奎斯特診斷 (DGX) 2009 Q2 法說會逐字稿

Welcome to the Quest Diagnostics second quarter 2009 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 copyright 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'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.

You are cautioned not to place undue reliance on forward-looking statements which speak only as of the date that 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 investigation, lawsuits or private actions,t he competitive environment, changes in government regulations, changing relationships with customers, payers, suppliers and strategic partners, and other factors described in the Quest Diagnostics 2008 Form 10-K, quarterly reports on 10-Q and current reports on 8-K.

As noted on the last call a new accounting rule went into effect January 1st, FAS 160.

This requires minority interest be renamed net income attributable to non-controlling interest, and companies present consolidated net income that includes amounts attributable to such non-controlling interest for all periods presenting.

This change did not impact our previously reported numbers but did change how our P&L is presented.

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 Web site at www.QuestDiagnostics.com.

A PowerPoint presentation and a spreadsheet with our results and supplemental analysis are also available on the Web site.

Here is Surya Mohapatra.

Thank you, Laure.

We made good progress executing our 2009 plan and drove strong financial performance during the second quarter.

Total revenues increased 3.5% to $1.9 billion, and earnings per share grew 20% to $1, and based on our strong performance we have raised our full year EPS guidance to between $3.70 to $3.80.

The growing and aging population continues to increase demand for our services.

We are the leader in an industry that has been recognized for the value we bring to healthcare.

Diagnostic testing will play an ever greater role in helping to improved healthcare quality and manage costs.

The evidence is clear.

Diagnostic testing accounts for less than 3% of total healthcare spending, yet it drives more than 70% of clinical decisions.

Diagnostic testing is a tool to detect diseases and monitor therapy.

If diseases are detected early, actions can be taken to avoid painful and costly complications.

Lab tests are increasingly being used to identify one's predisposition to disease, allowing individuals to make healthcare lifestyle changes.

In areas such as cancer and infectious disease, diagnostics are helping physicians personalize treatment and care for each patient.

Diagnostic testing provides critical evidence for evidence-based medical diseases.

The current healthcare reform discussions recognize the value of early diagnosis, and we are supportive of the President's key goals for healthcare reform, expanding coverage, enhancing early detection programs, promoting health and wellness, and reducing overall healthcare costs.

In addition to benefiting from these positive trends, we continue to differentiate our company in a number of ways, including our patient-centric culture, Six Sigma quality, unparalleled access and distribution, and innovative science, medicine and information technology to help drive growth.

I will discuss our growth drivers after we hear from Bob on our financial performance.

Bob?

Thanks, Surya.

As you heard, our business continues to build momentum.

Revenue growth has accelerated, our profitability has continued to improve, and cash flow has continued to be strong.

Earnings per share from continuing operations for the quarter were $1, 20% above the prior year, with the increase principally driven by strong operating performance.

Included in our second quarter results are several nonrecurring items which, for the most part, offset each other.

Included in other operating income net is a $15.5 million gain contributing $0.05 per share associated with an insurance recovery which we disclosed when we reported first quarter results and included in our previous guidance.

That benefit was essentially offset by two charges totaling $13.3 million, or $0.04 per share, reflected in other expense net, which sits below operating income on the face of the income statement.

These two items consist of a $7 million charge associated with an investment writedown, and $6.3 million charge associated with the early extinguishment of debt in connection with our recently completed tender.

Consolidated revenues were $1.9 billion, 3.5% above the prior year, and our net of a 1.3% reduction associated with foreign exchange and fewer business days in the quarter.

Each contributing about half of the reduction.

Revenues for our clinical testing business which accounts for over 90% of our total revenues were 4% above the prior year.

And about 5% above, before the impact of our pre-employment drug testing business, a strong improvement from the first quarter.

Volume was about half a percent below the prior year, driven by a 24% decline in pre-employment drug testing which reduced consolidated volume by 1.7%.

In addition, last year's exit from several lab management agreements which did not meet our profitability criteria reduced volume by close to 1%.

Also the second quarter had fewer business days than the prior year and impacted volume by half a percent.

After giving consideration to these factors underlying volume grew about 2.5%, up from about 1.5% growth in the first quarter.

Revenue per requisition increased 4.6%, with the increase continuing to be primarily driven by a positive mix and a benefit of about 0.5% from the Medicare fee increase which went into effect January 1.

Revenue in our nonclinical testing businesses, which include our risk assessment business, clinical trials business, point of care testing business, and MedPlus, and contain most of our international revenues, were below the prior year by about 2%, which was more than accounted for by a 6% decrease attributable to foreign exchange.

These businesses as a group reported a strong profit improvement in the prior year.

A table containing footnote six to the earnings release summarizes the impact of various revenue metrics associated with the number of items I just discussed.

Operating income as a percentage of revenues was 18.9%, up from 16.8% last year.

The improvement is principally due to a more profitable revenue mix and progress we're making with our cost reduction program.

The insurance recovery mentioned earlier contributed 80 basis points of the improvement.

We continue to see strong and stable performance in our billing and collection metrics.

