奎斯特診斷 (DGX) 2008 Q2 法說會逐字稿

Welcome to the Quest Diagnostics second quarter 2008 conference call.

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

The entire contents of this call, including the presentation and question-and-answer session that will follow are 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 Communications and Investor Relations for Quest Diagnostics.

Go ahead, please.

Thank you and good morning.

I am here with Surya Mohopatra, our Chairman and Chief Executive Officer, and Bob Hagerman, our Chief Financial Officer.

Some of our commentary and answers to questions may contain forward-looking statements.

You are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date they are made, and which reflect management's current estimates, projections, expectations or beliefs, and which involve risks and uncertainties that could cause actual results and outcomes to be materially different.

Risks and uncertainties that may affect the future results of the company include, but are not limited to, adverse results from pending or future government investigations, lawsuits or private actions, the competitive environment, changes in government regulations, changing relationships with customers, payers, suppliers and strategic partners, and other factors described in the Quest Diagnostics' 2007 Form 10-K, 2008 quarterly reports on Form 10-Q, and current reports on Form 8-K.

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

A downloadable spreadsheet with our results and supplemental analysis is also available on the website.

Now here is Surya Mohopatra.

Thank you, Laure.

We delivered another strong quarter and I'm pleased with our progress.

Our business is performing well, executing our plan has enabled us to deliver double-digit top and bottom line growth.

Revenues grew 12% to $1.8 billion.

Earnings per share increased 14%.

Cash flow improved to $213 million.

Volume increased by 5%.

And we exercised strong cost discipline, which contributed to our margin improvement and positions us well to respond to changing economic conditions.

After we hear from Bob, I will share details of our progress.

Bob?

Thanks, Surya.

As you heard, we reported another strong quarter and are firmly on track to meet the goals we established for the year.

As I take you through the results, I'll highlight a number of key initiatives and our progress in each area.

Before I do, a quick comment regarding NID.

We are continuing our discussions with the government to attempt to settle this matter.

We have made no adjustments to our reserve and have no further updates to share with you.

Now let's turn to the results for the second quarter.

Revenues were $1.8 billion, 12% above the prior year, with AmeriPath contributing about 8% growth.

Revenues for our clinical testing business, which account for about 90% of our total revenues, were 12.4% above the prior year and about 4% above, without AmeriPath.

Volume was 4.9% above the prior year, and about 1% above the prior year before the AmeriPath acquisition.

Over the last three quarters, we have consistently seen growth in our underlying volume of between 1 and 2%.

This is despite a significant decline, almost 10%, in pre-employment drug testing, which accounts for about 7% of our total volume.

Given that this tends to be very low-priced business, the impact to revenue and profitability is generally much less.

Our employer business, which is predominantly pre-employment drug testing, and our risk assessment business, which serves life insurers, are our two businesses most subject to a slowing economy.

Yet the profits for both businesses are above the prior year level, due to aggressive actions we have taken to manage their costs.

These businesses, combined, account for less than 10% of our total revenues and we do not expect their performance to alter our consolidated revenue or earnings expectations for the year.

Revenue per acquisition increased 7.1%, with 4.5% of the increase due to AmeriPath.

The balance of the increase in revenue per acquisition, about 2.5%, continues to be primarily driven by a positive mix, partially offset by price reductions on various health plan contracts and is consistent with what we saw in the first quarter.

As we previously indicated, all of our largest health plan contracts have now been renegotiated for multi-year periods, and we believe there is much more stability in pricing than a year ago.

Lastly, on the topic of revenue growth, we saw strong double-digit growth in our point of care and healthcare IT businesses in the quarter.

You'll hear more from Surya on the point of care business.

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

Operating income as a percentage of revenues was 16.8% for the second quarter, and reflects continued improvement from both the prior year and this year's first quarter.

Principally due to revenue growth, and the progress we are making with our cost reduction program.

That program, which we expect to reduce our cost structure by $500 million as we exit 2009, delivered over $100 million in savings as we exited last year.

And we expect another $200 million as we exit this year, with the final $200 million in 2009.

Last quarter I outlined the major elements of our program which include: using Lean Six Sigma to streamline our processes and increase productivity in our labs, driving more of our purchasing through master contracts to take advantage of our scale, driving efficiencies in other areas by better aligning our service capacity with patient and sample flows, improving the efficiency of our logistics routes, using advanced route optimization tools and more fuel efficient vehicles.

And, deploying enhanced connectivity to our customers and patient service centers to reduce costs in specimen data entry and billing and lower our bad debt.

We're making good progress across all these areas, particularly in billing and collections, where we have accelerated a number of our efforts to reduce bad debt, days sales outstanding and the cost of our billing operation.

Bad debt expense as a percentage of revenues was 4.4%, 0.4% lower than the first quarter and 0.3% lower than last year before the inclusion of AmeriPath.

DSOs were reduced to 46 days, down from 48 days at the end of Q1, and 51 days a year ago.

As you know, AmeriPath carries a higher bad debt rate than the rest of our business, and is one of the opportunities we have identified.

During this last quarter, we have begun to see solid progress in this area.

With our disciplined approach and the acceleration of our efforts, we now expect to see continued strong performance in our billing and collection metrics, despite a slowing economy.

