奎斯特診斷 (DGX) 2009 Q3 法說會逐字稿

Welcome to the quest diagnostics third 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 copyrighted property of Quest Diagnostics with all rights reserved.

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

Now I'd like to introduce Laure Park, Vice President of 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; Bob Hagemann, our Chief Financial Officer; and Kathleen Valentine, our new Director of Investor Relations.

Kathleen will review the Safe Harbor Statement.

Kathleen?

Thanks.

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.

Risk 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, the competitive environment, changes in government regulation, changing relationships with customers, payers, suppliers, and strategic partners, and other factors described in the Quest Diagnostics 2008 Form 10-K, Quarterly Reports on Form 10-Q, and current reports on Form 8-K.

Additionally today's prepared remarks will reference non-GAAP measures which are reconciled to GAAP in the footnotes of the earnings release.

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

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

Now here is Surya Mohapatra.

Thank you and welcome, Kathleen.

Demand for diagnostic testing services remains strong and our business is performing well.

We drove solid earnings and revenue growth in the third quarter.

We also continued to improve efficiency of our business.

During the third quarter, earnings per share grew 26%, revenues grew 4% and cash flow from operations grew 14%.

Based on our strong performance, we have raised our full year EPS guidance to a range of $3.80 to $3.85.

While there has been recent progress on healthcare reform, the terms of the final outcome are still to be determined.

We have always been supportive of the growth of healthcare reform to expand access to quality care, to improve outcome, and reduce costs.

Diagnostics play an important role in achieving these objectives.

We are hopeful that the efforts in Washington will result in better outcomes for patients which is central to our mission.

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 perform well.

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

Earnings per share from continuing operations for the quarter were $1.02, 26% above the prior year, with the increase principally driven by strong operating performance.

$0.05 of the EPS growth is due to two items included in last year's Third Quarter which helped this year's comparison.

A $0.03 charge associated with an asset write-down and a $0.02 impact from last year's hurricanes.

Consolidated revenues were $1.9 billion, 3.9% above the prior year and our net of a 0.4% reduction associated with foreign exchange.

Our clinical testing business which accounts for over 90% of our total revenues grew 4.3% above the prior year and over 5% before the impact of our (inaudible) drug testing business.

Volume was equal to the prior year level, despite a 23% decline in pre-employment drug testing which reduced consolidated volume by 1.7%.

The third quarter volume comparison to the prior year was aided by about 0.5% associated with the impact of last year's hurricanes.

After giving consideration to these factors, underlying volume grew just over 1%, about 1% slower than the second quarter.

The decrease is principally due to a general softness in our business during the month of August.

August volumes tend to be highly variable and are impacted by vacation patterns and the timing of the start of the school year.

Nothing that we saw in our August volumes pointed to a reversal of the progress we are making in growing our business.

In fact we saw volume growth rebound in September placing underlying volume growth for September and July in line with the year-to-date level.

Revenue per acquisition increased 4.3% with the increase continuing to be primarily driven by a positive mix and a benefit of just over 0.5% from the Medicare fee increase which went into effect January 1.

Revenue in our non-clinical testing businesses which include our risk assessment business, clinical trials business, point of care testing business, and met costs and contain most of our international revenues was in line with the prior year despite a reduction of almost 4% attributable to foreign exchange.

A table contained in Footnote seven to the earnings release summarizes the impact of various revenue metrics associated with a number of the items I just discussed.

Operating income as a percentage of revenues was 18.4%, up from 17.4% last year.

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

The impact of the hurricanes which occurred last year served to aid the year-over-year comparison by about 30 basis points.

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

Bad debt expense as a percentage of revenues was 4.4%, consistent with the Second Quarter.

DSOs at 43 days were also consistent with the Q2 level and improved 2 days from a year ago.

Our cash flow continues to be outstanding.

Cash flow from operations for the quarter improved to $374 million compared to $329 million last year.

During the quarter we reduced debt by $100 million, repurchased $100 million of our stock and grew our cash balance by $128 million.

Turning to our full year outlook, we continue to expect revenue growth to approximate 3%.

We now expect operating income as a percentage of revenues to exceed 18%.

We expect cash from operations to approximate $1.2 billion excluding the NID settlement payment or $900 million after such payment.

Capital expenditures are estimated at $180 million.

And lastly, we have increased our estimate of diluted earnings per share to a range of $3.80 to $3.85.

Our business is performing very well.

It is growing and becoming more efficient.

In addition to driving current performance, we're looking ahead and making important investments which will continue to differentiate quest diagnostics and further improve healthcare.

These include advancements in science, medicine, and technology, and now I'll turn it back to Surya to discuss some of these accomplishments.

Thanks, Bob.

We continue to execute our plan and drive growth.

Our strategy is bi-focal.

We are managing the business by both the short and long term.

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

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

Our cost reduction program continues to improve our productivity and enhance quality and service.

Revenue growth in the quarter was driven by continued strong demand for gene based and esoteric testing including cancer diagnostics.