Bad debt expense as a percentage of revenues was 4.4%, improved slightly from the first quarter, and consistent with the prior year.

DSOs at 43 days were consistent with the Q1 level, improved one day from the year end and improved three days from a year ago.

Our cash flow continued to be very strong.

During the quarter we funded the $308 million settlement associated with NID while achieving a debt level which was unchanged from the previous quarter.

The settlement payment was reflected as a reduction to cash from operations.

Cash generation before this payment exceeded the prior year level by over $80 million.

Now let's turn to our full year outlook.

We continue to expect revenue growth to approximate 3%.

We expect operating income as a percentage of revenues to improve to about 18%.

We expect cash from operations to approximate $1 billion excluding the NID settlement payment, or approximately $700 million after such payment.

Capital expenditures are estimated at $200 million.

Lastly, we have increased our estimate of diluted earnings per share to between $3.70, and $3.80.

We continue to make steady progress in growing our business and improving its profitability to effective execution of our plan, and we are making investments in our business which will further strengthen our competitive position.

Now I will turn it back to Surya.

Thank you, Bob.

As you just heard, we delivered strong performance in the quarter.

We are bi-focal managing the business for both the short and long-term.

I will discuss the drivers of growth in this quarter and also the investments we continue to make for the future.

Second quarter profitability was driven by top line growth and improvements in quality and efficiency.

Our cost reduction program is improving our productivity and enhancing the overall patient and physician experience.

Some of these improvements include assessment tracking and connectivity via Care360.

Second quarter revenue growth was driven by continued strong demand for gene-based and esoteric testing.

Revenues for this test continue to grow more rapidly than overall revenue and account for approximately 35% of all revenues.

We have seen strong growth in a number of disease categories.

Demand is growing for a range of cancer tests.

That is a particular interest in tests that drive early detection since most forms of the disease, such as cervical, colorectal, ovarian and skin cancers, have higher cure rates when the disease is detected early.

For example, HPV testing increased more than 10% as we continue to educate physicians about the testing guidelines and the benefits of HPV testing with pap tests.

Sexually transmitted diseases remain a major public health challenge in the United States, and the medical community has responded by stressing the importance of screening.

As a result, we have seen our volume of chlamydia and gonorrhea testing continue to grow at about 10% annually.

Demand is also growing for screening and diagnostics associated with chronic conditions including cardiovascular disease, diabetes, allergies and asthma.

For example, allergy testing using ImmunoCAP grew almost 20%.

Also, researchers continue to find new links between vitamin D and a range of conditions from cancer to diabetes and heart disease.

As a result, we have seen a more than 50% increase in vitamin D testing using our proprietary tandem mass spectrometry technology.

We continue to invest to build capabilities that will serve us in the future.

During the second quarter we launched a number of innovative new services to improve outcomes for patients and reduce overall healthcare costs.

We were the first commercial lab to introduce a laboratory developed test to specifically identify the H1N1 virus.

I'm proud of our scientists who in response to the Swine Flu crisis, were able to develop and bring to market this test within a few weeks of the initial outbreak.

We added important new companion diagnostics.

This can help doctors personalize medicine by selecting the appropriate therapy for patients with metastatic colorectal cancer and HIV.

When it comes to diabetes, hemoglobin A1C is the cornerstone for the long-term management of diabetes patients.

During the quarter we expanded our point of care offering to include a hemoglobin A1C test with quality that compares to a laboratory test.

We completed a small acquisition of a highly innovative company called Oral DNA that provides diagnostic testing to the dental market.

Studies have shown a strong connection between periodontal disease and more serious conditions including heart disease and cancer.

We believe that the 140,000 dentists in the United States will play a more important role in identifying disease, and I'm excited about this new platform for growth.

Healthcare IT is a tool to drive patient safety, improve outcomes and appropriate use of diagnostic testing.

We are well positioned to play a larger role in our nation's healthcare information infrastructure.

We are already connected to approximately 150,000 physicians, many of whom are in small practices that have been slow to adopt healthcare IT.

In addition to ordering lab tests and receiving results online, Care360 allowed physicians to qualify for CMS E-Prescribing incentives today, and we believe more incentives in the future.

By the end of the second quarter E-Prescribing of medications using Care360 was up over 85% from year end, to a annualized rate of 8.5 million prescriptions and 30% from the end of the first quarter.

Our performance is a direct result of the outstanding contributions of our dedicated employees.

One of the way we attract and retain the industry's best talents is by investing in them and their health.

For example, our Healthy Quest initiative has helped thousands of employees quit smoking, lose weight and adopt healthier lifestyles.

As a result, we are recognized by the National Business Group on Health as the best employer for healthy lifestyles.

In closing, we delivered strong results in the second quarter and are raising our earnings guidance for the full year.

We are bi-focal doing what is required for the short-term and investing in our future growth.

We are the leader in a vital and growing industry and are excited about the opportunities before us.

Thank you, we will now take your questions.

Operator?

Thank you, at this time we are ready for the question-and-answer session.

(Operator Instructions).

Our first question comes from Ralph Giacobbe with Credit Suisse.