Diluted earnings per share from continuing operations were $0.83, compared to $0.73 in the prior year, a 14% increase.

About $0.01 of the increase is due to a lower tax rate than a year ago, as a result of a favorable resolution to certain tax contingencies.

When we initially provided guidance for 2008, we indicated that we expected to make investments in systems and our start-up in India, which together would reduce full year EPS by about $0.20.

We incurred $0.04 of the impact in Q2, bringing the total for the first half to about $0.07, and now expect to incur about $0.17 per share for the full year.

Our lab in India became operational towards the end of the first quarter.

We are still in the very early days of ramping up our selling efforts and other support functions.

While this market is expected to be a significant contributor to our international operations, we are not expecting it to contribute material revenues this year.

Our revised estimate for start-up losses this year is about $0.04 per share, compared to an initial estimate of about $0.07.

We have incurred $0.02 through the first half of the year, with $0.01 realized in each of the first two quarters.

Our systems investments, totaling $0.13 per share, associated with developing and deploying standard systems across AmeriPath and our clinical labs, are on track.

The deployment of the upgraded AmeriPath lab and billing systems is on track, and the linking of Care 360 with the AmeriPath systems for test results is going well.

Additionally, we have made good progress in the development associated with standardizing our clinical lab systems.

Through the first half, we incurred roughly $0.05 per share, $0.03 in quarter two, of the $0.13 per share we expect to spend this year on systems enhancements.

Cash from operations increased to $213 million for the quarter, compared to $129 million last year.

During the quarter, we reduced debt by $168 million, bringing our total debt reduction since the AmeriPath acquisition to about $700 million.

Cash at the end of the quarter was $143 million, and capital expenditures were $48 million in the quarter.

Turning to guidance from continuing operations, we continue to expect revenue growth of about 9%.

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

We expect cash from operations to approximate $900 million.

And we now expect capital expenditures of between 240 and $260 million.

And lastly, we have increased the midpoint of of our estimate for diluted earnings per share and now expect between $3.10 and $3.20, excluding any potential special charges.

While we are in challenging economic times, we continue to make solid progress and reported strong results for the first half.

And, we expect our continued focus on executing our plans will position us well to achieve both our financial and strategic goals for this year.

Now, I'll turn it back to Surya.

Thanks, Bob.

We differentiated ourselves and drive profitable growth by providing a superior experience for our patients, physicians and hospitals.

This forecast is producing results.

Now I will provide a brief update on three key areas, driving profitable growth, expanding our margins and building a sustainable platform for long-term growth.

Our efforts to driving profitable growth is to leverage our sales, service and science.

We provide value to our new and existing customers with our superior service offering and innovative tests and technologies.

Gene-based and esoteric testing revenues increased about 20% in the quarter.

We saw double-digit growth in a number of esoteric and gene-based tests including Vitamin D and testosterone testing, chlamydia and gonorrhea tests and immunocap allergy testing.

In addition to our leadership position in gene-based and esoteric testing, we are also the clear leader in anatomic pathology.

These are the two fastest growing areas in four industry.

We perform esoteric and gene-based testing at our major sites, our two constituent labs, Focused Diagnostic and Specialty Laboratories.

We are the laboratory's laboratory, receiving unusual or difficult cases from not only hospital labs but also academic institutions and other commercial laboratories.

Our hospital business is growing, and accounts for more than $1 billion in revenue.

An example of how we think about solutions to difficult diagnostic challenges is in ovarian cancer.

We believe a number of tests based on various markers will be required to help detect and monitor various stages of cancer in different categories of patients.

Ovarian cancer is the fifth most common cause of cancer-related deaths among women in the US, with more than 15,000 deaths and nearly 22,000 new cases diagnosed per year.

We are developing tests through relationship with three pioneers in proteomics and biomarkers.

(inaudible - heavy accent) Diagnostics, Vermilion and CoreLogics.

Tomorrow, we are launching the first FDA cleared blood test based on fully-reviewed HE4 biomarker.

We are the first commercial lab to make this test available to monitor ovarian cancer patients.

In addition, we are also evaluating the OVA-1, the ovarian cancer tumor trial tests from Vermilion which filed an application with the FDA in late June.

Similarly, we are taking a portfolio approach to expand our leadership in colorectal cancer screening.

Given that patients' compliance with colorectal screening guidelines is poor, tests need to be easy and convenient to take.

For several years now, we have offered our proprietary Ensure Fit, test an FDA cleared test for colorectal cancer screening, with a patient friendly sample collection process.

During the quarter we introduced a clear wave version of this test called Ensure Quick Fit that can be performed in a doctor's office.

We are also developing the first blood-based test to detect colorectal cancer using the Septin 9 modulated biomarker from Epigenomics.

Our important carrier test using iron mobility technology is the first and only test that directly measures lipoprotein particle size, which is critical to assessing cardiac risk.

We are excited about the potential for this unique test, which was the subject of a story published online recently in the journal, Clinical Chemistry.

In addition, we continue to enhance the patient's experience.

Our collaboration with Google empowers patients to manage their own health information.

Using Google Health, people can store their diagnostic test results and all of their medical information online.