Revenues from this test continue to grow faster than the overall revenues.

Gene based esoteric and an atomic pathology testing accounts for approximately 35% of all revenues.

Anatomic pathology accounts for the majority of our cancer testing revenues.

Increasingly (inaudible) are supplementing anatomic pathology testing with molecular test such as HPV.

HPV cervical cancer testing increased approximately 10% compared to the prior year.

[In addition], we continue to extend our cancer diagnostics portfolio with the launch of new tests such as EGFR pathway test for metastatic colorectal cancer, and our proprietary Leumeta family of plasma, there's leukemia and lymphoma test which has grown more than 45% year-over-year.

We have seen more than a 50% increase in vitamin D testing which is increasingly used for a range of conditions from osteoporosis to cancer to diabetes to heart disease.

And testing using Amino cap grew more than 15% reflecting continued adoption for this broad based allergy testing method.

Our continued focus on innovation is driving growth today and preparing us for the future.

I'd like to highlight a few exciting innovations we have recently announced in infectious disease, diagnostics for predicting therapy response, cancer diagnostics, and healthcare IT.

For example, we recently introduced the first commercial test for the H1N1 flu virus authorized by the FDA for emergency use.

Our H1N1 test is a good example of how strength in rapidly developing and deploying innovative diagnostics to improve patient care.

In fact, we launched our tests a little over two weeks after the US government declared a pandemic emergency and about 10 weeks later the FDA authorized the test for emergency use.

Last week, the FDA granted us emergency use authorizing for our H1N1 flu test to run on our recently introduced neuro patient testing platform.

We are the only Company in the US that the FDA has authorized to both perform the tests in our lab and also offer H1N1 test case to high complexity labs.

This will expand the nation's capacity to perform testing and reduce turnaround time for H1N1 results.

We focus our efforts on cancer, cancer, infectious disease and cardiovascular disease.

Earlier this month we introduced an innovative gene based test for cardiac patients that uses a saliva sample.

This test helps physicians predict response to the blood thinner Plavix.

Most of the roughly 1 million patients who undergo stent procedures each year are prescribed Plavix, yet 30% or more of people possess genetic mutations that impede response to Plavix.

As a result they may be prone to develop blood clots and can cause heart attack and stroke.

Quest is the first health system in the United States to offer this gene based testing as part of its care for patients electing to undergo stent procedures.

This saliva based gene test puts us at the forefront of (inaudible) diagnostics for cardiovascular disease.

On the cancer front, we collaborated closely with Vermillion on the development of its OVA1 ovarian cancer test which the FDA cleared last month.

This multi-analyzed test we view as a proprietary algorithm provides a new option for helping physicians assess if the pelvic mass is benign or malignant prior to scheduled surgery.

This information is expected to help physicians determine whether to refer a woman with high risk of cancer to a specialist or just a general surgeon.

We expect to launch OVA1 in the Fourth Quarter and have a multi-year exclusive license for the clinical reference laboratory market in the US.

We are also the exclusive reference laboratory provider for the FDA cleared HE4 biomarker monitoring test, with HE4 and OVA1 in our portfolio, we are now the only diagnostic testing Company to offer FDA cleared test for ovarian cancer patients in the pre and post surgical setting.

We are differentiating our Company through enhanced healthcare IT solutions.

More than 150,000 physicians already use our (inaudible) solution, such as (inaudible).

This enables them to provide better patient care, build more efficient practices, and qualify for government incentives.

Use of our E-prescribe service contributes -- continues to grow rapidly.

Monthly prescriptions volume grew more than 25% since June and is up 140% since December 2008, at a rate of more than 10 million drugs per year.

Additionally, CarePhysics mobility features enable care teams to check a patient's lab results and prescription history anywhere, anytime, using a desktop, laptop, or our proprietary iPhone application.

We recently announced this service to enable doctors to also prescribe medications remotely.

We believe that the patient empowerment and personal accountability are essential to quality healthcare.

Healthcare IT is a tool to empower patients, helping them to understand and manage their health data.

We recently announced our collaboration with Kias, a new and innovative interactive online health education and coaching site.

This [arrangement] like our collaborations with Google Health and Microsoft Health Fault enables us to facilitate patient access to their lab data.

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

We are doing what is required for the short-term while investing in our future and we are excited about the growth opportunities before us.

Thank you.

We'll now take your questions.

Operator?

(Operator Instructions) The first question is from Ralph Giacobbe from Credit Suisse.

Thanks, good morning.

Just a couple questions on the volume side.

Bob, I know you mentioned sort of normalizing looks like the number was up 1.1% last quarter.

It was up sort of mid 2%.

Could you just go through, I missed some of the comments you said August was softer simply because of seasonality around sort of the summer months and that's kind of unpredictable and September picked up again, is that what you said?

That's right, Ralph.

As I mentioned August is a pretty variable month.

Sometimes it's affected by the timing of vacations and school starts and the like.

