impact that we've told you about.

And we would expect that there could be some increase in bad debt, as there's going to be an increase in DSO's as well.

Lastly on the 60% of the operating cost that is -- could be variable in the next six months, is courier costs considered variable operating costs?

Well, it depends upon where you are in that cycle.

But yes, sir, as we get further out and we look at whether or not accounts have moved, it allows us then to potentially restructure routes.

As you restructure routes, then you start getting into the distribution costs, which are not only people but vehicles and things like that.

Okay.

But should we assume that for an account that you've just seen kind of a loss of United business and you're not seeing any loss on the other managed care contracts, you'll keep the same service levels?

Oh, absolutely, that's one of the things that will allow us to hopefully maybe get some of the United work back, and win other business.

Ricky, this is early days.

It all depends on the execution.

We see what United has done, has created fear and uncertainty in the minds of the doctors and the patients and we saw quite a lot of business has moved away from us to other providers.

But we will continue providing the best service we have and want to ensure that the doctors and the patient can come back to Quest and many times if they are referred by the in network physicians we have the right to bill United as if they were in network.

Right.

And then just, I think you mentioned that you're going to use your balance sheet to grow into -- to expand into high growth areas.

Can you give us a little bit more detail there?

Are you looking outside the clinical diagnostic testing world?

Yes.

You know, as I have said many times, we are going to use our expertise and experience in diagnostic testing and grow our business.

So the future growth is going to come internally from gene-based necessary testing, saves a billion dollars, 10%, it will come from cancer testing including [highly accented] and hospital business.

But the two new business opportunities, which we are going to focus for the next 12 to 24 months is international expansion and entering into the point of care of newer patient testing.

We are exploring opportunities very actively and we intend to capitalize on those growth areas. [highly accented] testing is a $6 billion market growing at 8% to 10% and we want to play a role there to augment our main business.

And when it comes to international, we have narrowed it down that we'll go to selective countries in the South Pacific and South America.

Thank you.

Thank you, Ricky.

Our next question comes from Adam Feinstein of Lehman Brothers.

Great, thank you.

Good morning everyone.

A few questions here.

Bob, could you provide more detail on another cost-cutting?

You made comments here in terms of cost-cutting opportunities you identified.

I wanted to see if you could provide more clarity, curious if you could give some more details.

And was also curious in terms of what's included in the guidance in terms of the cost cutting and I have a few follow-up questions.

With respect to costs, essentially what we're looking at is pulling out the, what I'll call the variable costs, the $18 to $20 a REC that's out there.

And then starting to get at some of the fixed costs but frankly how much fixed costs we pull out and how long that takes to get at, is going to be a function of how quickly we replace some of the the lost volume.

Remember, we're not assuming that we just lose the United work and Horizon work and we don't get any other work in, and as we just mentioned a minute ago, service levels and maintaining service levels are going to be critical throughout this year.

Because frankly that's why physicians will come back to us, because in some cases they're not going to be happy with the service levels that they're getting.

We may see patients not happy with the service levels they're getting and come back to us.

So really the cost actions are going to be a function of what the volume levels are, and we've developed plans at various volume levels to take various actions.

Now, as you know, about 50% of our costs are people costs.

It's a very labor-intensive business and as a result that will be adjusting the size of the work force to the volume levels will be the first action that we take.

And then we'll be looking at infrastructure costs based upon how much volume actually moves.

But there's really not too much that will leave off the table, we need to do the right thing to manage the business, but at the same time make sure that we don't do any harm to differentiated service levels that we've got out there.

What's included in other guidance?

I mean, do you include some of those [inaudible]?

There is some towards the back half of the year but I would say that the majority of the cost reductions that we've anticipated, the 60% of the costs that are variable in the near term.

Okay.

And then one more question here on this topic, you gave a number out in some of you're prepared comments, I'm sorry, I didn't catch it, I just wanted to see if you could give us that number?

The -- on the cost actions taken to date?

Yes.

Over 100 million annualized at this point.

Okay.