We are expanding our operating margins through top line growth and cost savings.

We improved underlying margins in each of the last four quarters and are on track to meet our commitment to reduce our cost structure by $500 million by the end of next year.

We have reengineered many of our processes using Six Sigma and Lean principles to improve efficiency and remove unnecessary work.

As a result, we have 1300 fewer people than 12 months ago.

We increased productivity while continuing to deliver unmatched service levels to our patients and physicians.

Our employees are driving a strong culture of continuous improvement.

The quality of our people and their dedication to excellence is a strong differentiator for Quest Diagnostics.

Growth is being driven by our physician, hospital and anatomic pathology businesses.

This growth will be supplemented over the longer term by expansion of our near-patient testing and international businesses.

We continue to see double-digit growth in near-patient or point of care testing.

During the quarter, our HemoCue business obtained a clear waiver for the first quantitative microalbumin point of care test.

This test enables doctors to detect and monitor a marker for chronic kidney disease that affects 26 million Americans.

Also, our Focus Diagnostic business received the CE mark for a new test kit that enables doctors for the first time to simultaneously detect and differentiate three major parasites connected to diarrheal disease.

These parasites are found world-wide.

We plan to distribute this kit in Europe and developing nations and to apply for FDA clearance in the US.

Internationally we continue to build our service capability and add customers in India, which we see as a long-term opportunity.

In addition, based on our quality and service, the government of Ireland has selected us to perform all PAP testing for Ireland's first nationwide cervical cancer screening program.

We are entering the decade of diagnostics and have tremendous opportunities to use laboratory tests to help doctors and their patients better manage health and reduce costs.

It is gratifying over the past few weeks to see the US Congress recognize the value and importance of laboratory testing.

As I'm sure you noted, Congress last week passed legislation that detailed Medicare competitive bidding for laboratory services, eliminated costs from physician fee schedules for 2008 and provided for a 1.1% increase for 2009.

In addition, next year, the clinical laboratory fee schedule used to determine government reimbursement will contain a CPI increase of approximately 4.5%.

Based on the preliminary analysis, this could increase our revenues up to $40 million in 2009.

This is the first CPI increase in five years and only the second in the past 11 years.

In summary, diagnostic testing is a very attractive industry.

While it is not immune to economic challenges, they are far outweighed by the opportunities.

Demographics and pace of innovation will continue to drive growth.

We are the clear leader and continue to differentiate ourselves from our competitors through our superior service, Six Sigma quality, innovative tests and our advanced information technologies solutions.

Our business is performing well, and we are executing our plan.

We are bifocal, doing what is right for the business in the short term and planning for the long term.

We are on track to deliver our commitment for 2008 and are well-positioned for the future.

We'll now take your questions.

Operator?

(OPERATOR INSTRUCTIONS).

Please stand by for the first question.

The first question is from Ricky Goldwasser from UBS.

Good morning.

With the scheduled volume improvement that you showed in the second quarter, could you just provide us a little bit more color on the key variables, namely United, if you're gaining back any business there and pull-through and also as we think about the second half of the year, are there additional tail winds that would help continue that trend?

And then secondly, just to clarify, if you could repeat the breakdown of the $0.24 in cost for the year, and is the increase coming from India and if so, if you could give us more detail on that.

Okay.

Ricky, let me try and get each of those.

But first, let me clarify one thing.

The $0.24 in costs that you mentioned, it's $0.17.

You may recall we initially indicated we expected to invest $0.20.

We've now adjusted that down to $0.17, the change principally coming because we're spending less in India.

We expect the India investment to now be $0.04 a share versus the $0.07 we had initially estimated.

Thank you for clarifying that confusion.

With respect to volume, basically this is the underlying volume.

We tried to take out the noise for you.

As we said, it's been increasing 1 to 2% over pretty much the last four quarters now.

The UHC impact, we actually decided to stop talking about that because it's less than it has been.

As you recall, we lost most of that business last year in the first quarter, by the end of the first quarter, and we didn't plan on spending a lot of time talking about it, principally because it's not having a significant impact on the year-over-year comparisons any longer.

The impact to volume is less than 1%.

And the revenue impact is around 1%.

With that said, though, we did retain over 20% of the volume, and we've seen no change in the associated pull-through with UHC.

And in terms of volume, as you know, we don't give guidance for price and volume.

But I'm encouraged by the fact that we've seen nice steady trends in volume growth over the last four quarters or so.

Thank you.

The next question is from Robert Willoughby of Banc of America Securities.

Thank you.

Bob, can you run through the CapEx numbers were down, did you give a reason why that was off as sharply as it was for the year?

No, I did, Robert.

We did reduce our estimate for capital spending by about $40 million for the year.

And mostly, that's just prudent management of our capital.

There is a little less spend in India, but remember, we were anticipating less than 10% of our capital spend this year would be associated with India anyhow.

Really it's just us managing the capital spend for the year.

That's a big drop, though, Bob, isn't it?

Have you deferred a project of some sort or just -- ?

No major projects have been deferred.

I think there are a lot of things that we were looking at early in the year and want to give ourselves the flexibility in our guidance to be able to do those.