And while there's not a direct correlation we also saw a similar pattern with scripts that were written in the month of August.

They were down, but as I said earlier how our volumes did rebound in the month of September and when we look at September and the month of July those volumes were pretty consistent with what we've seen year-to-date.

So we don't think that there's anything in the underlying performance that affected August.

We think it was just an anomaly.

So in terms of your opinion, what's the underlying growth rate in the volume number excluding some of the one-timers?

Well, again if you look at the table that we have in the footnotes, Footnote 7 you'll see that adjusted it's 1.1% for the quarter, but we're not attempting adjust for the month of August in there.

Okay, and then staying sort of on the volume, can you talk about if there's typically any difficulties you may face on the volume side in the face of everything you're doing on the cost side of the business?

I'm assuming some of the cost savings is coming from downsizing to some degree so should we think of it as once that stabilizes, you would expect it to be easier to maybe accelerate volume trends?

Well, I wouldn't say that there's any connection at all.

In fact, what we're doing on the cost side we believe is also improving service levels.

We're making things more efficient, we're actually improving service levels and if anything I think that's going to help us grow faster in the future.

Okay, and then just my last one.

Can you talk about any potential flu impact in the quarter and maybe comment on whether you've seen any meaningful uptick this month just given all of the news out there on the Swine Flu?

We have seen a meaningful uptick in our testing for H1N1 but it's still a very small piece of our business and it's really not having any noticeable impact on the results at this point, and really don't expect it to have any significant impact for the Fourth Quarter either.

We really look at the H1N1 as really a support of our innovative capabilities and the speed in which we brought the test to market is we think an important factor for people to look at.

Great.

Thank you.

The next question is from Darren Lehrich from Deutsche Bank.

Thanks.

Good morning, everyone.

A few things here.

Just to circle back here on the volume question, could you just characterize the growth rates that you're seeing between routine and Esoteric in the quarter?

Maybe some broad characterizations there would be helpful.

Sure.

As in the past, the Esoteric business is growing much faster than the routine, and we expect that will continue.

A lot of it is driven by new tests that are introduced and certainly some of the things that Surya talked about in his prepared remarks are driving volume and revenue growth.

And we would expect that that sort of pattern would continue as we go forward.

And the magnitude of that in the third quarter was what?

What would you say roughly the spread is in terms of the growth rates?

Gene based and esoteric tends to grow close to double digits.

While you can see the rest of the business volume wise was a little over 1% or so.

Okay, and if you could just maybe talk a little bit more, I know Surya, you mentioned some of these new test launches that you've had and maybe if you could give us some indication of how important some of these recent ones might be financially, particularly OVA1 how big do you think that test could become, how many tests do you think are out there and then I believe you've got the Septin test coming in the Fourth Quarter.

Could you talk a little bit about the launch and the timing of that?

Okay, first of all, we continue to drive our strategy towards diversification of higher growth and higher margin business, so whether it's H1N1 or whether it is test for Plavix or whether it is Septin 9, or whether it is OVA1.

They're all, you're seeing a pipeline of products.

We're show they are science and innovation, so let me just answer some question about OVA1.

We work very closely with the Vermillion.

This is really a great story how a small Company can work with a relatively large Company and bring in innovations and never give up.

There are 22,000 women that are diagnosed in ovarian cancer and half of them unfortunately die.

But 290,000 people go to the hospital with a pelvic mass.

This is the first test, at least to my knowledge, where the doctor, the physician can really triage what kind of surgeons they're going to send.

For example, if the pelvic mass is malignant, then it has to go to an oncological, gynecologist staff than just got to a gynecologist or a surgeon.

So it is changing the standard of care.

Now, testings are used to find out and triage what kind of doctors now.

It's going to take some time to pick up and it's going to change the standard of care and we're very excited.

We are now actually working with a marketing plan and we're going to launch that test in the Fourth Quarter.

So let me tell you a little bit about the Plavix.

Again, this is a test which is done from saliva, not from blood test.

And again, there's -- so many people are on Plavix.

30% of people it doesn't work because they cannot metabolize this thing.

So now the fact we work with Scripts clinic and they have maybe the standard of care, people can really do this test at home or in the office.

And we expect also Plavix, our test for Plavix is going to be useful and again we don't have the numbers yet.

But we didn't know -- you know that within the next three or four quarters we want to provide you how this is growing.

But just remember no one test is going to really move the needle so it's close enough creating a portfolio test.

Yes, this is Kathleen.

On the Septin 9 test that you questioned about, if you'll recall we licensed the right to develop a molecular based lab test that can help physicians detect colorectal cancer using a patient's blood specimen instead of a stool specimen.

so it's a great innovation.

So we're working on, we're in test development currently, we're working diligently to make the test commercially available.

We're also participating in a clinical study to see the effects of this test in detecting as a screening for colorectal cancer.

So we're making really nice progress on Septin 9 and we're excited about bringing that test to market.

Great.