Thanks, good morning.

I was wondering if you could helps with the one timers or maybe when we anniversary some of those volume headwinds, the lab management contracts and drugs of abuse testing.

I'm assuming we should get less pressure as we moved in to the second half of the year.

This is Bob Hagemann, let me respond to both of those.

First, on the drugs of abuse testing, that's a business that we think has probably hit bottom at this point.

If you look over the last several quarters, the volumes relative to the prior year have been down by a consistent amount, about 24%, 25% or so, but we don't see that impact anniversarying until late in the fourth quarter this year because it really wasn't until December of last year that we saw the big drop off to where we are now.

The other piece of your question had to do with the lab management agreements.

They actually anniversary in the third quarter, at the beginning of the third quarter.

In terms of the operating margin guidance, 18% for the year, halfway through we are there already.

Anything we need to keep in mind for the back half of the year as I would think we should continue to see sequential improvement in that margin?

I think what you will see is continued improvement over the prior year as we get into the back half.

Remember that the first half of this year has the benefit of the insurance settlement in it which was 80 basis points in the quarter and about 40 basis points year to date so far.

But in the back half of the year we do expect to see continued improvement versus the prior year.

And just my last one, last week we had the CPI release that obviously translates to a 1.9% decline for the Medicare fee schedule next year.

First, is there anything you or the industry can do to change that, or is it, it is what it is?

Second, can you remind us how you negotiate your managed care rates and is it hinged on Medicare and/or CPI?

Ralph, this is Laure.

As it relates to the CPI, as adjusted for the 50 basis points, that's legislated by the 2008 bill, so right now that's in effect.

What we are working to do along with the industry is to deal with the proposal that's sitting in one of the bills around having a productivity adjustment, as well, which we are vigorously working with on the trade association.

As it relates to our health plan contracts, very few are linked directly to either CPI -- very few to the Medicare changes.

Some are CPI, and others had different modifiers going forward.

But each contract is unique.

Okay.

When you say some are linked, any way to quantify that?

It's a very modest amount.

Small percentage of our total contracts.

Most are separately negotiated fee schedules.

And not linked to the Medicare fee schedule.

Great, thank you.

Our next question comes from Adam Feinstein with Barclays Capital.

Your line is open.

Thank you.

Good morning, everyone.

Just a very strong quarter here.

My first question is just with the margins and the opportunity there, you guys have done a great job, so as you think about the initiatives that you put in place to drive that margin growth, how much of it is still left to uncommon?

And just curious in terms of just all of the things you guys have been doing, are we at the tail end here?

Just want to get some feedback there and I have a couple of follow up questions.

First, with respect to the program, we are firmly on track there, fully committed to deliver the $500 million by the end of this year.

And as I've mentioned in the past, the gains that we are getting there, or the benefits that we're getting there are really sustainable cost reductions because of the fact that we are taking work out of the process by redesigning the process using in Lean Six Sigma and the like.

So we feel very very good about that.

In terms of what is next and where we go from here, we are constantly thinking about what is next and how to build on what we've already established here.

And rather than you thinking about a new big program, I'd rather us be thinking about what we are going to build on from the existing program to drive further improvement.

The thing to remember about the program that we've got in place is there are not one or two really big items that are driving all of this save here.

This consists of many small initiatives that we are executing very very rigorously, and it's that sort of rigorous execution that we are going to apply against all of our processes and against all of the ideas that we continue to generate.

Think of this more as a continuous improvement process as we go forward rather than announcing a big, big program.

Great.

Just as we think about testing, and it's helpful that you break out the impact from some of those noncore items, but as we think about the core business, as we just separate routine from esoteric, I just want to get some color in terms of what you saw in other quarters had the esoteric tests, has the volume growth held up there well?

If you are not able to provide any specific numbers, if you could just speak about it from a very high level that would be helpful.

Certainly the gene based and esoteric testing continues to be the fastest growing piece of our business but we have seen improvement in both the routine testing as well as that piece of the business.

We feel good that all of the aspects of the business are continuing to grow here.

Okay.

Finally, there was a question earlier on the impact from Medicare.

I wanted to just follow up.

So the clinical lab fee schedule, you were talking about that before, but with the physician fee schedule and some of the proposed cuts there, just curious in terms of how you are thinking about.

I know it only impacts a smaller percentage of your business but still wanted to get your thoughts.

And also last quarter there was some discussion in the industry about MUEs and the impact of that, so just curious in terms of whether that reversed itself in the second quarter.

Thank you.

Adam, as you said, the physician fee is a much less significant impact to us, it's going to be less than $10 million the way we size it at this point.

With respect to MUEs, we've never identified that as a significant impact to us.

In fact, many of the edits that were put in have been pulled back at this point.

That was an impact -- the modest impact was on cash timing only not on revenue recognition.

Okay.

Great, thank you.

Our next question, Bill Quirk with Piper Jaffray.

Your line is open.

Thanks, good morning.

Just wanted to talk a little bit about healthcare reform.

You mentioned it briefly in your opening comments.