As a result of going through the cost reduction efforts that we've been, we've been identifying not only ways to reduce the P&L spend, but ways to reduce the capital spend as well.

Okay.

And just in a better free cash flow environment, should we pay down more debt or can we expect acquisition sooner than maybe you might have planned.

As you know, we've never really ruled out acquisitions, but to the degree we are generating excess cash flow, as I've said we'll first deploy it right now, at least this year, to pay down debt.

But certainly keep our options open as it relates to potential acquisitions and frankly share repurchases as well.

Okay.

Thank you.

The next question is from Bill Quirk from Piper Jeffrey.

Thanks, good morning.

Just to clarify, Surya, your comment about the potential revenue impact from the CPI adjustment and I guess a quick question would be what percent of managed care contracts are explicitly tied to Medicare pricing?

Actually 15% of Medicare.

Medicare represents about 15% of our total revenues.

No, no, no, understood.

But in terms of the actual managed care contracts.

Very little.

Bill, there is very little contracting that's actually tied to changes in the pricing for Medicare.

Right.

Most of them are fixed fee.

That are separately negotiated.

Understood.

Secondly, Bob, if I heard you correctly, sounds like your assumptions for bad debt expense are not likely to change, given the economic conditions.

Did I hear that -- I guess that --

I don't expect the economy to have a significant impact on either our bad debt or our DSOs.

As you saw, they've both been improving.

And a lot of that has to do with our processes that we're executing to try and improve both of those areas.

As I mentioned, we're making good progress on the AmeriPath side.

I'm encouraged by that.

But additionally, we've been executing very well against the rest of our operations and not only reducing the cost of the billing operation, but really driving down bad debt and DSOs.

As I've said in the past, our bad debt is not principally associated with people unwilling or unable to pay.

A lot of it is driven by process, and when I say process I'm talking about making sure that we get appropriate and accurate information up front to bill the patient the first time.

When we get that, we have a very high rate of collections.

Thanks very much.

The next question is from Dawn Brock from JPMorgan.

Good morning.

I just wanted to dig in a little bit to the revenue side.

You posted a really, really solid quarter on the top line.

You've got a number of proprietary products that are doing well, they're higher revenue, higher margin, higher growth, more on the esoteric side.

Are you looking to see some more strength on the top line and because of the product mix and the strength in the mix that you've been talking about, actually see some potential upside in margins and earnings, maybe on the top end of your guidance range?

Well, again, I would tell you that I'm certainly encouraged by the fact that we're growing not only the underlying volume, but the revenue per acquisition.

Much of that continues to be driven by test mix.

The organic growth that we're estimating for the second half of the year that's built into our guidance is between 4 and 5%.

And we would expect over time that our goal is to drive growth at or above the rate of the industry.

Which right now, we're estimating is in that 4 to 5% range at the moment.

Just want to add one thing.

If you remember three years ago we started our strategy to diversify our revenue base and I'm really pleased that 34% of our total revenue now comes from esoteric gene based and pathology.

This is the two fastest sectors in our industry.

And we have added a lot of proprietary, exclusive, or have some temporary advantage in the product.

So you can see the number of new products that is coming on in the pipeline is going to help us in the long-term to accelerate our growth.

Surya, just as a follow-up to that, are you seeing that the esoteric testing is having a shorter shelf life as far as driving pricing and margin i.e.

that pricing doesn't stay as high for as long and maybe that's why you're not expecting a significant increase on the revenue side for an extended period of time, even though you do have a lot of products in the pipeline?

Well, you know, it depends on what test and also depends on how the tests are accepted by some medical society.

You know, the important thing, if you see, we used to have 70% of our revenue four years ago routine testing and the most important thing or important strategy for us is to go towards professional component anatomic pathology and also the gene based testing.

But it's usually three to four years that the tests remain esoteric and then it becomes routine.

It really comes down to Surya's point on adoption.

If we take HPV as a specific example, that was included in the ACOG and HCS guidelines at this point almost four or five years ago, and we're still seeing a nice adoption rate on that.

So it really is going to depend on the test and the rate of adoption by the practicing physician.

But there is no single test we believe in the portfolio of tests and I also believe that we will see in two or three years this approach of portfolio of tests proprietary and exclusive is going to give Quest a much stronger position in growing the market.

Excellent.

Just more on the macro side, you know, obviously we're not necessarily seeing on the volume side or on the pricing side a significant impact that's at least clear from the economy, given your results.

But the question remains, are you guys even anecdotally seeing any sort of pullback on physician office visits and/or the potential adoption of the new products in the office simply because docs don't want to push it on patients that are there for one reason, they don't necessarily want to push it any further?

Why don't you comment if you see any number and I can tell what you I see and what I feel.

Dawn, listen, we don't believe we've seen any impact to our volumes for the first half.

As I said, the underlying volumes have been pretty consistent now for about four quarters and frankly if a patient doesn't come into a doctor's office, we don't know that.

And even if we did, we wouldn't necessarily understand why.

With that said, though, to the degree that volumes do get impacted here, we don't believe they necessarily would be significant.

We would certainly be in a position then to further adjust our costs to match the volume levels.

But the sluggish economy is there.

We are not immune to that.

But there are so many opportunities in diagnostic testing that that particular risk should not really stop our growth.

