奎斯特診斷 (DGX) 2007 Q2 法說會逐字稿

Welcome to the Quest Diagnostics second quarter 2007 conference call.

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

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

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

Now, I'd 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 regulations, change in relationships with customers, payers, suppliers and strategic partners, and other factors described in the 2006 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 web site at www.questdiagnostics.com.

A downloadable spreadsheet with our results and supplemental analysis are also available on the web site.

Now, here is Surya Mohapatra.

Thank you, Laure.

We made significant progress in the second quarter and our business is getting stronger.

We delivered 4% (inaudible) in our growth strategies.

We signed a number of important (inaudible) agreement, we've recognized the differentiated level of service we provide.

We improved the efficiency of our operations and we are the leader in clinical pathology gene based (inaudible) testing now with AmeriPath we have become the undisputed leader in anatomic pathology.

We use Six Sigma, lean principles and technology capabilities to drive our personal excellence in our laboratories.

We have identified opportunities to improve efficiency and further reduce costs by $500 million over the next two years.

This would allow us to expand margins in the face of rising pressures and continue to invest in growth.

During the second quarter, consolidated revenues grew to $1.6 billion, operating margin was 16.6% of revenues, and improvement of more than 3% from the first quarter largely a result of actions we have taken to reduce costs and higher revenue for acquisitions.

And we continue to generate considerable cash flow.

We continue to drive organic growth by leveraging sales, service and science.

We executed a number of important health plan contracts.

With the new [regiments] with [Coventyry] and Blue Cross/Blue Shield of Massachusetts we expanded our agreement with Blue Cross/Blue Shield of Florida, we signed new agreements with Medical Mutual of Ohio and [Culinary] Health form in Las Vegas.

We signed a multiyear contract extension with Cigna Healthcare and we have been working with Aetna to implement our expanded contract, which was effective July 1st.

Having this large contract signed has improved our visibility and reduced uncertainty in this competitive environment.

We differentiate our services by continually enhancing our value proposition, that includes superior personal experience, Six Sigma quality, unparalleled access and convenience, innovative tests and our advanced IT solutions.

For example, waiting time for patients in virtually all of our present service centers is under 20 minutes and can be significantly less for persons who use our electronic appointment scheduling system.

In our most recent customer satisfaction survey, physicians continue to rate our service higher than the competition.

We continue to enhance service by deploying a unique specimen tracking system, enhancing our hospital and physician connectivity and introducing cash collection in our business service centers.

And the use of our care 360 portal continues to grow with more than 115,000 physician users.

Our superior service and quality have been honored with the prestigious Governor's Sterling award in Florida, which was based on the national Malcolm Baldrige criteria for performance excellence.

Our focus on scientific innovation does create a unique and exclusive tests is drive growth.

For example, [Numeta] while testing provides an alternative to painful bone marrow biopsies, during the quarter we added new tests to this growing family with revenue doubled compared to 2006.

We're the only national lab to offer immuno care allergy testing, which has been shown to be significantly more accurate than other tests and continue to grow.

(inaudible) select from our focus diagnostics is the best selling diagnostics product on the market for heart beat simplex (inaudible) with revenues doubling over the prior year.

We left the development of use of [LC tender] (inaudible) specs to enhance vitamin D and testosterone testing, which is growing in high double digits year-over-year.

We recently launched the only automated test for (inaudible) syndrome, the most common form of [inhaled] and mental retardation.

We've had the potential to provide (inaudible) testing and drive future growth.

We are very excited about the opportunities to accelerate growth in our (inaudible) pathology by combining with AmeriPath.

We have begun to join our companies in a way that preserves the uniqueness of AmeriPath.

Since the acquisition was completed on May 31st, my staff and I have travelled around the country to meet with the pathologists, management and employees.

They are very supportive and excited about the opportunities for our combined company.

At Quest Diagnostics, we now have a medical and scientific staff comprising of approximately 900 MDs and [PLDs] including some of the world's [luminaries] in the major diagnostic disciplines.

Now, I would like to turn it over to Bob who will provide analysis on our results before I come back with some additional comments.

Thanks, Surya.

As Surya noted, during the second quarter we made excellent progress in building on the momentum which we established exiting the first quarter.

Our progress is clearly reflected in our operating results and provides us increased confidence regarding the outlook for our business.

Given that the acquisition of AmeriPath, which is included in our results as of June 1, has affected a number of our metrics, I'll highlight its impact as I go through the result.

In addition to highlight our progress, I'll point out improvements in certain metrics compared to the first quarter.

Revenues were $1.6 billion, 3.7% above the prior year, with AmeriPath contributing about 4.5% growth.

Revenues for our clinical testing business, which accounts for over 90% of our total revenues, were 2.1% above the prior year with AmeriPath contributing [4.6%].

Volume was 6% below the prior year and approximately 8% below without the AmeriPath acquisition.

Revenue per acquisition increased 8.6% with 3.1% of the increase due to AmeriPath.

The balance of the increase in revenue per requisition continues to be primarily driven by a positive mix shift and an increase in the number of tests ordered per requisition.

AmeriPath's organic revenue growth for the second quarter was almost 8% with particular strength in dermatopathology and hospital testing.

We estimate that consolidated revenues were reduced by about 4.5% due to our change in status with United, with clinical testing volume reduced by about 7%, partially offset by a positive impact to revenue per requisition of about 2%.