My last question here is just an update, please, on the India strategy as well as any financial outlook you have with regard to that market and while you're on the topic of India, can you just comment on any other significant developments that we should be looking out for in the other international markets.

Thanks.

Okay, good.

You know as I have said that international is a core strategy for our Company and we made an announcement that 10% of our revenue is going to come from international and we are investing in India.

It does take a little longer than I would have liked but I am very pleased to say that the laboratory is completed.

We have got GAAP, we've got NAV approval, we have made some management changes and now we're in the process of setting up the sales and marketing.

The India market is a $1 billion, but that's actually emerging market and evolving market.

If you think about just the potential of 300 million middle class, it's the same population as the United States, we are expecting to have significant growth in India.

We're going to be there for the long haul and it's going to take some time in international.

So the first thing is we're going to be -- in India, we are going to invest in India.

But with that also we are exploring.

For example our work in Ireland, that model is a little different and it's been very successful.

We don't have bricks and mortars there yet but we are helping, the Irish Department of Health how to reduce the time taken for cervical cancer screening.

And I'm really so excited that the Irish women don't have to wait for nine months to get that PAP Smear study done.

Now it's 10 days so again we will be selective in the international market but we are going to make sure that we are successful where we are whether it's in Mexico or whether it is the UK or whether it is Ireland or India, but it is really part of our main strategy to grow international business.

Bob, is there a financial update on India and the impact?

Nothing significant at this point.

We continue to invest there and I think it's going to be a net investment for a while but that investment is still pretty small, probably in the range of a $0.01 impact to EPS a quarter right now.

Great.

Thanks very much.

Thank you.

The next question is from Kevin Ellich from RBC Capital Markets.

Good morning.

Thanks for taking my questions.

Just kind of wanted to follow-up on the volume questions you guys have had.

Have you seen any changes in the trends as you exited the third quarter and what's your expectations going forward?

Have there been any changes?

Kevin, as I said earlier in September, we saw volume rebound pretty nicely and we are very comfortable with our full year guidance which implies that Q4 revenue growth is going to be in line with Q2 and Q3.

And then can you remind me, does the drugs of abuse testing, the drag that it creates, is that annualized next quarter?

It will probably not annualize until we get into December.

That's really when we saw a drop off last year, so coming out of this year is when we'll see the full impact annualize.

Okay, and then going back to a press release you guys put out in August you guys acquired a lab business from hospital system in Boston.

Can you talk about how that business is looking, what the integration process is looking like and what's the landscape look like for other hospital acquisitions?

Let me make a comment about the landscape and then Bob can talk about the numbers.

What you were seeing now is what we expected whether it is the recession or whether it's a lack of capital but the number of hospitals are now realizing how to monetize their output business.

Once our output business grows a little bigger it doesn't become efficient because you have to put money in logistics and billing.

So here we have an opportunity of the hospital system decided to monetize their outreach business but most importantly, picked us as a partner to help them to implement information technology, healthcare IT, whether it is with their physicians or with the hospitals.

So it's a win-win situation where we can bring [or wire] them the reference studies and they have access to our esoteric laboratories to monetize there.

And if it's an asset and at the same time we become partners in providing [informatics] medical information when they want and where they want.

So I will see this trend is going to grow and certainly, we really like that because we can bring our laboratory testing to the hospital and they can practice medicine.

And Kevin, relative to the integration, it's proceeding as we do with all integrations, we moved with what I'll call deliberate speed and I would expect that towards the end of this year, most of that integration will be done.

It's a relatively small transaction so it's not an overly complex integration but as Surya referred to the connectivity is an important piece of this and we want to make sure that we get that right.

Got it.

Could you guys provide us an update on the payor landscape and your views on reimbursement as we exit 2009?

Well, one of the things that's important to understand is that all of our largest contracts are locked in into 2010 or beyond, so the pricing is really set by the terms of those contracts.

And there is very little business that we have with third party payors that floats with Medicare rates so the fact that we're having a Medicare rate change in January 1, is going to have very little impact on our managed care.

Got it.

Got it.

And then just lastly, we touched on the diagnostic testing relationships and what you guys have available or what you're working on.

What are the areas, where would you like to drive that business?

Diagnostic testing did you say?

Yes.

Sorry.

Well, again going back to -- just talk about cancer diagnostics.

You have 1.5 million people diagnosed with cancer and almost 560,000 people will die and our goal is to make Quest Diagnostics the destination for cancer patients.

And that's why we acquired (inaudible) and that's why we're integrating anatomic pathology with molecule pathology and with the digital pathology.

So when you put all those three things eventually you will do more and more and become the destination for cancer diagnostics for all cancer patients and oncologists so that's number one.

Number two in the short-term obviously the growth is going to come from esoteric and gene based testing but in the medium and long term we're not only looking for international but we are also looking for how the point of care devices can be integrated with IT, and take diagnostics to the patient bedside or to the hospital.

So we are pretty excited about the industry.

We're pretty excited about Quest Diagnostics because we could invest in appropriate product portfolio to grow this Company short-term and long term.