There are new innovations, there are new demographics, and I'm very bullish about the diagnostic testing and the value to healthcare and what impact it will have for the next 10 years.

Okay.

Thank you very much.

The next question is from Ralph Giacobbe from Credit Suisse.

Thanks.

Just a couple quick ones.

Can you quantify the incremental Aetna in the quarter?

Again, Aetna's been one of the contributors to our growth but we don't specifically talk about contracts and what each of them contribute.

But you should assure -- rest assure that Aetna volumes have continued to grow for us.

Okay.

In terms of the AmeriPath integration, is the deal sort of accretive at this point?

Neutral?

I think it was a little bit dilutive last quarter.

Any benefit there?

With respect to AmeriPath what I will tell you is we're actually making very good progress there.

We've got good pathology retention.

We've renewed or extended a number of contracts.

We've got strong customer retention.

As we said the last quarter the specialty integration is complete.

We've begun integrating the sales force and as you heard earlier, we're making very good progress on the bad debt.

With that said, we haven't broken out the AmeriPath impact because it's starting now to become part of one business, and we haven't done that for any other acquisitions in the past and wouldn't expect to do that for this one.

But with that said, over time we expect this to be an accretive acquisition, principally because we expect to accelerate growth there.

We're making good progress on the cost synergy side and we're starting to get all the things in place right now to position us to accelerate the growth.

Okay.

Fair enough.

Just my last one, in terms of India, looks like you guys are looking for a loss of $0.04 versus I guess a $0.07 loss estimate.

Is that just the operations there improving ahead of schedule or is it something where the incremental cost is going to kind of get carried over as we think about 2009.

The change for this year is really a function of how quick we're building out the infrastructure.

The business is ramping a little slower than we had initially anticipated.

Therefore the investments in infrastructure are going at a slower pace.

But we are still targeting to break even before the end of 2010 and we're very excited about the opportunities.

I wouldn't expect that next year, and we haven't yet given guidance for next year, but next year's investment will be significantly different than what we initially estimated for this year.

Okay.

Fair enough.

Thanks.

The next question is from Adam Feinstein from Lehman Brothers.

Okay.

Thank you.

Good morning everyone.

Just I guess a few questions here.

Bob, I understand you don't want to break out AmeriPath separately because now you view it as being part of one company, but just could you just talk roughly around the bad debt expense for if you could give us what the stand-alone Quest bad debt expense is or a rough ballpark in terms of what the AmeriPath bad debt expense.

Sounds like you're making progress but trying to get a better sense in terms of the magnitude.

Just curious if you could provide any feedback about the bad debt at the AmeriPath side.

On the AmeriPath side for the quarter, it contributed about 0.4% increase to our consolidated bad debt rate and in the first quarter it was about 0.6% impact.

Okay.

Great.

And then with respect to Aetna, you know, if I remember correctly that contract kicked in July 1st of last year.

So should we expect a little bit lower growth in the back half of 2008 since you have now annualized that or will it not really move the growth rate?

Well, certainly it will impact the comparisons, year-over-year, as we get into the second half.

Okay.

So we'll factor that in.

Okay.

And then just on the cost cutting side, as you talked about the $200 million, and I understand that you don't want to give a specific number every quarter, but just as we think about just the ramp-up, should we think about being more back end loaded or pretty equal throughout the year?

How are you viewing the $200 million benefit for 2008?

Without getting too specific, Adam, it does tend to ramp up on -- not quite a straight line basis, but it's not all back end loaded.

You know, we had to get a lot of it last year so that we had a good solid run rate coming into this year and we continue to make progress on that.

Good, solid, steady progress on that.

And keep in mind that that's a $200 million -- incremental $200 million run rate as we exit the year.

Okay.

And then just my final question, Surya, you mentioned 34% of the business coming from esoteric and gene-based testing.

As you think about that number going forward, do you see that number moving higher and I guess you'll probably say yes, but just curious in terms of the magnitude.

You answered my question, yes, it is going to grow.

You can see from our progress, we've been adding a lot of new tests, some of them are proprietary, some of them are exclusive.

We have also gone towards disease solutions rather than just one test.

So, when we said that we're going to do this thing, people said well you can't really grow and now we have 34% coming from the two fastest growing sectors.

So I expect that we're going to grow that sector as we go forward.

Adam, just one other thing to keep in mind is, you know, typically a test starts out as esoteric and over time if we're lucky, actually, it becomes routine because that's when the volumes pick up and it becomes much more widely accepted.

So the rate at which we've been growing, what we'll call today, the esoteric revenues won't continue at the same rate because those things sometimes become routine in nature.

So there's going to be a natural limit on what percentage of our total revenues can come from routine or come from esoteric testing.

But you know, the reason why we acquired AmeriPath and we said we are the clear leader and the number one cancer diagnostics company, because anatomic pathology is a very important sector and that's going to grow as people age.

So you have leadership in clinical pathology.

You have leadership in anatomic pathology, and you have leadership in esoteric testing.

I would expect our strategy will continue to that section and even going to go more and more towards our goal of expanding our margins, both on top line growth and the cost reduction.

Okay.

Thank you very much.