The positive impact of revenue per requisition is associated with higher reimbursement on the retained United work, with almost 0.5% of the second quarter increase associated with a true-up in United's rates.

The year-to-date impact of United on revenue per requisition is a positive 1.5 %.

As of the end of the second quarter, we estimate that about 75% of the United volume has moved to other contracted providers compared to about 70% at the end of March.

We expect that some additional United volume will move before the end of the year due to United's ongoing efforts.

We continue to be encouraged by physicians' decisions to select Quest Diagnostics when they are given a choice.

We have seen no further loss of discretionary work during the second quarter.

With our sales force now focussed on winning new accounts and selling additional tests, coupled with the new Aetna agreement, which went into effect July 1, we expect to see further improvement in year-over-year comparisons as the year progresses.

Revenues in our nonclinical testing businesses as a group, which include or clinical trials testing business and the risk assessment business acquired as part of the LabOne, were up slightly from the second quarter of last year.

The acquisition of Focus Diagnostics, Enterix and HemoCue contributed about 2% to consolidated revenue growth.

Operating income as a percentage of revenues was 16.6% for the quarter compared to 18.8% in the prior year.

Margins were reduced by about 40 basis points due to the acquisition of AmeriPath.

Therefore, the more comparable margin percentage reflected a decrease of 1.8%.

This is a significant improvement from the first quarter comparison in which margins were down 3.5% compared to the prior year.

The improvement, which we expect to continue as the year progresses, is due to actions we have taken to reduce our cost structure, the avoidance of certain costs incurred in the first quarter associated with business retention and workforce reductions and higher revenue per acquisition in the second quarter.

Bad debt expense as a percentage of revenues was 4.3% and 4% before the inclusion of AmeriPath.

The 4% rate compares favorably to the 4.4% rate in Q1.

AmeriPath, which carries the higher bad debt rate than the rest of our business, much of it due to the inpatient work done for hospitals, will increase our bad debt expense in the back half of the year by about 1%.

Although it is unlikely that we will be able to reduce AmeriPath's bad debt to the rate we maintain for the rest of our business, because of their business mix, this is one of the areas we have identified as a synergy opportunity.

Diluted earnings per share from continuing operations were $0.73 compared to $0.78 in the prior year.

The decrease is primary due to the change in contract status with United, the impact of which was significantly mitigated in the second quarter compared to that of the first quarter.

Keep in mind that last year's second quarter included a $0.04 charge to write down that investment.

Included in footnote 7 to the earnings release is a table which summarizes the impact of various measures for a number of the items discussed.

Cash from operations was $129 million and was reduced by $57 million of fees and other expenses paid in connection with the acquisition of AmeriPath.

Cash flow adjusted for these payments was strong and compares favorably with the $170 million reported in the prior year.

During the quarter, we made capital expenditures of $49 million and invested $2 billion in the AmeriPath acquisition.

The permanent financing for the AmeriPath acquisition consists of a five-year bank term loan and the proceeds from a very successful offering of 10-year and 30-year notes which was concluded on June 22nd.

$90million of the term loan was repaid towards the end of June.

We were out of the market for repurchasing shares throughout the second quarter due to all the activities associated with the closing and the financing of the AmeriPath transaction.

We plan to resume repurchasing shares in the third quarter, but at a reduced level until we achieve some of the expected improvement in our credit statistics.

Days sales outstanding were 51 days, 4 days above the Q1 level with all of the increase associated with AmeriPath.

We expect AmeriPath's impact on our DSOs to decrease to approximately 2 days by year-end and less than that over time.

Before moving to full-year guidance, I'll take a few minutes to put our progress in perspective.

We've had an excellent track record of driving growth in revenues, earnings, cash flows, and shareholder value.

Coming into this year, we indicated that 2007 would be a year of adjustment due to our contract change with United, and intensified pricing pressure resulting from a heightened competitive environment.

Yet, despite the near-term challenges we face, we've remained committed to a strategy that we believe will deliver superior long-term performance and shareholder returns.

While we will continue to face challenges, the progress we have made has given us better visibility on a number of uncertainties and reinforced our confident in the long term prospects for our business.

First, while facing intense pressure from a major competitor and a number of payers to commoditize our business, we remain committed to providing a superior service level to patients, physicians and other customers.

As a result, we were able to renew, and in some cases expand, our relationships with a number of important health plans.

In each case, on economic terms, which worked for both parties, and at prices which recognize the differentiated level of service we provide.

While there remain a number of managed care agreements that we renewed over the next six months ,we now have contracts in place accounting for almost 60% of our contracted managed care business we had coming into the year, with most of the newly contracted business extending into 2010 or beyond.

This gives us much improved visibility in terms of access and pricing for this contracting cycle.

We've also taken actions to adjust our cost structure to the new volume levels.

We've reduced the size of our workforce in the clinical testing business by over 2,000 during the last six months, while maintaining and in some cases improving service levels.

We've now pulled out over $200 million in annualized costs.

However, we need to do more than adjust costs in connection with changes in volume if we are to expand margins in a highly competitive environment.

As such, we have done extensive analyses of all of our business processes and identified specific opportunities, some of which we have already begun to realize, which will reduce annual costs by another $500 million over the next two years.

Much of the savings will come from streamlining the way we operate our existing labs and patient service centers, not necessarily from reducing capacity and certainly not from reducing service levels.

In addition, redesigns of the way we do purchasing, billing, logistics, as well as how we operate our administrative functions ,will contribute to significant savings.