So 100 million annualized, and but the timing is still uncertain in terms of --

Well, that 100 million, the actions have already been taken and it's annualized.

Keep in mind that the revenue impact is about $300 million annualized at this point as well.

Okay.

And just so people know, the summary of the prepared comments will be posted on the Internet probably within the next 30 minutes or so.

All right.

And then thank you for all of the detail there.

One more question from me here.

In terms of stock buyback, clearly your stock's come down a lot, you guys decent free cash flow even after the lost business here, your leverage is very low.

Why not get more aggressive with the share buyback?

Well, in the fourth quarter, Adam, we repurchased almost $200 million, so we obviously were more aggressive there.

We'll be repurchasing shares in '07 as well, but as I've said before, our first priority for the cash flow and leveraging the balance sheet is going to be to drive growth.

When those opportunities aren't available, either at the right price or at the right time, we'll deploy the excess cash into share repurchases.

You should assume that the stock price is depressed that we would obviously be buying more than we would otherwise be buying.

All right, thank you.

Our next question comes from Jim [Kassel] .

Hi, historically Quest has been amongst the most successful and in some sense the most aggressive in the industry in collecting the portion that the patient owes for the testing.

As the United business moves to out of network where there are higher deductibles and co-pays, are you folks ramping up or have you made provision to ramp-up the collection efforts to make sure that you get that portion that the patient owes you?

We anticipate that there will be more effort involved in collecting portions that are due from patients, and that will also be one of the things that impacts the bad debt percentage as well, all of which is built into the guidance that we've given.

But in terms of more aggressively pursuing patients, no.

We don't plan on doing that.

I mean, have you gone out and added collection agencies and done that sort of thing recently to -- in anticipation of greater volume than you had historically?

We have not added collection agencies.

Obviously, we will adjust the different areas that support the billing and collections function where we need to.

But in the end, we're trying to minimize the impact on the patient.

Our first route is going to be to bill United and understand how they reimburse us.

And then actually appeal on behalf of patients, try and get paid that way.

And then as a last resort, bill patients and try and keep them out of the middle whenever possible.

So in other words not to offend them and have them lean on the doctor to move the business?

Well, we don't think it makes sense to try and put the patient in the middle here.

Okay.

Thank you.

Our next question comes from Kemp Dolliver of Cowen & Company.

Thanks, a couple of questions.

First is with regard to the business that has moved, what's your sense as to who has picked it up in terms of your national competitor compared to the independent labs, and does the mix of who picked up the business impact your thinking regarding recapturing business?

Ken, this is Surya.

As we said, that we're going to fight for every person and every doctor.

What is new is the United letter threatening doctors that they're going to penalize them and creating uncertainty.

And also, telling patients that they're going to be paying more.

Now, what we have seen the doctors, including my own doctor, has moved samples to other labs.

But we don't know how much of them have gone to the competitor who has the contract with United versus how much have gone to the hospitals and how much is going to other labs.

So we will know this -- we will know more within the next three or four months, how it is going to settle down, our feeling is there are probably going to be a number of laboratories, just not one.

I would tell you that we feel as though our service levels stack up very well against all of our competitors, so in terms of thinking about whether or not it's going to be easier to get back from one or the other, we think we've got a pretty good service office that compares well to all of them and hopefully it will move back to us regardless of where it's gone.

Okay.

That's helpful.

Related to that, you are already decided to reduce your cost structure in that you've essentially -- you made some decision or evaluation with regard to amounts of business that would come -- that would come back.

So my question in that context is what's your ability to essentially -- how quickly can you flex infrastructure up with more business comes in than your initial cost reductions assume?

Kemp, I would see that we are being very deliberate in taking costs out so that we don't get caught in the situation where we can't respond and maintain service levels if business does come back.

Now, with that said, we've got to be disciplined in making sure that we manage costs to the appropriate volume levels, but I don't see us putting ourselves in a position where if the volume comes back, we're not going to be able to appropriately support it.

Okay.

That's super.

The last question is broader.

You all discuss your expectation of picking up business during the course of the year, you have a competitor who has become very aggressive on price, and certainly a marketplace that would like to take advantage of that.