The next question is from Kemp Dolliver from Cowen and Company.

Thanks.

Just a couple questions on the AmeriPath related projects.

First with specialty, what functions did you -- are actually integrated now?

And secondly with the sales force training, could you just give us some color on the sales force structure now that you've put the organizations together?

Thanks.

Well, first of all, specialty is part of our hospital business.

So all the hospital channels, sales channel, is completely integrated.

Specialty also part of the four large esoteric centers we have, which is the Two Nickels Institute and Focus Diagnostics.

So from a forensic point of view and also a sales point of view we are very pleased that that integration is complete.

We mentioned about how we are doing the cross-selling in anatomic pathology, especially AmeriPath and that particular program has started and we are training our physician salespeople to bring the leads to our pathology group and as we go on, we will let you know how that goes, but we are very encouraged with the way the physicians respond to this.

And there are some early wins.

That's great.

Thank you.

Next question is from Bill Bonello from Wachovia.

Good morning.

Couple of questions.

Can you just elaborate a little bit, Bob, in terms of taking your guidance up, raising the low end, looks like about $0.03 of that came from the lower India cost.

Is the rest of that due to a better outlook for operations or is it really just a reflection of greater cash flow and lower interest expense?

Certainly $0.03 of it was the investments and as you recall, I mentioned there was another $0.01 in the tax rate in the second quarter.

But with that said, the outlook that we have for the back half of the year really hasn't changed.

We're tracking our plan for the year.

We feel good about the progress we're making.

And some of the improvement certainly is from operations and we would hope to continue driving improvement there as the year progresses.

Okay.

And then just if I look at your guidance, it's sort of implicit in that that even if you got to the high end of the range, Q3 and Q4 would be flat to down sequentially and I know there's about $0.03 of more investment cost in the back half than the front half, but why else wouldn't we see more growth in the back half of the year?

Well, remember, the $0.10 that we're talking about in the back half compares to $0.07 in the first half but compares to practically nothing in last year's back half.

So you've got to factor that in there.

And as I said, the outlook for the back half of the year really hasn't changed for us.

But still, I get the point about $0.10 versus nothing last year.

But if I -- I'm just thinking about your Q3 and Q4 EPS relative to your Q2 EPS, is there a reason that we wouldn't see sequential growth from Q2?

You've got to be a little careful, just looking at it quarter-to-quarter.

The quarters have their own sort of seasonality attached to them and at times can be a little choppy.

But yeah, I think the best thing to do now is really look at our business on a full year basis, because the components of the business have changed too.

And what we historically saw as some of the trends between Q1, Q2, Q3 and Q4 are starting to change a little bit.

Okay.

And then the last question would just be just because someone was pressing you on the esoteric issue, did tests fall out of the esoteric bucket?

Is that what you were saying?

Or once the test is classified as esoteric, does it count towards that volume forever?

Well, certainly nothing fell out of the bucket this quarter.

And what I was trying to say earlier was it doesn't stay he's -- sometimes it doesn't stay esoteric for the long-term.

What is esoteric today might become routine in the future.

So we would classify it out of the esoteric bucket.

We typically do that once a year, though.

We don't do that on a quarter-to-quarter basis.

Okay.

Thanks.

The next question is from Amanda Murphy from William Blair.

Hi, good morning.

Just a couple questions.

In terms of the one to 2% underlying volume growth rate, how do you expect that to ramp or do you expect that to ramp in the longer term?

And how does that compare to the overall industry growth rate?

From an industry perspective, Amanda, we really don't have good industry data that would tell us between the components of revenue and revenue per acquisition and volume.

Keep in mind, the way we count volume is not the number of tests.

It is the number of patients we serve.

So we think the best way to look at this is on a revenue basis.

What we see right now as Bob indicated earlier, we think revenue for the industry is at about 5%.

We think that we're tracking about on that and we would expect over time that you would see us to grow revenues above the industry rate.

Okay.

And then in terms of volume in the second half, now that you've reached the Aetna anniversary, what initiatives do you have in place to grow volumes in the US in the second half?

Well, as I said, the way we increase our revenue that we leverage are sales, service and science and we have made some changes in our sales tactics and most of our salespeople are now selling rather than trying to reduce confusion in the marketplace.

And we have a number of new tests and we are educating the doctors.

We have now most of the managed care contracts.

So in fact, their productivity is higher.

So that's going to -- that is helping us to increase our penetration in the marketplace.

Okay.

And then in terms of India, now that you have a couple of quarters or so behind you, can you provide some updates on the utilization for reimbursement trends and also what else, if anything, has surprised you about that operating environment relative to the US?

Well, first of all, let's remember why we went to India.

Okay.

There are 300 million middle class there and almost the same population in the United States.

Going to an international country and starting from scratch is going to take some time.

We have been very prudent how we establish ourselves.

We want to establish a company of highest quality and ethics and technology and we have now established our laboratories, our operations in charge.

We have got a number of hospital contracts.

So it's moving in the right direction.

Now, for me, it could move a little faster.

But obviously we are taking a cautious step to establish our position in Delhi, in the central Delhi area and once that is successful, we will go to the other areas in India.

What surprises me, it's difficult to hire the right people and the amount of people so it's taking a little bit of time.