One-time costs anticipated in achieving the savings have not been finalized and are not netted in the $500 million.

In addition, we've made excellent progress in executing our growth strategy.

Over the past 12 months we have completed the acquisitions of AmeriPath, HemoCue, Enterix and Focus Diagnostics, and have in place major elements needed to drive future growth.

Our focus will now turn to fully integrating and aligning the capabilities of these companies and those acquired with LabOne to fully realize the synergy and growth opportunities they create.

Accordingly we expect limited acquisition spending during the next 12 to 18 months.

With key elements of our growth strategy in place, our focus is now on flawless execution and operational excellence.

In connection with the AmeriPath financings, we committed to our lenders to improve our credit metrics over the next 12 months.

We expect that much of that improvement will result from improved operating performance and some debt repayment.

As our operating performance continues to improve, and we continue to gain better visibility into our projected performance, it will afford us the ability to direct more of our cash flows and balance sheet capacity into share repurchases.

And although I'm not currently in a position to commit to a minimum level of share repurchases over the next 12 to 18 months, we are committed to maximizing shareholder returns by driving operating performance and practicing prudent capital management.

Now I'll turn to our outlook for 2007.

Our current guidance for results from continuing operations is as follows: We expect revenues to approximate 6.6 to $6.7 billion, the increase in previous guidance is principally due to the AmeriPath acquisition.

We expect operating income as a percentage of revenues to approximate 16%.

The addition of AmeriPath, which currently carries lower margins than the rest of our business, will reduce margins by about 1% in each of the last 2 quarters and about 0.5% for the year.

We continue to expect cash from operations to approximate $800 million.

This is net of $57 million of fees and expenses paid in the second quarter in connection with the acquisition of AmeriPath.

And we expect capital expenditures of between 210 and $220 million.

And lastly, we expect diluted earnings per share adjusted to exclude the $0.04 in first quarter charges to be between $2.80 and $2.95, this reflects modest dilution from AmeriPath which we expect will become modestly accretive next year.

Please note, the estimates exclude any additional charges related to potential restructuring activities.

Now, I'll turn it back to Surya.

Thanks, Bob.

As you have heard we are making progress driving both top and bottom-line growth.

We continue to be focused on high-growth areas like cancer, (inaudible) [muscular] disease and infectious disease.

We are growing our business in these areas and diversifying our revenue stream.

Today as a $7 billion company we generate about 35% of our revenues or almost $2.5 billion from high-growth areas such as gene-based (inaudible) testing and (inaudible) pathology.

This compares to about [35%] or approximately $1 billion in 2002 when we were a $4 billion company.

In addition to organic growth we have used acquisitions to drive change in our industry and growth in our company.

Our acquisition of SBCL changed the game in clinical pathology and the (inaudible) business.

The company of [AML] and our (inaudible) institute created unmatched capabilities and drove growth in our hospital business.

Now with AmeriPath we have the opportunity to again change the game and take advantage of the convergence of (inaudible) pathology, clinical pathology and molecular diagnostics.

Key elements of our growth strategy are now in place.

We are the clear leader in a number of high-growth testing areas and we provide the most comprehensive and integrated diagnostic offering available anywhere in the world.

In summary, our business is getting stronger, we continue to improve on an already differentiated service offering, we have signed a number of important (inaudible) agreements, and we are making major improvements in the potential for operations.

And we remain committed to our longer term goals of driving profitable growth and delivering superior shareholder returns.

We will now take your questions.

Operator?

Thank you.

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

(Operator Instructions) Our first question comes from Adam Feinstein with Lehman Brothers.

Sir, your line is open.

Okay.

Thank you.

Good morning everyone.

Just a few questions here.

It seems like the biggest change from the first quarter is, you guys did a great job in terms of really cutting your costs, it seemed like the loss of the UNH business in the first quarter had a big impact on margins and, once again, you guys did a fair job cutting the costs.

I just want to get you to just provide some more details there.

I know you spoke about the run rate and everything Bob, but I just wanted to get you to go back through that and the opportunity going forward.

And then just also wanted to see if you could just also comment in terms of the pull-throughs, you mentioned you lost about 75% of the UNH business, but just want to see if you can provide anymore details about the pull-through and the impact on the associated revenue as well?

Thank you.

Sure, Adam, you may recall in the first first quarter we talked about our costs and whether or not they're fixed or variable.

We said in the short term, let's call it six months or so, about 30% -- I'm sorry, about 60% of our costs are variable.

And what we've been doing over the last six months is really adjusting those cost levels.

As I mentioned earlier, we've reduced our FTE's, or full-time equivalents, by 2,000 since the beginning of the year, and most of that is through normal attrition, and managing the way we add people to the workforce.

Obviously, there are other costs which go a way, as volume goes away, supply costs, bad debt, et cetera.

But we've been very deliberate in the way we manage the cost structure over the first half the year to make sure that we're not impacting service levels.

The other thing to keep in mind is in the first quarter we incurred some extra costs to try and retain business.

And we said we did not expect those to occur again in the second quarter.

So it's really a combination of avoiding some of those costs that we incurred in the first quarter to retain business, and the continued progress that we've made in pulling out what I'll call some of the variable costs in the short term during this next quarter here.

And in terms of pull-through, I would say it hasn't changed.

We have not seen any additional loss of discretionary work and to us that's a very good sign that physicians, when they have a choice, want to continue to use Quest Diagnostics.

Okay.