Is price on or off the table with regard to recapturing business, from your perspective?

Well, you know, most of the managed care organization bids based on the size of network, type of service,al medical quality, the member preference and the preference of doctors and patients and then price.

And what is really happening here is you have one competitor and one managed care to not worry about the choice and reduce price so we don't expect to win all the contracts but we are monitoring the competitive landscape and we're going to take strategic action to defend the contracts we have and at the same time we'll get some new contracts.

But it is a situation where for the next six to 12 months we will see pricing pressure in the industry.

That's very helpful.

Thank you.

Our next question comes from Andreas Dirnagl of JP Morgan.

Hi, good morning.

Bob, clearly your guidance, and what you've seed about it in terms of volume losses and UNH contract, can you talk about what you've seen so far and try and characterize some of the volume losses, i.e. is it more on the routine testing side, more on the esoteric testing side, are you seeing it sort of move away sort of along the lines of what your overall testing volume is?

When work moves, it's not so much a matter of the physician picking and choosing what work they move.

They essentially move most of the work.

But I will say, though, that we do have some proprietary tests which physicians value very much and we've not been able to analyze the work that we've retained and the work that's moved.

But I would expect that some of those proprietary tests will help us keep and retain some work.

And some [highly accented] and the oncologist and some of those people who used to send to people out of network, they will probably still use Quest Diagnostics.

But again we will see people moving to other providers, but I don't know how long they will tolerate the service and they may be coming back for some of the tests we have.

And just in the event you're thinking the tests we might retain will be much richer priced than the other ones, I caution you there, some of these proprietary tests are routine in nature as well.

Unicap testing, some of the InSure colorectal cancer testing, in addition to some of the esoteric tests.

But the mix shouldn't be dramatically different overall.

Okay.

Great, I may have missed this, did you actually say to whom you lost the Horizon, Blue Cross/Blue Shield?

We did not.

We're not sure, quite frankly, exactly where the work goes.

But as we did say, it doesn't really matter which competitor it goes to, we feel as though we will be able to get it back if it's going to come back based upon our service levels.

The Horizon contract doesn't end until April 1st, just to be clear on that.

Right.

Okay, thank you.

Our next question comes from David MacDonald with SunTrust.

Good morning, guys.

I have a couple of housekeeping questions.

You gave a couple numbers that I apologize I missed on net interest expense, I think it was depreciation, if you could just repeat those.

And one other question is on the option expense, is the number that we saw in the fourth quarter kind of a good run rate number as we look into 2007?

The first question for you on the net interest and amortization, interest expense, net interest expense, $90 million, nine-zero, amortization expense, $13 million, one-three.

Okay.

Then with respect to the FAS 123 expense, no, the fourth quarter's probably not a good amount to use as a run rate.

It's probably more appropriate to look at the full year amount and think about something closer to that, quite frankly.

Okay.

Thank you very much.

Our next question comes from Vivek Khanna of Civic Global Healthcare.

I just had a question, what are you assuming for organic revenue growth for yourself, excluding the loss of these contracts for '07?

Wondering on the loss of revenues, is there any geographic color you can provide or is that pretty well balanced across the country?

Thanks.

On organic revenue growth, aside from the contract impacts, we're anticipating that we grow in the 6% range consistent with the way we grew this year.

As I mentioned earlier, without getting into the specifics of the particular markets, we have some markets where the concentration of the United work was as much as 15% to 20% of our total revenues there.

Great.

Thank you.

Our next question comes from Bill Quirk of Piper Jaffray.

Have come, good morning.

A couple of questions, if I may.

First off, considering the comments about what payers assess when they're looking at contracts, are we seeing a shift in the prioritization from, say, looking at service and establishing a weight for that, versus price?

No, I don't think so.

We had a great relationship with United.

We served half of their patients and I think every [highly accented] has an important goal to take care of their members and at the same time reduce costs.

I think this is a unique instance where one managed care company and one laboratory company coming together for almost 10 years, and again, how much of this $200 million of leakage is driving this kind of behavior, I don't know.