Got it.

Thanks.

The next question is from Tom Gallucci from Lazard Capital.

Good morning, everybody.

Thanks for the color so far.

Looking at the margins I think, Bob, you mentioned that the improvement is due to mix and cost cutting.

Your margin expectations have been coming up throughout the course of the year.

So is one side or the other maybe ahead of what you were expecting?

Well, certainly, I feel as though we're firmly on track with respect to our cost reduction program and the good news about that is that the cost reductions that we're achieving are going to be sustainable.

Because as you've heard me say before, these are a result of taking work out of the system rather than just trying to do more with less.

And a by-product of this as well is building in the culture of continuous improvement.

So in that regard I feel very good about it.

We're tracking exactly where we thought we would be, maybe a little bit ahead at this point, and we feel as though the progress that we've made with this program is going to put us in very good shape going forward to continue reducing our costs and becoming more efficient.

So maybe on that note then how do we think about the longer term, obviously the $500 million has gone very well.

The long term goals is it still sort of 20% EBIT margins eventually?

It absolutely is and it's going to be a combination of us continuing to get more efficient but also driving top line growth.

At the end of the day, we can continue improving efficiencies but we do need to drive top line growth in order to get the margin expansion that we've been talking about.

And certainly, the things that Surya has been discussing, the focus on innovation, the investments we're making today I think has put us in very good shape for the future and put us in a position to actually grow faster than the market over time.

Any time frame for getting to that 20%?

Next several years.

Okay, and then maybe just one more, on the cash flow.

You rated your expectations there pretty nicely.

Can you just remind us how you're thinking about the priorities there and what the acquisition landscape looks like over and above the hospital deal that you did?

Sure.

Well, first let me step back and say our practice continues to deploy all of the cash we've got and utilize the leverage capabilities that we have in a very prudent way to drive shareholder returns.

and the first priority there is to make sure we preserve our credit ratings.

It's important to maintain investment grade credit ratings especially in this environment.

It gives us good access to capital and attractive rates and it also gives us the flexibility to be opportunistic as it relates to growth opportunities.

With that said, while we're continuing to operate within the parameters that preserve that investment grade rating, the first priority has been and will continue to be to invest in growth, whether that be acquisitions, licenses, other opportunities to develop new tests and the like.

That's always the first priority because it creates sustainable shareholder returns.

Secondly, to the degree that we don't have growth opportunities in a particular quarter and we've got the capacity, you'll see us do share repurchases, and that's what we've historically done.

At this point we still have about $150 million left under our current share repurchase program and for the most part we're going to be in the market in most quarters.

As you know repurchasing at least 3 million shares a year to offset the dilution associated with the equity programs that we have here but to the degree we can do more, we will.

And then just the acquisition landscape generally speaking?

Surya talked about Keritas, and the fact that hospitals are looking to monetize assets, I think that's going to continue.

I also think as you think about regional laboratories that in the past may have been owned by private equity and are going to have to do some refinancing over the next several years or so, that refinancing is going to be more difficult so I think that's probably going to create some opportunities also.

And then the other areas that we've talked as elements of our growth, whether it be point of care, business and maybe down the road international as well.

Great.

Thank you.

The next question is from Bill Quirk from Piper Jaffray.

Thanks, good morning.

Quick question here.

We've successfully staved off the lab tax.

Surya, you've addressed it a little bit in your prepared comments, but how do we think about one, the prospects for reform at this point and then two, the pass through if any that we might see from the potential device tax that's being floated?

Yes, hi, Bill this is Kathleen.

As the healthcare reform continues to evolve down in Washington, we continued to believe in the goal of healthcare reform and we think for Quest Diagnostics and the industry we think it will be a net positive.

Expanding access and coverage for patients who are currently today uninsured is a good thing.

The emphasis on prevention and wellness will certainly create a demand for more testing which will certainly benefit us.

And then also, the focus and incentives that they're looking at relative to healthcare IT, we have as you've heard today and previously, we bring to the table a lot of very helpful, healthcare IT solutions that we think will bode very well for us and position us very well.

So we're not going to speculate on the final outcome of healthcare reform but net-net we think it will be a good thing when you offset that with whatever comes from the price reduction perspective and as it relates to the notion of the tax on the devices, we're not going to comment on that, I'm not going to speculate there.

But what I would say with respect to the tax on devices at least for a significant portion of the items that we purchase, we have fixed price contracts in place.

And certainly, as we think about working with our suppliers, we look for ways to help them reduce their costs so that they can help them manage the costs that they will charge to us.

So while I don't know how that's ultimately going to shake out, I think that we'll have some opportunities to mitigate some of that impact.

Understood, and Bob, just to follow-up there.

I assume these are roughly five year rolling contracts so we're looking at something like 20% of vendor contracts coming up each year?

It varies, five years is a long time but we do have multi-year agreements in place with many suppliers.

Very good.