But there are no real operational surprises and as far as reimbursement is concerned, most of the payments are in out-of-pocket expenses, some in service, but not like in this country.

There are not major health plans there.

So it is a market which is going to be very helpful to us and as I said, that as we grow our core business, India and point of care is going to help us in three to four years, significant to expand our position in the world.

Okay.

Thank you.

The next question is from Matthew Borsch from Goldman Sachs.

Hi, thank you.

This is Shelley Gnall on behalf of Matt Borsch this morning.

A couple quick questions.

First, on the -- was wondering if there was any specific initiatives around cost cutting that maybe were accelerated or introduced that allowed you to offset the slowing drug screening business, maybe pressure from rising fuel costs, et cetera.

Well, a couple things, Shelly.

Certainly, as I mentioned, we accelerated some efforts on the billing and collections side, which have improved both bad debt and DSOs during the last quarter.

And we feel very good about that.

And that's across the company.

That's not just in the drugs of abuse testing business.

In the drugs of abuse testing business, we have identified a number of areas that we wanted to target.

Even prior to this slowdown as part of our program to reduce cost by $500 million.

And some of those, frankly, when we saw a slowdown we looked to accelerate.

In fact, we consolidated the number of laboratories that we do our drugs of abuse testing in.

And we've actually adjusted some of the other costs as well as we saw changes in the volume.

So it's not as though it's easy to do, but I think we made the difficult decisions and took quick action there when we saw the volumes change and accelerated some of the things that we had already teed up.

And that's more broadly too, we saw some pretty significant improvement in both cost of sales and the SG&A lines.

Despite the slowing economy, despite some slowdown in volumes from the drug screening business, we had highlighted some potential pressure from fuel costs.

Just wondering if some of those initiatives had been accelerated on purpose because of the slowing economy and in particular are there other levers that could be pulled if volumes see any slowdown in the back half of the year?

You mentioned fuel.

Let me just comment on that.

Our fuel consumption is actually down about 10% from what it was a year ago.

Principally because of all the actions that we have been taking, which is to basically restructure some of our routes to convert to more fuel efficient vehicles, to eliminate non-productive stops, so that was actually a big save for us.

I wouldn't say that we accelerated that.

That's something we had planned and it turned out that we had it planned at a good time, given the rising costs of fuel at this point.

But I would tell you that the plans that we've got laid out for the most part, the timing of them is pretty much set, although there are things that we can continue to do.

You recall last year in the first quarter, when we had to pull out some significant costs associated with the volume changes from United, we did that over the course of about two quarters.

And by the time we got to the third quarter last year, the underlying margins were back to where they were the year before.

So this is something that we can do if required to, but yeah, as we do it, obviously we want to keep an eye on the service levels and make sure that we continue to maintain the service levels that we have just like we have over the course of the last year or so as we've been pulling costs out.

Okay.

Great.

And then also, given that there have been productivity enhancements that have -- sounds like they contributed to a reduced headcount, was wondering a couple of things.

Could you give us 1300 fewer people have been cut since a year ago.

Can you tell us roughly what percent of your headcount that is.

And then secondarily, as you've increased productivity, has there been any increase in staff turnover from the early part of 2007?

Is there more pressure on the staff as they're asked to work harder or work more?

One thing to give you a sense, yeah, as Surya said earlier, this isn't about asking people to do more.

It's about eliminating unnecessary work.

And that's what Six Sigma and Lean Six Sigma are all about.

That's really what's enabled us to reduce 1300 people out of about a little over 40,000 in total, roughly 43,000 employees is what we've got.

With that said, we've been doing most of that through voluntary attrition.

We have voluntary turnover of about 6,000 people each year and that's what we're doing, what we're using to manage most of the workforce reductions where we can.

But as I said, that you know, our people have been really great.

Their quality and their culture and their dedication to really removing the unnecessary work but also driving the culture of continuous improvement.

So credit goes to all the people who have been really working and making sure that our productivity goes up and even though we have less people.

So we don't use the word cost cutting.

We take away unnecessary work.

That's very helpful.

Thank you.

Two more quick ones, if I could.

Wondering if the new guidance range takes into account potential increased pressure from suppliers raising prices.

We have seen Thermo Electron a couple weeks ago talking about price hikes.

Could the new guidance range, is it broad enough to take into account I anybody creased from your suppliers.

First of all, the majority of our supplier contracts are fixed cost, so that the prices are fixed over the term of the contract.

So there's not a lot that we see in terms of changes as a result of that.

With that said, certainly our guidance would anticipate any changes that we would expect on the cost side.

Okay.

Great one quick housekeeping.

The tax rate was better than expected at the second quarter.

Run rate expectations tore the year?

I wouldn't necessarily change the run rate.

Remember, I mentioned that we had resolved some tax contingencies in the quarter and that's why the quarter's rate was lower than it had been.

Great.

Okay.

Thanks very much.

The next question is from Gary Taylor from Citigroup.

Hi.

Good morning.

I think what you're saying on the tax rate we've got to move back to where it was before this quarter; correct?

That's correct.

Can you provide your balance sheet allowance today or do you we need to wait for the Q for that.