And just on that point, so it's still that 4 to 1 ratio that you mentioned?

Actually, the ratio's improving a little bit because we're not losing any additional discretionary work, yet we've lost a little bit more of the United work.

Okay.

And then just back on the cost (inaudible), you had identified an additional $500 million over the next two years.

Can you just talk about the timing of those cost savings just so we can think about that?

And then I just wanted to make sure I had the correct numbers in terms of just the cost savings in terms that you've already implemented in terms of what the run rate is?

Well, in terms of the run rate of cost savings, it's about $200 million on an annualized basis that we've already taken out.

On top of that, we expect to reduce costs by roughly another $500 million on an annual basis by the time we get to the end of 2009.

And you're going to see that actually come in over the next several years.

We've got a little bit of that in 2007, but we're going to see that ramp up in 2008 and in 2009, and these actions are really designed to help drive the operating income to that 20% of revenues over time that we've committed to.

Some of the savings gets us the structural cost reductions required to offset the loss of the United volume, which I previously talked about.

Some of it is to offset the pricing pressure that we're seeing.

And some of it is to allow us to invest in growth and further service differentiation as we continue to grow the business.

Okay.

And just a final question from me, then I'll get back in the queue here.

I just wanted to get some commentary, you guys certainly sound a lot more optimistic about the industry environment, I guess earlier in the year on the call in some of the presentations you guys seemed a little bit negative, I guess, about the competitive environment.

So just wanted to get your thoughts, it seems like things have definitely improved and you signed a lot of contracts in the most recent quarter, so I was just curious in terms of your thoughts in terms of the terms of the contracts, have they been better than what you were thinking back in the beginning of the year?

I guess what I'm getting at is, there was a lot of concern about price war earlier this year but it seems to be dying down, I wanted to see what your expectations are there?

Thank you.

Well, Adam, as I said in the beginning of the year, that there are going to be a period of uncertainty.

But now that we have signed a lot of [laser] contracts, including Cigna and Aetna, we feel that a number of uncertainties have been reduced.

We also feel that managed care organizations are different, they are not buying only one strategy, which is a long-term contract with the (inaudible), so we feel very happy that each [managed] organization will have their way of differentiating themselves and we are providing that valuable position to them, and as Bob said, we are almost 66% of the contracts are signed.

So that has cleared up a lot of uncertainties.

Now, as far as competitiveness is concerned, we still will have some challenges in front of us, and I think pricing is always going to be under pressure but obviously (inaudible) which is really going to help us win.

And nothing is like signing a large number of contracts and that's what we have done over the last six months and we feel pretty encouraged and confident that what happened in [October] is a disruption not a trend.

Okay.

Thank you very much.

Appreciate the detail.

Thank you.

Our next question comes from Bill Bonello with Wachovia.

Sir, your line is open.

Yes, a couple of questions.

I'm sorry for the first one but I want to be absolutely crystal clear, Bob, that you are saying the 500 million is above and beyond the 200 million that you've already achieved?

So think of it since the beginning of this year through the end of '09 something on the order of 700 million of savings?

That's correct.

Okay.

And then you mentioned that the increase, excluding AmeriPath, that the increase in revenue per requisition was largely driven by mix and the number of tests per requisition.

I'm just wondering if you can give us any sense of what the revenue per test would have been up on a year-over-year basis or some sense of what happened on a pure price basis, excluding mix and test?

As you know, Bill, over the years that the improvement in revenue per requisition has not really been driven by pure price, it's really been driven by mix shift.

Mix of tests and the number of tests ordered per requisition.

That really continues now.

We are not seeing any significant increases in price per test.

And as I've mentioned, we're seeing continued pricing pressure.

It's not necessarily going away, although we do feel good in that now we've signed up a whole bunch of managed care agreements and we believe that, although the economic terms work for both parties, it also recognized the fact that we do provide a differentiated level of service.

Can you give us any kind of sense of the magnitude of the actual price pressure that you've incurred?

Bill, for obvious reasons I don't want to get into talking about price too much at this point.

I don't think that it's a wise thing for us to do.

But as I said, I think we had economic terms that we were able to work out for both the payer and ourselves as we went through each of these contract negotiations.

Okay.

And then, just on the cash flow, can you tell us, it looks like operating, as you said, operating cash flow would actually have been up year-over-year without the AmeriPath fees, despite the lower net income.

And just trying to understand what's driving that cash flow improvement?

Some of it is just the timing of payments, and what not, but obviously we're very focused on cash flow, managing the balance sheet, managing the DSOs and I would just call it basic blocking and tackling.

As you know, in any one quarter cash flow can fluctuate a little bit and year-over-year through the first six months we are down versus the prior year, principally due to the impact of the contract change.

But it's something that we're very focused on and we do our best to drive the cash flow in a particular quarter, but not at the expense of the business.

So it's really just managing the balance sheet as prudently as we can.

And any big unusual items that were a benefit in the quarter?

I mean, on timing of --

Nothing big, unusual.

The only thing that I pointed out was that the big unusual negative, which is the stuff that came through associated with AmeriPath.

Yes, okay.

Great, thank you very much.

Thank you.

Our next question comes from Art Henderson with Jefferies & Co.

Hi, good morning, very nice quarter here.

A couple of questions for you.

Surya, I know you talked about thinking about that there's still some competitive challenges ahead.

Can you articulate kind of what you're thinking there?

Obviously the pricing environment seems to have stabilized to some extent and your contracts have been renewed but what's giving you concern looking forward competitively?