And then actually just to touch on a couple of the balance sheet metrics, continue to see very low carrying of inventory looks like about six and a half days down substantially a couple days or so year-over-year.

How should we think about that going forward?

Are we kind of at a bottoming here?

How should we like I say think about this moving forward?

Well, first of all I wouldn't spend a lot of time focusing on inventory.

It's relatively small asset for us in the scheme of things.

Certainly DSOs are the much bigger opportunity for us, but as you've seen we made good progress with both inventories and DSOs.

And a lot of that has to do with the fact that this year, I think I talked about this on the second quarter call, we've implemented a program whereby we're measuring each of our business units and naturally incenting individuals to manage capital deployed in their business.

Which includes both inventories, DSOs, and our capital spending.

As you noted, as you may have noted our capital spending is actually a little bit below where we were last year and we've actually just reduced our estimate for full year capital spending by about $20 million as a result of this program.

Very good.

Thank you.

The next question is from Amanda Murphy from William Blair.

Hi, good morning, just a couple of questions here.

First just to follow-up on volumes.

It seems like the concern that rising unemployment rates might have a delayed impact on volumes in the back half of the year hasn't really played out.

I'm just curious are you concerned about the end of Cobra subsidies going forward having an impact?

Amanda here is what I would tell you.

As unemployment has ramped up, we've seen our volumes continue to grow.

So while there may be some correlation there's not a significant direct correlation and I think that we'll be able to mitigate much of any potential impact from Cobra dropping off.

We haven't seen a significant change in physician office visits and certainly what's driving a lot of our testing is the fact that there are new tests.

There's increased demand for testing and certainly demographics are going to continue to drive it as people get older they need more testing.

I think that's some of what we're seeing in the underlying results.

Okay, and then on the esoteric side of the business, it seems the an atomic pathology market has become a little more competitive over the past few years as independent labs have entered the market, et cetera.

Would you agree with that and could you just run through how you view Quest in that market and what your specific advantages are?

Yes.

I wouldn't say that it's become more competitive because independents have entered the market.

I think it's more of a case where we've seen some of our customers start to internalize work, the technical component, the professional component, and that's an industry wide phenomenon.

What I would tell you though is as you think about AP, think about it as an important element of the broader market for cancer diagnostics.

And increasingly we're seeing molecular tests ordered in connection with the tissues and the other AP work and that's where when we step back and look at the market that way, we feel very very good about the way we're positioned.

Certainly, we've got the most extensive pathologist network and we believe we've got the most extensive molecular test menu so we feel very very well positioned to grow in cancer diagnostics and APB a very important piece of it.

Okay, thanks very much.

The next question is from Paxton Scott.

Hi, good morning, very nice quarter.

My first question is on the guidance.

I know Q4 last year was particularly weaker due to the economy and you had some non-recurring costs in there related to the workforce reductions.

But can you remind us if there's anything else that we need to be thinking about in terms of Q4?

Particularly given that you've done about I guess $2.91 in EPS year-to-date and your full year guidance implies $0.94 at the high end?

So just want to know if there's anything else we need to be thinking about there as we model that out?

Thanks.

There's nothing specific that you should think about in our Q4 this year.

I would make a statement though relative to last year in that last year's fourth quarter was actually very strong overall.

The volumes were impacted by the drugs of abuse testing business but the underlying business performed extremely well last year from an earnings standpoint and a cash flow standpoint.

Okay, thank you.

And my only other question was on the Medicare clinical lab fee schedule.

First am I correct in saying that about 12% of your revenue is derived from that fee schedule and secondly, based on the CPIU update and the 0.5% additional reduction, is it correct to say that you're facing about a 1.9% reduction for 2010?

Thanks.

Yes.

Paxton, this is Kathleen.

The expected reduction that we're seeing for 2010 on the Medicare fee schedule is 1.9%, so we are looking at that and based on what's currently proposed that's what we're expecting.

The other thing you should note too, is our Medicare revenues are about $1 billion or so with about 85% of them reimbursed under the lab fee schedule and about 15% or so reimbursed under the physician fee schedule.

So your percentage is about right.

Okay so about 12%?

Yes.

Okay, thank you.

The next question is from Shelley Gnall from Goldman Sachs.

Hi, thanks for taking my question.

So, back to H1N1 just for a quick second.

I know it sounds like it wasn't a material impact on volumes but was there an upside on pricing or I should say revenue per acquisition?

Very modest because again the impact on volumes was so small it's not going to move the needle there.

So your revenue per requisition in run rate if you take out the one-time items has actually been getting stronger each quarter this year.

Is that -- I guess what is driving that?

Is it just then a matter of esoteric testing becoming a bigger part of mix or is there something else driving that?

Well, again it's not just esoteric testing but it's the continued utilization across-the-board of various tests.

We're continuing to see an increased number of tests ordered per encounter and a lot of that has to do with new tests that get introduced but also increased demand for things like Vitamin D, et cetera.

So if you were to look at our revenue per acquisition adjusted for the things that we have in the footnote you would see that it's been ramping up slightly but again, it's pretty much test mix driven.