I think most of us are probably keeping a pretty close eye on the senate finance committee for guidance.

I would love your current thoughts here.

All of us know healthcare reform is required.

Our healthcare in the United States is very complex, very costly, and frankly very confusing.

What is really good for this industry is that you cannot practice evidence-based medicine without evidence.

And the laboratory testing is one of the main testings you do to really get objective data.

So we are actually very supportive of the President's goal to increase, expand coverage and enhance early detection programs and also promote healthcare and wellness, and also use of healthcare IT to reduce costs.

One of the most difficult things at the moment, whether it's primary care or it's hospital or the rehab centers, there is a lot of inefficient handoffs between the parties.

So we are strongly supportive of healthcare reform.

Very fortunately laboratory testing is only 3% of the total healthcare costs, but now the administration and the medical community is realizing the value of diagnostic testing.

So we are in a very good position and we're helping that as far as we can as far as recognizing the value of diagnostic testing.

Understood.

As we think about the various bills, make their way through committees and such, how should we think about or --

Here are some things we look at.

First off, as I said, we don't have a crystal ball, but all we have is thoughtful consideration of come of the factors.

Access is positive.

Expanded access.

When you bring in 20 or 30 million people out of the 47 million uninsured that is positive for the industry.

Doing testing, whether it's for illness or wellness, that's positive.

Healthcare ID for our company is positive.

Obviously something is going to be negative which will be the reimbursement or fee schedule.

But, as you know, as far as our company is concerned, we have gone through some of those things so we know how to really modify some of the operating efficiency to really have a sustainable margin.

On that front we are also keeping to educate them that over the past several years the clinical laboratory industry has been impacted, to some degree, disproportionately on the negative side from a fee schedule adjustment compared to durable medical equipment or outpatient services, and we are working to educate key members of both sides of the aisle and house and senate on those changes.

When you think about it, just about every provider is going to have some pressure as it relates to reimbursement.

If you look at the lab space, we are 3% of the total spend, so it's not where the big dollars are.

So would it be safe to assume that you are not expecting any draconian reimbursement changes here in the relatively near term?

In other words, the CPI less 50 basis points deal, maybe a good thing to look at in terms of several year barometer here?

Bill, we are not looking at any type of draconian cuts based on what is being discussed currently.

The only thing definitively that's under discussion right now is the productivity adjustment onto the CPI.

Beyond that it's really, I don't think, appropriate for us to speculate what type of components might be on the senate side.

We have not seen anything specifically outlined at this point.

Very good, thank you.

And then just one quick followup.

One other point on that.

The productivity adjustments, as looking at those two, the incremental impact of that is not overly material either.

Again, less than $10 million as we calculated.

And maybe to put it into, to Bob's point, a context at this point in time, we are looking at, on the CPI adjustment based on what is currently in place, we are looking at about a $25 million impact to the company, which is clearly less than one-half of 1%.

Agreed, thank you.

One quick follow up and shifting gears quickly.

Inventory levels continue to tighten up.

Bob is there a level here or turn ratio that you are targeting?

Not a specific turn ratio, but it's interesting that you noticed that.

This year we have made a concerted effort to manage capital more efficiently.

And in fact we've deployed a capital charge charge to each of our businesses to get them more focused on managing capital very effectively.

And it's actually worked very well.

I think that we have rung out some excess capital out of the system, and obviously, as you know, the less capital that you need to operate your business the more you've got to grow your business.

So not a specific target there per se.

You look at our balance sheet, inventory is not a big number.

The big opportunity, really, is in DSOs and I think we continue to do a good job there in managing those down and keeping those under control.

Our next question, Charles Rhyee with Oppenheimer.

Your line is open.

Thank you for taking the question.

Maybe a question for Bob here, just looking at the guidance relative to what you guys put up here in the quarter, particularly on the interest expense.

I understand here the early extinguishment of debt, and when we think about, should we think about the interest expense going forward at this current level, and if so, it seems like you are going to benefit by a couple of pennies per quarter.

Am I thinking about that correctly or is there something else that I should consider here as we think about the back half of the year in terms of guidance?

Just to give you some perspective, we don't provide specific guidance on interest expense.

And obviously the tender is going to help reduce interest expense somewhat in the back half of the year but it's not a couple of pennies a quarter.

At best it's a $0.01 a quarter.

Okay.

Staying on with guidance here, just wanted to ask about the volumes.

Obviously you're doing a lot better here than maybe some people had expected, and particularly the revenue growth here in the second quarter.

At what point would you feel comfortable saying 3% revenue growth is maybe at the low end of our range, and we could see something better than that?

Or is there anything out there in the future that we should consider, that 3% remains the target and trajectory you are on and as we move to maybe Easter or comps in the back half of the year?

Certainly if you look at the full year guidance, we're about 3%.

It implies that the back half of the year is going to be as strong as we saw in the second quarter here.

And I would tell you that's a little premature for us to be thinking about raising revenue guidance but I'm glad that at least you are thinking about that at this point.

Great, thanks a lot for the questions.

Our next question Darren Lehrich with Deutsche Bank.