First of all we are not completely out of it, although we are 66% signed, but we still have quite a bit of contracts.

The thing that really worries me a little bit, the activities last October, now created a new water line for this industry.

And what we have been doing is reducing our dependency on routine low/margin testing and diversifying our revenues, and we are moving towards higher esoteric and higher margin of (inaudible) pathology, and one of the concerns I have is that what's going to happen with that sector, but that market is growing and we have now with AmeriPath, have created an organization to provide superior service.

So that's one.

The second thing, although we don't like competitive bidding, [development] is doing this demonstration and that's certainly a concern I have.

And the third thing in our business, always is actually the people, how do we really get the right people doing the right business.

So execution is the most important thing for us.

But as far as the market is concerned, we have been in a situation of price pressure, it got worse and now we're going to have a new standard, but we have to move on, and that's the reason why we have taken our $200 million annualized cost and by using Six Sigma and lean principle and technology we're going to reshape the Company too, and take out another $0.5 billion in the next two years.

And that's going to give us the strength we need to meet the competitive environment and also increase our margin.

Okay.

That's helpful.

Bob, just a couple of quick questions for you.

Obviously, we've seen 75% of the United volume switch over.

You indicated that there may be a little bit more in the back half of the year.

Where does this stable out in terms of a percentage shift over to other providers?

Yes, we have not given specific guidance around a percentage, but we do, Art, expect that over the course of the year the volume will continue to move to other contracted providers because United's putting a lot of effort into making that happen.

And all along, we've anticipated that that would be the case.

So we would expect over time that the United volume will continue to move.

Okay.

And then final question for you, Bob, I know you've hit on the 500 million a couple times here in this call, but specifically looking in terms of the areas, obviously, is this 500 million is more fixed costs, longer term fixed costs in nature than the short term that you've talked about with the 200 million; is that right?

Absolutely.

It's us fundamentally looking at the way we manage a lot of our processes and making fundamental changes in them so that the costs come out permanently and we're getting at the structural costs.

And is there one big area that you're looking at or is it a handful of areas?

As I said, we're looking at every single -- we've looked at every single process we have across the Company.

And essentially when you think about where our costs are, the costs are coming out reasonably proportionate to where they are, whether it be in the labs, outside the labs, in the administrative functions, et cetera.

Okay.

Great.

And then one last question, I'll jump back in the queue.

On AmeriPath, obviously the margins are a little bit lower than your core Quest business.

The areas that you're focusing on right off the bat to sort of shore those up a bit, can you identify where those are?

Is it purchasing or what areas?

Well, the first thing that we're doing is making sure that the top line continues to grow and that we're not creating any distraction t here.

Because that's the reason that we acquired this company.

We believe that there are some tremendous growth opportunities there and we want to make sure that we're all on board with how to accelerate the growth for both their business and our business.

With that said, there are certainly some cost synergies that we've identified in the past that we're going to be going after, think of those in the areas of purchasing, overhead costs, there are some in logistics, then there's the bad debt opportunity that I spoke about.

But the big benefits of AmeriPath are really going to come from accelerating their growth and our growth as well.

Okay, great.

Congratulations, very nice quarter.

Thank you.

Thank you.

Robert Jones with UBS, you may ask your question.

Hi, it's Ricky, good morning, and congratulations for the quarter.

Thank you, Ricky.

I have some few questions on the flop.

As far as, I think initially, earlier in the prepared comments you said that you signed 60% of the managed care contracts that were up for renewal.

Can you quantify what percent of revenue did the 60% of contracts account for?

Well, Ricky, the way to think about it is we've said about half or so of our revenues in the clinical testing environment come through managed care.

So that should give you some sense.

Now, I would say that a little over 90% of our managed care business is contracted business.

And it's 60% of that number that we've now signed up.

Okay, that's helpful.

Now, just to clarify on the pricing comments, I think you talked about the fact that the United contract established kind of a new waterline.

Based on the visibility that you have now and with some of the contract going extend through 2010, from what you are seeing, are there any step-downs in the out years or is it just kind of the initial year or the initial pricing that's now going to be adjusted to a new level?

Ricky, I really don't want to get into the details of how the pricing works in each of the contracts.

I'm not sure that that's a good discussion for us to have here.

As I said, there continues to be pricing pressure, but we think we came out in a good place for both parties.

In each of the contracts.

And frankly, that's one of the reasons that we are instituting this program, to pull addition costs out of the business so that we can continue to expand margins in the face of that pressure.

And just lastly, you might have said that in the Q&A and I missed it, is part of the additional 500 million cost savings related to any AmeriPath synergies?

Yes.

Whatever synergies we get from AmeriPath are included in that number.

But they are a relatively minor piece of that.

Again, keep in mind that we did that acquisition to accelerate growth, not really for cost synergies.

Okay.

Can you quantify what percent of the 500?

No, it's a minor piece, as I said.

Okay.

Thank you.

Thank you.

Bill Quirk with Piper Jaffray, you may ask your question.

Thanks, good morning.

Concerning the 60% of managed care under contract right now, can you remind us where we were about six months, that same metric?

I don't have that specific percentage in front of me, but many of those were in discussion at that point.

And frankly, that is one of the reasons that we told you that we had a lot less visibility back then than we do now, obviously.

Not only in terms of pricing, but in terms of access, whether or not we'd be a participating provider on some of those contracts.