And Shelley, this is Laure.

If you look at our revenue per acquisition in each of the first three quarters it's actually almost exactly flat quarter to quarter, it's relatively flat.

So we've been showing consistently strong growth for each of the quarters.

Yes, that's true.

I'm wondering if you share the number of managed care contracts you've negotiated through 2010?

We have not but again I'll reiterate that the majority of our contracts particularly all of the large ones are negotiated through 2010 or beyond.

Okay, and then just one quick housekeeping.

Understanding that you did share repurchase during the quarter it doesn't seem to be reflected in your share count for the quarter end.

Is there something else that was going on in an issuance during the quarter?

No.

I think you have to look to the timing of those share repurchases and the like but it certainly is reflected in the share count.

And (inaudible) the footnote [six] which talks about the ins and outs of the share count.

Great, thank you.

The next question is from Anthony Vendetti from Maxim Group.

Just a quick question on Vermillion.

I know that's the first test, FDA approved for ovarian cancer.

From what I understand they use five specific biomarkers.

Can that test and you have an exclusive for multi, I forget how many years you said but can that test be used or that technology be used to come up with other specific cancer tests?

Let me just take it.

First of all, as you know, these are multi-analyzed tests and these are algorithms so it takes a longer time.

Now will the process be used for other tests?

I think yes and that's why actually they're working a number of other tests but this is the one which is most promising and they have gone through the FDA approval and we're very excited about it.

And this is Kathleen, Anthony.

Just on the OVA1 test, the FDA clearance we are going to use and promote this test based on the FDA cleared labeling.

So the OVA1 test that we are bringing to market it will use those five biomarkers coupled with the proprietary algorithm.

It will give the numeric indication indicating whether the women's pelvic mass is malignant or not so that's how we're going to market with this test.

But to your point and to echo Surya's comment, we'll continue to work with Vermillion to see what other uses for those biomarkers we may be able to use, or beyond that.

But this is an OVA1, we will promote the test based on the FDA labeling.

So you do have rights to other potential tests or is it exclusive right now just for ovarian?

We have some rights to other tests.

Okay and lastly, can you talk about the pricing on this type of test, obviously it's a high end type test?

I would assume it would be an expensive one.

We are working with the marketing plan and the reimbursement.

It's too early to really make any comment on that.

Okay, great.

Thanks guys.

The next question is from Tom Bundock from RAM Partners.

Yes, hi.

I just had a question on cancer diagnostics just generally.

You're seeing a lot of growth in that area and is the growth primarily volume or is it pricing or a combination?

Can you sort of quantify what is pricing and what is volume?

And can you just give me sort of a range of prices for cancer diagnostics, what is the low end to the high end?

Tom?

This is Bob Hagemann.

What I would tell you is, think of it as volume driven.

Again, these are principally new tests that are getting introduced and in many cases those tests carry higher reimbursement than the average that we've got, so it is helping the revenue per requisition as well.

But in terms of pricing for cancer diagnostics, listen, it runs from a routine Pap Smear which is around 20 some odd dollars to some very high end tests that could be in the hundreds maybe close to $1000.

Okay, thanks a lot.

I appreciate it.

The next question is from Adam Feinstein from Barclays Capital.

Okay, thank you.

Just I know it's late in the call here so a couple of minor questions.

I guess first, how do you guys think about I guess for the fourth quarter, you had the easier volume comps.

So will we indeed see positive volume growth in the fourth quarter?

I know you don't give guidance.

I'm not asking for a point-on number but just in terms of the absolute trend?

You should expect you'll see positive volume.

Okay, great.

And then just as we think about the industry, how would you guys think about the industry growth rate these days?

We've seen the impact on volumes and obviously we have the long term historical trends but in terms of as you think about your market share and what's going on more generally speaking from the industry, how would you think about the industry growth rate and how would you compare your growth rate to that as we think about your market share?

Adam, as we've told you in the past it's very difficult to get a good handle on how the market is growing but we do participate in all aspects of the market, including the drugs of abuse testing business, which is significantly down versus the prior year.

But when you look at our total revenue growth in the 3 to 4% range, we think that we're growing pretty close to what the market is doing right now.

Okay, great and one final question.

You guys have done an absolutely phenomenal job in terms of the efficiencies in the business and just bringing down costs the last couple years, so are we at the full run rate now?

I know you had said by the end of the year what was the (inaudible) $500 million that you had talked about a while back so is that fully in your numbers now or will it not be until the end of the year?

Well, what we've committed to is we're going to have $500 million as we exit this year.

That that's exactly what we're tracking towards and feel very very comfortable with that.

Maybe a little bit better than that, but I'm trying not to give quarterly numbers on that.

Understood, understood, just wanted to get that clarity.

Okay, thank you very much.

Great quarter.

The next question is from Charles Rhyee from Oppenheimer.

Yes, hi.

Just had a quick follow-up, Bob.