Your line is open.

Thanks.

Just a few things here.

I wanted to go back to the volume question and want to get some commentary from you about what your sales force is seeing in the physician offices there.

Has there been any kind of broader base recovery that's led to your test volumes?

Can you just comment on the tenor of the activity in the system throughout the quarter.

Sure.

First I would tell you that it's very hard for us to assess actually what is happening in physician offices.

Anything that we get there is very anecdotal.

But what I would tell you is that we are continuing to effectively execute our plan, and this is all about blocking and tackling and effectively selling.

And selling our value proposition which includes very comprehensive menus, includes superior service.

That's what we have been doing over the course of the last year, and that's why I think we have seen steady improvement in our underlying volumes.

And that's why we are confident in the guidance that we got out there for the remainder of the year.

If I could maybe just shift to Swine Flu testing, and just a couple of questions there.

I know you had a release in May that Surya referenced.

Where do you stand with regard to how you in the industry might coordinate with public health entities?

I just wanted to better understand how you think some surge volume activity in the fall or winter may play out relative to this flu, and can you just help us think about that and whether you saw any kind of activity in the quarter relative to the new PCR test?

Thanks.

First of all, I'm very proud of the way we brought this test, laboratory developed test in the market, very quickly.

But obviously this is a pandemic, and we are working with the State Department, CDC and FDA, and we are getting ready that if it's required, hopefully it's not required, but if it's required then we will be able to provide testing to the patients and the physicians.

But over the last few months we have not seen enough to move any number.

And again there is a lot of discussion going on to prepare the country in case this happens.

And the most important thing for us now is that we have a test which can be done commercially.

While the volumes, Darren, weren't big enough to move the overall results, they were higher than what we would see in a normal off season for flu perspective.

Sure.

Okay.

Then just the last area of questioning I had was on the pathology front, and I want to get some comments from you about your progress in recruiting clinical leadership for that business.

I think it was a few months ago we saw a number of posts in your pathology business and I just wanted to put that into perspective relative to clinical leadership within that business line.

I'm glad you are tracking the newer time.

First of all, as Bob said, and as you have seen, we are building this company in a number of platforms, whether it is Crescent Central City or whether it is growth through acquisition or organic growth of developing people.

So a few months ago you saw that we hired our first Chief Medical Officer, and he is not a pathologist.

He is Dr.

Jon Cohen.

He was our advisor to Governor Patrickson, and he is a vascular surgeon.

Our head of science and innovation was Dr.

Jay Wohlgemuth.

He is a cardiologist.

And what we are trying to do, as we told before, that we are going to be laser focus on cancer, infectious disease and cardiovascular disease.

We are building up the science and medical leadership in this company so that we can lever the 800 MD and 100 (inaudible) that we have.

Here is what is happening to the healthcare.

The demand, as you saw demand has grown by cancer testing.

Whether we like it or not, every year 1.5 million people are diagnosed with cancer and also half a million people will die.

But the good news is that 10 million people survive the cancer.

So skin cancer, breast cancer, prostate or colorectal cancer, we have the ability to do the test and provide the information.

So that's the reason why we are enhancing our medical and scientific leadership and our future is based on actually how we deliver this information to these three large categories, along with the chronic diseases.

Have you completed those?

This is a continuous process.

As we go, we will keep, just like people, we refine people, we add people, but you are seeing a new structure.

One other comment I want to make, one of the reasons why we are doing good in sales, is we changed our approach to sales and we have new leadership in sales, and for the last 10 or 12 months we have been very focused on how to really call on various customer categories, whether it's physicians or whether it's hospitals or whether it is the insurers.

But in the physician business we have new leadership driving the engagement to our customers.

Just a point of clarification, Darren, those two ads were actually for people to go to out to our Nichols Institute to expand on capabilities on the cancer side there.

You will see more of this kind of activity going forward, whether it's personalized medicine or whether it's something diagnostic, whether it's clinical trial.

We are going to expedite some of the science and innovation hires.

Great, thanks a lot.

Our next question, Kevin Ellich with RBC Capital Markets.

Your line is open.

Good morning, thank you for taking my questions.

Just going back to healthcare reform, I know it's been discussed quite a bit this morning, but I was curious if you could talk about what opportunities, you talked about the healthcare It initiatives and what-not, but what other opportunities and challenges do you see coming from healthcare reform?

Let me first talk about the challenges.

We are all supportive of the healthcare reform but it's a complex issue, so the most important thing is to have real appropriate thoughtfulness to figure out how to expand coverage and we're going to get the money.

We still have a lot of deficit as far as where the money is going to come from.

While the legislators and regulators are trying to have the discussion, from our investor point of view we find very positive indications of where we could help to reduce healthcare costs.

For example, if you diagnose disease in an early stage the total life cycle cost of a patient goes down.

For example, you may expend $600 for diabetes to save 15,000 amputations if you are not taking care of it.

Simple tests for wellness can keep people away from the hospital.

I think there is a culture change required with all of us to take care of our health along with the government helping us to give some incentive on various areas.