And then are you willing to take a shot at, say, six months from now, kind of where that percentage could shake out?

I mean presumably we're still under -- in discussions, I should say, with several of the other payers.

One thing to keep in mind is that there will always be a bunch of agreements that are up for renewal, about -- I'd say about 10 to 15% of our contracted managed care business, ex AmeriPath, is under one-year agreement.

We need to deal with those every year, sort of on an ongoing basis and there's no particular date on which they all anniversary.

They anniversary at different times during the year.

And as you know, the Humana contract is still out there that we need to work through over the course of this year as well.

But at any given point, there's typically a fair number of managed care agreements that are out that have to be negotiated.

If you think about generally on average our contracts are 1 to 3 years or so, that means that you've got almost 50% of them coming up in any single year.

Now, given all the ones that we've signed up, we've actually extended that out for a while because now we've got 60% signed up and the majority of those extending into 2010 or beyond.

So we've stretched out the cycle a little bit here.

I guess that's kind of where I was going, it certainly sounds like that's exactly kind of what you guys have decided to do from a strategy perspective is to, I presume, to get improved visibility from a longer term perspective there?

Absolutely.

And we know what the bogey is.

Fair enough.

Lastly, just with the closing of AmeriPath, can you give us an update on the acquisition strategy moving forward?

Yes.

Now, as Bob said, and I also indicated, we have been working almost over the last five or six years, to not only have organic growth, but have acquired growth and have capabilities that will give us the opportunity to be leader in clinical pathology, to be leader in gene-based specific testing and AmeriPath has now brought us to a situation where we are the undisputed leader in (inaudible).

And also it gives us an opportunity to change the game by combining the molecular diagnosis in AP.

So in the short term the growth is in the hospital business, in the short term the growth is in the (inaudible) pathology business, in the short term and medium term, but in the long term, also we know as technology is moving, also the testing is moving near the person's bedside.

That's the reason why we acquired HemoCue, Enterix and Focus Diagnostics and quite a number of businesses has gone international.

So with all these key elements in place in the next 18 months, our goal is to integrate and extract the value from all these acquisitions and to have cross leverage.

Remember, the central piece of our strategy has been diagnostic testing, information and services.

It doesn't really matter if there's pharma company or insurance company or physician.

So we don't expect any major acquisition within the next 12 to 18 months.

We've got plenty of things to really [declare] value.

Thanks guys.

Thank you.

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

Bob, a couple of questions, just what are the deleveraging plans over the next six to 12 months?

Will you pursue an accelerate debt reduction program or will it be kind of a more measured pace?

And secondarily, with the deals announced to date as well as the cost cutting and any deleveraging effort, should we throw out kind of normal seasonality considerations and model sequential higher earnings kind of into 2008?

Well, let me answer the last one first.

I think some of the seasonality with respect to the operating margins, is affected given the way that the costs are coming out and given some of the things that we're doing.

But if you look at the guidance and you look at what we're anticipating for the back half of the year, it's not too different than the back half of last year.

So what that tells you is we made a lot of progress in adjusting our cost structure, in trying to regrow the business, replace some of the UHC work, I think it's a little difficult to give you a sense right now as to what the seasonality looks like.

Certainly from a top line perspective it shouldn't change all that much.

But in terms of the margins from quarter-to-quarter, it's going to be a little more difficult until we can give you some visibility as to when those additional cost savings are going to flow through the P&L.

In terms of deleveraging, as I mentioned, we did make some commitments to our lenders to get our credit statistics back in line, and the way we're going to do that is by obviously doing some debt repayment, but also improving the operating performance of the business.

We know that if people are asking a lot about share repurchases and how we're going to use the capital structure, but we think it's important for us to make sure that we have a capital structure in place which is prudent.

And what I mean by that is it needs to give us the flexibility to be opportunistic with respect to growth opportunities like we were with AmeriPath.

It needs to give us the flexibility to deal with unforeseen situations, which could have a significant impact on operations, like we had with UHC.

But all that said, we are committed to maintaining the capital structure which is going to maximize shareholder value over the long term.

But we want to be prudent with how we manage it as a public company.

Actually, as a public company, we are probably more leveraged than most.

When you look at the S&P 500 companies, there are about 85% of the S&P 500 companies which are rated investment grade, better, and about 70% of those are either at or greater than our rating right now.

So-- and actually, there's only about 15% that are not investment grade.

So currently we are more aggressive than most of the S&P 500 with respect to our capital structure, but we still think that it's a reasonable place for our business, given where it is right now.

And as I said, as we get greater visibility into our projected performance, I think we can then afford to be more aggressive with how we deploy the cash flows and the debt capacity of the business.

I guess the last question, Bob, with the HemoCue deal and some of the international investments, will the disclosure of all this well so that we can better gauge the performance of those entities and the returns on those capital investments?

Since none of those qualify as a separate reportable segment, you won't get a lot of additional detail in the public filings.

We'll try to give you some sense as to whether or not those businesses are having a significant impact on our operating performance when we report to you.

Right now, those businesses are relatively small compared to the total.

So not having significant impact over time.

We'd hope that they would have much greater impact.

We'll start talking more about them.

Thank you.

Thank you.

Tom Gallucci with Merrill Lynch, you may ask your question.

Good morning, thank you.

Bob, first thing I was just hoping you could just expand a little bit on what you meant by the true-up on United pricing that positively impacted the revenue per acquisition in the quarter?

Yes, Tom, the fee schedule that United was using during the first quarter was incorrect.