The Q will be filed this week which will have the reserve numbers on it.

Keep in mind DSOs came down and it was driven by collections.

Finally, can you just remind us what impact you're expecting from Lab One and the United contract and the timing on that.

As we've indicated coming into the year, the Lab One really represents less than $10 million in revenues under UNH contracts so any risk there is pretty limited.

And the timing of that was middle of the year, sometime, I thought, is that right?

It.

Was during the second quarter and as Bob indicated exiting the quarter we retained 20% of the united business.

So that includes -- that's specific for Lab One or that's just total.

It's inclusive, 20% inclusive.

But you've already seen some of that impact.

Yes.

Already last year.

Okay.

Thank you.

The next question is from Tom Gallucci from Merrill Lynch.

Good morning.

Thanks for taking all the time.

Not a lot left on my end.

A couple quick ones.

Esoteric growth, I know you talked a little bit about the percent of business, but what was the growth in the quarter.

Almost 20%.

And then what about, that includes AmeriPath so is there sort of an organic number.

The organic number is double-digit.

Okay.

And then I know you're not talking about guidance for '09.

You mentioned India may be sort of similar expense this year.

IT, do we still sort of conceptually expect that to be less next year than this year, or is that on track?

You should expect to it generally be a little less next year.

We'll still be deploying some of the standard systems as you get into next year, so there'll still be some IT investment, but I expect it will be somewhat less than this year's.

Okay.

And then just a last question on pathology.

Talking about some of the integration of the sales force there.

We read a little bit here and there about some start-ups, venture capital money, seems to be sort of a hot area.

Can you talk a little bit about the competitive landscape in pathology and if you're seeing anything significant there in terms of change?

Well, you know, Tom, pathology is a hot area.

That's the reason why we went and acquired AmeriPath and added their business to our business and we have now 800 of MDs here.

I think as people get older, and the demographics changes, more and more going towards anatomic pathology and cancer diagnostics, colorectal, breast, ovarian cancer.

I feel very confident having the luminaries we have and having the people we have in the company, they are guiding us to do what is the right thing for the patients and the health plans and the employers.

So I think from the competitive spread, there will be some venture people.

There will be some pathologies go from one place to the other.

But in reality, you have to have a very strong infrastructure to serve this professional group of people.

Starting from managed care contract, to have strong IT, logistics, reporting, and that's the advantage of Quest Diagnostics, that we have a very strong base and foundation from which these Professional Services can be delivered.

So I'm pretty excited about it.

What Surya just described is basically we're trying to create a company that will be very attractive for pathologists to come and join and to the degree that there are changes in ownership in some of these companies, that might create further opportunity for us to attract some of those pathologists.

Bob, you mentioned maybe some changes in historical seasonal patterns, could you just expand on the types of things that you're seeing there as opposed to I think historically we always saw the first half a little stronger than the second half, revenue-wise.

Yeah.

For example, last year our fourth quarter I think from an EPS standpoint was probably our strongest quarter of the year.

Now, some of that was due to the fact that we were dealing with the UHC change in the first quarter.

But we've added some new businesses.

The AmeriPath business is a little different than the rest of our business was in terms of the way that cycles through the year.

The risk assessment business is a little different.

And the drugs of abuse testing business has its own seasonality attached to it.

So without trying to get into giving you specific quarterly guidance because you remember we got away from that a while ago, yeah, I want to caution everyone to use -- to not necessarily use the historical patterns that we saw quarter-to-quarter and project that out.

Maybe just to clarify then, it sounds like you're describing things that are more changes in your mix of business as opposed to any real changes in the underlying seasonality of the historical core lab business, is that fair.

Correct, correct.

Okay.

Great, thank you.

Next question is from Jason Gurda from Leerink Swann.

Thank you.

Most of my questions have already been answered but I just wanted to follow up on earlier question which was related to the CPI increases for next year.

Besides Medicare, what other, if any, sources of revenue do you have that are tied to the or directly tied to like a CPI type increase?

In some of our contracts, we have fixed fee increases.

In some cases they may be tied to CPI.

In other cases, they're negotiated fee increases.

But I would say that there are limited changes associated with the CPI outside of Medicare.

Okay.

Thank you.

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

Just a follow-up on the Google relationship.

Can you speak to the economics there?

I'm trying to figure out why you would give somebody access to the data, since that is such an attractive asset.

The person who gets access to the data is the patient.

That's who gets the access and that's the person whose data it is.

That's true.

Are you paying to put the data into the Google database or are they paying you?

We're doing this thing as a series of activities we are doing to empower the patient.

It's going to empower the patient and the physician and also the health plan.

We do provide some medical records, the print records to the patient in some states.

What Google relationship is doing is actually helping the patients to go to the doctor and say instead of getting the paperwork, can I really put it in this place.

No, we don't pay to put the patient data.

And again, we do a number of things to improve our stickiness and our relationship with the patients and the payers and this is another project which we are doing to improve our differentiation from our competitors.

Okay.

Thank you.

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

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

A replay of the call will be available from 10:30 a.m.

on July 22nd through midnight on August 19th, 2008 to investors in the US by dialing 866-431-7950, investors outside the US may dial 203-369-0981.

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.