From a diagnostic testing point of view, I think it's very positive and we are getting ready, as I said continuously to really see what the government is doing.

One thing in this company, two or three years ago we instituted a wellness business.

So there is another opportunity on prevention and wellness and we have a division with ExamOne to provide that kind of mass diagnostics required, whether it is with the employer base or with the health fair.

We talked a little bit about healthcare IT.

The most important reason why the IT adoption has not been there is because most of the doctors have a one, two, three physician practice and it is very difficult for big companies to go and approach them.

We are so fortunate we have 150,000 doctors on Care360, and they can get money now for E-Prescriptions, and going forward I think it's an opportunity for us with the stimulus growth when we introduced the meaningful use of some of those healthcare IT.

Then thinking about the uninsured, if indeed there is some sort of mandatory coverage, what percent of your bad debt comes from the uninsured versus the copays and deductibles?

Most of our bad debt actually comes from the uninsured.

The bad debt associated with copays and deductibles, obviously, is higher than the overall bad debt.

But most of it comes from the uninsured.

If you think about our patient bill, roughly 13% of our revenues are from patients with about half of that associated with the uninsured and about half of that deductibles and copays.

Then just a the last question on the reform side, if indeed these uninsured people all of a sudden have coverage, do you see an increased market opportunity as they are going into the physician office and maybe the doctors are ordering more lab tests?

I think physicians who order whatever the test is required for the patient.

But obviously there are more people in the system, depending on actually what kind of people it will go to the physician office.

If your question was do we think that the folks that are uninsured today who will be insured in the future are going to have a different level of utilization, I don't see that necessarily.

But the opportunity, if you're looking at are they going to come into the doctor's office versus the ER, absolutely that's an opportunity for us where most of our work does originate in a physician office setting.

I think the broader opportunity has to do with the increased awareness of the value of diagnostics in early detection, like Surya was talking about before.

When you look at what is being defined as the essential healthcare benefit, that's expected to include lab services, and I think that's important recognition of the value that we bring.

Those people do end up in the emergency room, and that is what the government wants to avoid because it's very expensive.

Once you have the coverage they can have doctors and then they can be under physician care and that's going to reduce catastrophic illnesses.

Got it.

I know this is going off the deep end, but with Swine Flu and H1N1, did you see any impact on volume in the quarter?

Nothing that would move our numbers at all.

It was very very small volumes of that.

But as Laure said, higher than we typically see during a non flu season, but certainly nothing to move the needle.

Got it, and then last question, could you talk about the uses of capital and where you stand on the buy back.

I don't think you purchased any stock in the quarter, but given where the stock is today how attractive do you view that?

I'm not going to get into making comments about the attractiveness of the share price, but as you know all of the cash that we generate we deploy, and it's going to be deployed into one of three areas, either further debt repayment, share repurchases, or acquisitions.

And while there will be some further debt repayment most likely over the course of the year, we are in a position now where we can give a lot more consideration to acquisitions and share repurchases.

And frankly, the priority between those two would be acquisitions, as it always has been because those can create sustainable growth for us.

When acquisitions aren't available either on a timely basis or at the right price that's when you see us deploy the excess cash into share repurchases.

While we may not be in the market every quarter for share repurchases, over the course of the year, though, you should expect at a minimum we are going to be repurchasing enough to offset the dilution associated with benefit plans which translates into about 3 million shares a year or so, But you should expect that in every quarter we are going to make good use of the cash that we generate and deploy it to drive shareholder value.

And in this quarter, unfortunately, we had $300 million that we needed to fund, which we did without adding incremental debt at the end of the quarter.

So I feel very good about the cash flow generation and the ability to continue deploying that to drive shareholder growth and shareholder value.

Understood, thanks and nice quarter.

Our next question, Shelley Gnall with Goldman Sachs, your line is open.

Great, thanks for taking our questions.

First I was wondering if you could share a little bit about your contracting relationship with Health Net, given the news on the United acquisition?

Shelley, we don't comment on specific arrangements with payers.

Okay.

My question being I was wondering if there was a chance that Quest could lose some of the Health Net lives, if they could be migrating out with United because of the acquisition.

Keep in mind, Shelley, that Health Net, has only sold their Northeast business which is a limited number of lives, therefore the impact to us, to the extent that we lose some of that volume, is very limited.

Thanks.

On the CPI, just a follow-up question on the CPI.

I know that the Administration is looking to put these productivity cuts in place, as well.

That sounds like that would reduce the Medicare rate by a further 1.5%, if I'm getting that right.

As I said earlier, that impact would be less than $10 million to us.

Right, I'm wondering if that is in place, I'm wondering if the Administration is targeting 2010, and then my question would be does that have any long-term implications on your negotiations with managed care if the Administration is successful in getting some productivity cuts out of rates?

As we said earlier, our managed care contracts are all negotiated separately.

And each one is a separate negotiation.

And over the years, as Medicare has moved either up or down or been flat for years, it really hasn't impacted those discussions.

As we said earlier, it is a very small piece of our contracted business that is linked to the Medicare fee schedule.