And we went to them and pointed that out to them and we corrected that in this quarter.

And as I said, that had about a half a point impact to the revenue per req.

Did you actually get some revenue on some first quarter testing as sort of the true-up, is that what you meant?

Yes.

Again, it was immaterial to this quarter about half a percent in terms of revenue per req.

Right.

And then what about the receivable side of United?

I know at one point you were concerned about collections, now they've used the wrong fee schedule, are you getting the money on a fairly timely basis?

Yes, we are.

As I said, at the end of the first quarter, actually, we are getting collections on a very timely basis.

United's really no different than any other payer.

If you provide them the right information that they need in order to reimburse you, you'll be reimbursed timely.

Okay.

On AmeriPath, you were mentioning before, focusing on growth and how to accelerate sort of the combined entities' growth.

Can you talk about just, I guess, revenue retention so far in AmeriPath on two different buckets, the old specialty business, mostly with the hospitals on the esoteric side, and then the core AmeriPath pathology related business?

We've seen no significant loss of business or customers at this point.

We feel very good about the retention there across all of the AmeriPath business.

Okay, good.

And then I guess just finally, you talked a lot about some of the contracts, I guess, with managed care that you've signed and some that are still out there.

One thing that we've been thinking about, it's just been United clearly is -- I mean, Lab Corp.

has sort of -- you've invested a lot in some of your core markets with United business at hand.

Can you just talk about sort of the competitive landscape at the local level?

So not really just for the contract, but then once you have the contract, assuming it's not an exclusive one, what you're seeing on a day-to-day basis as the sales guys hit the streets and if there's any increased volatility in the business or how the competitive landscape has changed from that perspective?

Right.

Tom our competitor had market position in New York, [New Jersey] area, it not like they didn't have the contract in this area.

But because of our [valuable position], because of the [differentiated] [state] of services, we had amazing market share and we had the doctors and the patients.

What happened with United and what happened with our competitor is that not only the contract, but this huge amount of transaction costs gave them the opportunity, to basically forcing the doctors to move.

And as you know, it created an issue for the patients and the doctors in some states, it's illegal.

So what is happening now is, as you saw from our activities, the so-called discretionary business is not changing.

We lost some, but the rest is improving.

We expect that most of the United business is going to go because it's not only the competitor but also the payer forcing it.

But most important thing for us that we did not reduce our service level, our sales people are interested in retaining the business and that gave us the ammunition and also the market position to sign Aetna and Cigna and other contracts.

So obviously, when somebody signs a contract to have so-called pull-through from other places, that is not working.

But having said all those things, we're still not out of the woods as far as this competitive landscape is concerned, and we will continue improving our service level, and we'll continue to get the business based on what we provide.

And I think that's what we are seeing.

And going forward, obviously, it's a little bit easier now because there are not a lot of major contracts left to be used by the same tactics somebody used for United.

Okay, thank you.

And thank you.

Sandy Draper with Raymond James, you may ask your question.

Thanks.

I wanted to maybe get a sort of longer term perspective, just looking back at the industry back in the '90s, the last time there was a real significant pricing war, primarily driven by SmithKline Beacham, I'm not sure if this is a fair question or not, but how would you characterize the pricing environment today versus that period back then, when we -- the last time we really saw significant pricing release discussed and out there in the open?

Is it better, worse, the same or maybe contrast the two periods?

Thanks.

Sandy, it's difficult to really compare exactly the pricing, what was 10 years ago, but what I would like to say is that when somebody uses price only to get a significant market share, especially in the medical business, it is not a long-term strategy.

And when we look at Quest Diagnostics over the last 10 years, and the latest (inaudible) three players, and Quest Diagnostics and SBCL work together in the most, and that created the change and that created the pricing discipline in the industry.

And as you know, SBCL and Quest Diagnostics, for us, were the game turning event in clinical pathology.

And again, that was in '99.

In '03 we acquired AML to strengthen the hospital business and that created our hospital business.

Now in '07 we are merging with AmeriPath to create another game-turning event in (inaudible) pathology.

So it is not only the price that we should be worried about, it's actually what services we provide and how we go forward.

And I've always said that the diagnostics is the right place to be, and in the last 30 years have been the years for pharma and medical devices, the next 30 years is going to be the diagnostics and monitoring for preventative care.

So I think the sector is good, there was a disruption that's behind us, I think the payers are working with us and now we want to get on with life and continue providing the best high-quality diagnostic services for our patient care.

Sandy, one other thing that's different is, back in the early '90s the performance of the lab companies was really influenced quite a bit by the fact at that capitation was coming on to the scene whereby the labs were taking utilization risk.

And frankly, that was one of the big drivers, not only were the labs taking risk, but it was also becoming -- excuse me -- an increased portion of the business.

So the mix had shifted to capitation.

Since then, capitation's become a smaller piece of the business.

And I would say that the industry in total is a lot smarter about how to price capitated contracts now.

Because we get a lot better information about utilization, demographics, et cetera.

So that piece of the risk, I think, is much better managed than it was back then.

Great, that's very helpful commentary.

Two quick follow-ups.

One, on the -- is the pricing issue pretty much constrained to your other national competitor or have you seen the smaller local players trying to match price and use price?

And then, Surya you referred to it a little bit, is the pricing more focused on just the basic tests?

And obviously esoteric always has some pricing, but is it more intense in traditional basic tests versus esoteric or is it more up and down?