But we have a lot of managed care organizations, it's only 2% to 3% of their total healthcare costs, rather have overall costs reduced by taking care of the patients rather than saved a little bit of money in diagnostic testing and not invest in growth, and have poor quality and not appropriate service.

So this is not the trend.

This is an exception and it's probably going to be resolved within the next six or 12 months when people realize that there is intrinsic value in medical quality and network.

It will be safe to say then that we should expect no changes to how Quest thinks about future contracts?

In other words, we are not going to see price, from your perspective, become the overriding factor, we're still going to look --

As I told you, price is part of any contract negotiation, but with my experience, price is not the only thing and we don't lead with price.

We want to price competitively.

We provide superior service and we will be paid fairly.

But my discussions with many, many managed care organizations, they they want to take care of the patient, they want to take care of the members.

And it is irony that one managed care organization is disturbing the network and creating different kind of relationship with the providers on who they eventually depend on.

That's very helpful.

A couple of additional questions, if I may.

With respect to potentially moving into point of care testing, should we think about this as more along the lines of placing disposable single-use tests into the physician office or are you actually exploring looking at potentially placing instruments and obviously reagents and what have you to support that?

Well, if you think about what we do, we do testing.

We've been block samples and we do centralized testing.

The technology has now come to a stage where some of the tests can be done at the patient's bedside, whether it's in the hospital, home, or doctor's office and nobody has to wait 12 hours or 14 hours to get the results.

What we are looking at, what we call the near-patient testing, which will have [highly accented] instruments which will provide the results at the person's bedside but have a connectivity component so that you can have the same results as if it is collected as a central laboratory.

So we want to combine the central laboratory testing information with the point of care information.

So it will include comparison of instruments and also reagent kits.

Okay, that's very helpful.

Lastly, as I think about CapEx assumptions for 2007, does that assume that we have some type of outside the U.S. infrastructure build ahead of, say, what we saw in 2006?

There is some built into that CapEx guidance for expansion, but not a substantial amount that's skewing the number year-over-year.

Okay.

So that potentially, then, is a subject to move depending on how we progress through the year and what opportunities we come across?

As it always is.

Fair enough.

Thanks much, guys.

Our last question comes from Robert Willoughby with Banc of America Securities.

Bob or Surya, do you mention how your pricing actually the business you're doing with United currently, what's left?

Are you more or less in line with your competitors there or did you take the opportunity to raise that now that you're no longer contracted?

Lastly, how have management incentive compensation metrics changed for this year with the lower guidance?

What will you guys get paid on?

Let me start with pricing, Robert.

First, what I would tell you, and I explained this earlier, it's going to vary market to market, plan to plan, and in many cases, as an out of network provider, there are local and other laws that govern what it is we'll be reimbursed.

In many cases we'll be reimbursed actually at a higher rate than we've enjoyed historically, but there will be other situations where net-net we probably don't get reimbursement.

And for purposes of guidance, what we've assumed is that the overall reimbursement on the retained work is not significantly different than the overall reimbursement we had last year.

One important point, though, to make, too, is the more business that you assume is lost, the less relevant the assumption on the reimbursement rate is.

Now, when it comes to management compensation we have a very active and engaged board and the board decides on the management incentive compensation, which is usually a 60% financial and 40% nonfinancial.

I think that's the balance quote" we use and the financial incentives, the financial metrics are based on EPS and revenue growth.

Thank you.

Thank you for participating in Quest Diagnostics Fourth Quarter and Full-Year 2006 Conference Call.

A transcript of the prepared remarks opposite this call will be posted later today on Quest Diagnostics Website at www.questdiagnostics.com.

The replay of the call will be available from 11:30 a.m. on January 25th through 11:00 p.m. on February 23, 2007 to Investors in the United States by dialing (866)361-4939.

Investors outside the United States may dial 1 (203)369-0187.

No password is required for either number.

In addition, registered Analysts and Investors may access an online replay of the call at www.streetevents.com.

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

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

Good-bye.