Frankly, what has driven our improvement in revenue per requisition, and will continue to drive it as we look ahead, is the mix of business shifting to more esoteric and gene-based tests as well as the utilization, increased number of tests ordered per requisition.

And we expect that will continue to drive improvements in revenue going forward.

I think an important illustration is that literally since 1997 the industry has received only three CPI adjustments, yet since 1997 we have driven continuous improvement in our revenue per acquisition.

That's helpful but I'm thinking more on the productivity side.

I'm wondering, so if the Administration sees an opportunity to trim rates further, whether this, the productivity piece, could flow through to managed care negotiations.

Maybe my question is how far in advance are some of your bigger contracts negotiated?

Do they tend to be one to three years in duration?

Have those escalators already been in place or are they at risk, as the terms are renegotiated is there potential for managed care to also seek productivity adjustments?

Shelley, there is the potential for them to do anything.

But there is a separate negotiation which is based upon the value that we bring to each payer.

That discussion is independent of what the government is doing.

Your question on contracting, all of our major contracts extend beyond 2010 at this point in time.

They're multi-year in nature and very much distinct discussions.

Right, and the pricing in those is negotiated and predetermined.

In some cases there are scheduled increases, in other cases there may be opportunities for the payers to get further volume discounts based upon moving work to us, and in some cases we have no adjustments to pricing over the contracted term.

But as Laure said, all of our big contracts are negotiated for multiple years at this point, and the pricing in those contracts is set and is independent of what is happening with the Medicare fee schedule.

Thanks very much for the color.

Our next question, Amanda Murphy with William Blair, your line is open.

Good morning.

Just a couple of follow-ups for you on a comment you just made about revenue per requisition being driven by mixed shift as well as an increase in tests per requisition.

I'm assuming it's mostly mixed shift at this point.

Is that fair?

And also, in terms of the revenue or the test per requisition, what are the trends you are seeing currently?

Amanda, it's really a combination of both.

It continues to be obviously the mix shift.

But as we introduce new tests, you have to recognize that many of those are ordered in conjunction with other tests so that's driving utilization and increasing the number of tests ordered per requisition.

Another way to think about is is just the volume of testing is going up while the volume of patient encounters is going up at a slower rate.

I think you will continue to see that.

As we continue to introduce new tests, that will drive additional tests per requisition or tests per encounter.

And then also you talked about the routine side of the business, could you provide some color on AmeriPath and where we stand there.

I think in the past you had talked about some weakness on the hospital side.

Are you still seeing that?

Maybe just give a little perspective on how that business is going.

First of all, AmeriPath integration is going well, and as you know their hospital part, their specialty, is all fully integrated with our hospital business.

As far cancer diagnostics, it remains the number one, and what we are trying to do now is trying to get leverage by cross selling to primary care for skin cancer.

I think apart from that, cancer diagnostics remains number one, and as I said we have increased our testing based on the outpatient tissues rather than the inpatient.

Absolutely Amanda.

As Surya said, the outpatient has definitely been stronger than the inpatient tissue value coming through with AmeriPath.

And what we're seeing, too, is increase in molecular testing associated with anatomic pathology, as well.

So, as Surya said, yes, we really need to start thinking about it as cancer diagnostics than just anatomic pathology because that's what is growing the cancer testing.

Okay.

Then just on the reform issue, again, sorry, but one of the things that seems to keep resurfacing is this whole concept of bundling.

What is your perspective on that?

In your conversations with people on the Hill, is that something you think could be incorporated into reform?

Amanda, we are not going to speculate on it.

Obviously we have a lot of questions in regards to how some of that would be implemented.

We are not going to speculate.

We are continuing to learn more and obviously to talk to the Hill about process.

If it was implemented, I guess it depends on how it's structured, but --

The devil is in the details, absolutely.

Not only how it's structured, how we will administer because having DRG in the hospital is very different than outpatient.

It's a very complicated proposal to bundle for ambulatory patients.

There's a practicality issue.

Last one here.

Last quarter I think you mentioned there were some expenses that were deferred.

Do you have any perspective on when those might flow through the P&L?

As we think about that, a lot of the expenses, I think I said this at the end of the first quarter, while some of those are going to flow through the P&L later in the year, sometimes the longer you go without spending something, the more likely you are to realize that maybe you didn't need to spend it in the first place, and I think that's what we are realizing here.

So some of those expenses will not come back through the P&L, others will come back later in the year, but all that is baked into our guidance at this point.

Thank you.

Our next question, Anthony Vendetti with Maxim Group, your line is open.

Thanks, just two quick questions.

On the genomic and esoteric testing, I know you said 35% was the number this quarter as a percent of the revenues.

If you stripped out anatomic pathology, or if you want to include it, where do you see genomic and esoteric testing going as a percentage of revenues over the next three to five years?

And then the follow-up question is going to be on unemployment as it approaches 10%, or a little over 10% in certain states.

What impact, if any, do you see in 2010 on that?

I think as so where do we see the 35% number going to, obviously if you think the gene-based component is clearly more and more testing is being used performed using a gene base.