And I'll jump back in the queue.

Thank you.

You know, Sandy, I think when you lead with price, it's bad for the industry, it doesn't really matter if it's a large company or small company.

I think that was the reason why we (inaudible) sign that contract it wasn't bad for our company and our industry.

We see this [price pressure] is a new waterline for all the players.

But having said that, we have to reorganize and move forward.

And I'm sure all the laboratories, whether small or large, have to do the same thing because it is a new, new game.

Thank you.

Next question.

Thank you.

Kemp Dolliver with Cowen and Company, you may ask your question.

Hi, thanks.

On the $500 million in cost savings, Bob, I guess my question is that if you take your commentary regarding the 20% operating margin goal that essentially the net benefit of those savings is that essentially that differential between your current margins and the 20%, is that an accurate assumption?

No, you need to keep in mind that we're going to get to the 20% margin, not just by reducing costs, I mean, by growing the top line as well, and growing it in the areas that Surya talked about the higher margin, higher growth pieces of the business.

So it's a combination of all of those things.

And I'd caution you to take, in taking any one of them and saying that's the principal driver of the margin increase.

Okay.

Just to take that discussion a little bit farther then, what -- I guess, what underlying cost inflation do you assume you'll have that you're trying to -- that this would -- $500 million would offset?

Well, costs in having -- I'm not going to get into guessing cost inflation with you and where that's going.

Every year we see cost inflation in our business.

The biggest piece of our costs are salaries, wages and benefits which accounts for about 50% of our total costs.

And certainly there's always inflationary pressures there.

The other pieces of our business, maybe a little less so, and as we work with our suppliers, obviously, we try to manage the impact of that.

And reduce costs there, wherever we can.

And additionally, as we become bigger and we're a bigger volume purchaser, that affords us deeper discounts and in some cases that offsets the impact of inflation.

But I don't want to get into giving you inflationary estimates at this point.

Okay.

And just in terms of say a percentage reduction in your cost structure, is it fair to say that it's maybe about 8, 9% cost reduction in your current cost structure?

Not too far off.

I mean, another way of thinking about it is we generate about $7 billion in annualized revenues now, so it's about 7% of annualized revenues.

That's great.

Thanks a lot.

Thank you.

And our final question comes from Bill Bonello with Wachovia.

Great.

Just two follow-up questions.

One is just the last time that you spoke about AmeriPath, at that point you were pretty confident that AmeriPath would stay as a contracted provider for United Healthcare.

I'm just curious if you have any more color now that it's actually part of Quest?

Not a lot additionally at this point, Bill.

We think that AmeriPath has a good relationship with UHC, they provide a very valuable service to their members.

And as we said earlier, we expect that they'll continue to serve UHC members.

We really haven't had any specific dialog with them about current agreements in place at this point, though.

Can you give us -- can you just let us know how long the existing contract runs for AmeriPath?

Their contracts, generally there are few national contracts that they have, many of them are regional and local agreements that have varying terms.

Okay.

And then the -- I guess just to follow up on maybe what Kemp was driving at a little bit, and your comment that you're -- at $500 million, you would be, all else held equal, you would be at an operating margin that is, I believe, significantly greater than 20%.

And so it would seem like, given that you think you're going to have decent revenue growth, that should offset inflation, it would seem like there's a pretty hefty expense that you're assuming you're going to have to take on to achieve these cost savings.

I'm just wondering if you can give us, not necessarily quantify it, but give us any color on what kinds of (inaudible) to take on to achieve the 500 million?

Bill, a couple things.

First, any costs that we would take on to incur this would be one-time costs.

Any cost that will be added to the permanent cost structure are already netted in that 500 million.

That's a net change to our cost structure.

Now, not all of the opportunities that we're going after are going to have a one-time cost to implement either.

But for those that do, as we approve the detailed plans and implement them, we may record charges at that point in time, and we'll cull those out and make people well aware of them.

But when you think about what's going to drop down to the bottom line, as I said, these actions are really to drive us to get to that 20% operating income over time.

Some of the savings is going to get us to the structural cost reductions that we need to make to offset the loss of the United volume, because remember, there was over $400 million in revenue there.

So far we've pulled out 200 million in annualized costs.

So we need to pull out more costs to get back to mitigating that full O&M impact there.

Some of the savings is going to be used to offset the pricing pressures we're seeing and obviously we said some is going to be to invest in growth and further differentiate the service offering that we've got.

Okay.

And it would just seem, and just tell me if my math is wrong, it would seem though then given what you just said, that theoretically if you're successful at this cost saving you could have operating margins that are in excess of 20%?

Listen, once we get to 20%, we're not going to try -- we're not going to stop there or put a governor on it, but, yes, we have a long way to go to get to the 20% at this point, quite frankly.

And this is something that we felt was necessary to get us there.

Certainly, when we get there, we're not going to stop, but I'm not sure that I can give you visibility beyond that at this point.

Okay.

We won't model it for next quarter.

(laughter)

Thanks.

Thank you.

Thank you.

[Lori], could you read the closing comments.

Yes.

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

A transcript of prepared remarks on this call will be posted later today on Quest Diagnostics' web site at www.questdiagnostics.com.

The replay of the call will be available from 11:30 a.m.

on July 25th through 11:00 p.m.

on August 21st, 2007 to investors in the U.S.

by dialing (866)421-0437.

Investors outside the U.S.

may dial (203)369-0799.

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' web site.

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

Good-bye.