I think you touched on it briefly a little bit earlier regarding the insourcing of some of the anatomic pathology work by these larger precision groups and just wanted to get your thoughts and maybe Surya as well.

How should we think about this trend going forward and how much of the impact have you already seen in the market?

And my understanding is that it's being done largely by maybe some of these large urology practices, so what's the ability of this kind of trend shifting maybe over to different specialties as well and maybe what do you think can be done about this?

I know that's a function of how the reimbursement works and clearly that's an issue that needs to be perhaps fixed over time.

But at least over the near term how do you look at this trend and how should we think about it?

Yes, again, I think you have evaluated the situation pretty well.

And as the physicians, especially the urologist and the GI specialists, who wants to internalize or the TCPC, we view the competitive changes and we are dealing with it but we believe that it's the short-term trend rather than the long term.

When you look at cancer diagnostics and look at long term, what is really happening and that's one of the reasons why we acquired (inaudible) it's just not at issue.

An atomic pathology which is morphology and histology is now combined with esoteric testing which is the molecular pathology.

And then the question is how do you really get this information to various people knowing the results were short of a number of specialists.

So we consider the TCPC challenge as short-term.

We are dealing with it.

We see our outpatient AP is growing better than inpatient because of the hospital but we are here for the long term and as I told you, we are investing money to make Quest Diagnostics the destination for cancer patients.

And the other thing Charles, that I'll add is self-referral which is what you've got in this case, and sometimes can lead to overutilization and we're doing what we can to try and educate legislators and the like around that and as you saw a number of years ago with the [Stark] legislation.

There were loopholes that were closed there and I think over time we might be able to address the same thing here.

Thanks for the comments and so any sort of impact that we've seen so far?

Do you think that the impact could increase over time or do you think any impact we've seen in the market is largely sort of the run rate going forward?

That's pretty hard to assess at this point.

There might be some additional pressure to do some more insourcing but as Surya said, over time we don't see this necessarily as something that we think will continue and could possibly end up reversing itself.

Think a little bit like hospitals doing outreach, just like clinical pathologists.

So this is like internalized and this is nothing new to our industry.

When a hospital internalizes esoteric testing, we have to deal with these things and now you have a specialist trying to internalize it and we have to rise above that and that's what we're doing.

Great.

Thanks for the comments.

The last question comes from Gary Taylor from Citigroup.

Hi, good morning.

Two or three questions.

The first is I don't think we explicitly talked about this.

I just wanted to come back to it.

There's a lot of debate in the market on the commercial contracts heading into next year.

How much of those are based on fixed escalators versus CPI based escalators and I think you've been asked before and have said that it's the lower number that's based on CPI.

But could you kind of talk around maybe if we can't have that explicit number what type of difference you might expect in terms of overall commercial pricing 2010 versus '09 or what sort of drag the CPI based component might have?

Gary, here is what I would tell you.

As we've said in the past, very little of our business which is the third party payors floats with Medicare rates and while we may have some CPI adjustments in there in most cases the adjustments that we have are generally fixed rate adjustments and in some cases we don't have adjustments at all.

So I don't think that the inflation number going into 2010 outside of what it does to our Medicare reimbursement is going to have a significant impact on our overall revenue per requisition or our pricing.

And if you look back over the years, frankly, what's driven our improvements in revenue per requisition has not been pure price increases.

It's been test mix and the number of tests ordered per requisition and that I think is going to continue to be a positive impact for us.

Okay, good.

That's helpful.

Second question is I just want to talk about labor costs a little bit and maybe get a sense of the environments helping you.

But first a question on the, the roughly $1.1 billion in cost of services, what percentage of that is labor?

Labor makes up about half of our total cost and it's probably not all that different in cost of services.

Okay, and are you seeing anything different?

I guess what might strike me based on what other companies have told us is maybe the economic environment might be driving say lower turnover in the types of employees that might be drivers and that might be a labor benefit and then maybe actually a deflationary type environment for certain clinical personnel and maybe tech, so could you talk about those two groups and are you seeing any of that?

What I would tell you, Gary, is over the last two years and as I expect going forward, most of the efficiency gains that we achieve are going to be as a result of taking work out of our business and using voluntary attrition to adjust the size of our workforce.

We continue to make as we did last year, provide merit increases to our employees and it's important to make sure that we compensate them appropriately, provide appropriate benefits because we want to make sure that we're attracting and retaining the best that there is.

So we will continue to do that.

That's been our philosophy and I don't see that changing.

Okay.

Finally, on the G&A number which has been a source where you've been able to take some costs out, what's the largest total component of G&A expense?

Would that be where the sales reps are that labor would be in that line?

Well, you have the selling cost in there.

You have bad debt and you have the billing organization.

Those are probably that -- you have the biggest costs within there and in addition you have the overhead and the like that sits in there but the salesforce, the billing organization and bad debt.

So it's really labor again is probably the biggest single component?

Yes.

Absolutely.

Okay, great.

Thank you.

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

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

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