What is important is the number can't grow for forever.

What is esoteric today is going to become routine tomorrow.

And that's not a bad thing.

It means the test is growing in importance and more and more people are using it.

While we would see that number going up, we don't see it moving to be 50% or more of our business.

It's important for us to keep a good strong pipeline to keep driving new tests to be introduced so as things become more routine that we are introducing new valuable tests to physicians and their patients.

And, Anthony, with respect to the unemployment question, over the course of the last year we have seen unemployment rise significantly, yet our underlying volume, when you strip out the drug abuse testing business, has been steady and started to grow.

And while we are not totally immune from further unemployment, I do expect that we will continue to grow our business.

Great, thanks.

Our next question, Robert Willoughby with Bank of America - Merrill Lynch, your line is open.

Thank you.

Surya or Bob, the E-Prescribing volumes you threw out there, a huge jump there, but you don't see any economics in the actual volumes, do you?

You're not paid on a per click basis.

Robert, the reimbursement is a monthly reimbursement per prescribing doctor.

That's where the revenue comes through.

You will get some but it's not really significant yet.

The important thing is that we we have a product, people like it and actually now we're seeing those areas where a bigger company cannot.

Today they are getting E-Prescription from CMS, tomorrow they might get the stimulus money, but the most important thing is also, as I said, it is a stickiness which we have created with our customers.

So no thoughts of ever charging on a per prescription basis, that you get $0.05 or something?

We have a small revenue model but it's not significant at all.

And it's not a per click model at this point.

Can you explain the economics on the new MedPlus relationship with the New York Clinical Information Exchange?

How does the money flow on something like that.

Robert, each HIE negotiation looks a little different.

With many of the HIEs, what the initial streams look like is a negotiation for the creation and development of the pipes, so to speak, as well as the software that's going in.

As it relates to ongoing revenue models they look a little different across the various entities.

It's licensing and it is service, but also we are acting as a system integrator so we get to charge them for our work.

Okay, but still no transaction kind of event driven revenue model?

This is all license fees.

There is the potential for that, Robert, and each one of these is a little bit different, quite frankly.

You've seen one, you've seen one basically.

But clearly, we think across the country, you will continue to see more and more of these exchanges being developed and the models will evolve as people get more experienced.

And there will be some opportunity for continuing ongoing revenue.

But again those models are still developing at this point.

Did you mention what the asset write-off was, Bob, the investment write-off that you had?

I did not.

It was just a small equity investment that we had made that the accounting rules at this point required us to writedown.

Thank you.

Our last question, Gary Taylor with Citigroup, your line is open.

Thanks for taking the question.

It seems to me this was a pretty important quarter in terms of just looking at payer mix and capturing any change in buy down that perhaps would have started flowing through in the Q1 and now you've had an additional quarter to look at it.

I wondered if you might comment on payer mix year to date.

It sounded like the comments you made about self pay, being 13% of revenue, half copays, half uninsured, sounds like that's pretty unchanged, so is it fair to say overall that mix and buy down really haven't moved much on total payer mix year to date?

I think that's a fair assessment at this point.

When you are talking about mix you are talking about mix of patient pay, versus third party pay?

Correct.

No, that has not changed substantially over the course of the year.

As always there is a little bit more patient pay in the first quarter, prior to people hitting their deductibles and the like, and as a result we always have a slightly higher percentage of bad debt in that first quarter, but nothing different this year from historical trends.

And can you give us the balance sheet allowance against AR?

I don't have it handy.

It will be in the 10-Q when it's filed.

But it has not changed significantly.

Last question, just backing up to the 1Q, so the bad debt trends have been stable, actually down a little bit in the 2Q, the DSO trend has been stable, actually down a little bit in the 2Q.

But if you look at the first quarter, your allowance as a percent of gross AR dipped a couple of hundred basis points sequentially.

What do you attribute that to?

Theoretically that would suggest the mix of the gross AR had improved.

Is that rate increases on the commercial side making commercial AR grow a little faster, or why would the gross AR mix have improved in the 1Q?

It could be driven by a whole bunch of things, it could be driven by improvements in the agents, it could be driven by the timing of write-offs, et cetera.

And what I would tell you is with respect to the adequacy of that allowance and the reserves that we've got up there, I feel very very good about that.

And I do not expect there to be any surprises.

We've got a very rigorous process around that.

It's reviewed by a dedicated team, it gets a lot of attention from our auditors as you would expect.

And any movement that you see in that reserve would be for the most part principally driven by just the timing of writeoffs.

And really nothing else.

At the end of the day, I think the way to get comfortable with your receivables and the adequacy of the reserve there is watch the DSOs and watch the bad debt rate.

If they are going in opposite directions, there is an issue.

If they're going in the same direction, generally you should feel pretty good.

The other thing you need to do is watch the cash at the end of the day.

As you've seen, the cash flow has been very strong in the quarter.

Thank you.

Thank you.

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.

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

eastern time on July 21st through midnight on August 22nd, 2009 to investors in the US by dialing 866-395-9177.

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

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Good-bye.