奎斯特診斷 (DGX) 2013 Q2 法說會逐字稿

Welcome to the Quest Diagnostics second-quarter 2013 conference call.

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

The entire contents of the call, including the presentation and a 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 Dan Haemmerle, Executive Director of Investor Relations for Quest Diagnostics.

Go ahead, please.

Thank you and good morning.

I'm here with Steve Rusckowski, our President and Chief Executive Officer.

During this call, we may make forward-looking statements.

Actual results may differ materially from those projected.

Risks and uncertainties that may affect Quest Diagnostics' future results include, but are not limited to, those described in Quest Diagnostics 2012 annual report on Form 10-K and 2013 quarterly reports on Form 10-Q and current reports on Form 8-K.

A copy of our earnings press release is available, and the text of our prepared remarks will be available later today in the investor relations 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's Steve Rusckowski.

Thanks, Dan, and thanks, everyone, for joining us today.

I want to make sure that you have seen our recent announcements, so I want to touch on those briefly.

You have all heard our news announcing our new CFO, Mark Guinan.

Mark will be joining us on July 29.

Bob Hagemann will remain as our CFO until Mark's arrival, and Bob has agreed to provide a smooth transition to Mark.

Again, I'd like to thank Bob for his years of service to Quest Diagnostics.

Given the timing of the transition, we thought it'd be best for Dan and myself to handle today's call.

We look forward to introducing Mark to all of you during the third quarter.

Second, we announced this morning that we have completed the sale of ibrutinib royalty rights for $485 million in cash.

We'll talk more about these later in the call.

So I'd like to take you through the top line performance, share our thoughts on reimbursement and utilization trends as well as healthcare reform, and review progress against our five-point strategy, and then Dan will provide details on the results.

Since January we have been saying that we anticipated continued revenue softness in the first half of this year, and that our efforts to restore growth would result in gradual improvement through the rest of the year.

So as expected, revenues and earnings improved from the first quarter levels but were below the prior year.

We saw continued revenue softness in the second quarter due to lower healthcare utilization, which impacted many healthcare providers as well as reductions in our reimbursement.

There are a number of factors that impacted our year-over-year comparisons.

As you'll hear later from Dan, after considering those factors, our underlying volume was down about 1.5% versus the prior year.

This compares to the first quarter which was down about 2%.

In addition, revenues per requisition decreased 3.7% in the second quarter, primarily due to a combination of Medicare cuts and commercial pricing.

The impact of the acquisition of Concentra's toxicology business, -- contributed approximately 50 basis points of the decrease.

We continue to expect underlying revenue per requisition before acquisitions to be down about 3% for the full year.

I'd like to discuss reimbursement, utilization pressures and the implementation of the Affordable Care Act, which have all been in the news recently.

Well, last week CMS proposed significant changes to the physician fee schedule and a mechanism to adjust the clinical lab fee schedule in the future.

Proposed reductions in Medicare reimbursement did not come as a complete surprise.

We have been saying that there will be continuing pricing pressure on our industry and have been preparing for it.

And this has been one of the driving forces behind our Invigorate cost reduction initiative.

The cuts proposed by Medicare last week could impact the industry and impact us.

Reimbursement from services related to the physician fee schedule for Medicare patients was approximately 3% of our 2012 consolidated revenues.

However, the impact will be greater on smaller, independent and hospital laboratories because they have a larger portion of Medicare business and I am participating with other industry leaders to proactively work with CMS regarding these proposals.

Last fall at investor day we introduced our expectation for annual average reimbursement pressure of 1 to 2% over a three-year period.

We took into account the known Medicare price cuts, sequestration, forecasted commercial payer price changes and potential other government reimbursement changes.

There have also been widespread signs that utilization is softer than last year.

Physician office visits and hospital admissions in the first half of 2013 are below the first half of 2012.

Additionally, payers have cited lower medical costs as a driver of improved performance.

Finally, turning to the Affordable Care Act, it's now seeming likely that the expected entry of the uninsured people into the healthcare systems will ramp up more slowly than initially anticipated.

Less than half of the states are moving forward with Medicaid expansion, which was seen as a major entry point for the uninsured.

In addition, the exchanges are taking longer to develop than originally anticipated.

And then finally, the delay of the employer mandate will see slower implementation of ACA.

We still believe that the Affordable Care Act will be net positive for the industry and for our Company but it'll take longer to see the benefits initially than expected.

But the longer term outlook for this market is attractive for a number of reasons.

The population is aging and growing.

More people will have access to healthcare, advances in genomics and advanced testing will lead to opportunities for personalized medicine.

Data analytics will improve quality and reduce costs, and this industry continues to consolidate.

We have said before that 2013 is a building year, that we are making solid progress executing our five-point strategy, and that we expect stronger performance in the second half.

The improvement in the second half is expected to be driven by easier comparisons, the impact of acquisitions, the benefit of investments we have made to drive growth, the excellent progress we're making with our Invigorate cost reduction initiatives and benefits from share repurchases.

We believe that the progress we have made this year will position us for a stronger 2014 despite the slower implementation of healthcare reform.

Now I would like to share a mid-year update on the progress we have been making executing our five-point business strategy.

So let's start with driving operational excellence.

The Invigorate cost reduction initiative is on track to deliver substantial savings this year.

To date, it has mitigated much of the bottom line impact of revenue softness.

We are currently on track to deliver more than $250 million in realized savings in 2013 versus 2012.

We have shared we expect twice as much in savings in the second half of the year than in the first half.

In addition, we are tracking very well against our goal to deliver $600 million in run rate savings by the end of 2014.

We're taking advantage of our size and scale to improve quality and are committed to our challenge to increase the $600 million goal to $1 billion beyond 2014.

The progress we are making on Invigorate flagship programs gives us confidence in the savings that we have projected.

Last fall we indicated that we had a highly complex organization that was not aligned with the market, and our two highest priorities in the market, driving operational excellence and restoring growth.

This complexity was also inefficient.

We said we had too many management layers and would remove between 400 to 600 management positions, resulting in expected run rate savings of $80 million.

We have essentially completed the elimination of at least three layers from the organization and have reduced approximately 450 Management positions from the Company to date with approximately another 50 reductions to come by the end of the year.

So we are on track to achieve our expected run rate savings goal.

Invigorate initiatives are enabling to us do a better job driving efficiencies in purchasing, centralizing support functions so we can provide better customer service and rationalizing excess capacity in our laboratory network.

We are also standardizing the way we manage data, the way we develop and use common business processes, enable them with enterprise IT systems.

Next, we have taken actions to restore growth.

The near-term focus is on bringing sales and marketing excellence to Quest Diagnostics.

Second is growing our esoteric testing through our disease focus.

And finally, partnering with hospitals and IDNs.

So let's take a look at each of these elements.

While the reorganization of our sales force is complete, we have a different and simpler organization headed by new leaders.

We have more sales people who are better trained, better equipped, incented and more focused on calling on customers than before.

We continue to make progress with our health plan relationships, and I am pleased that we have extended our relationship with Cigna and look forward to a continued strong partnership with an innovative partner.

We have also signed agreements with a number of payers for diagnostic services offered on the new health insurance exchanges that are an important part of healthcare reform.

We're improving the way we introduce new esoteric diagnostic information services, are developing new service offerings linked to our new disease focused clinical franchises.

We have invested in building seven clinical franchises organized by specialty disease state with each led by its own general manager.

We believe this is more thoughtful and will bring better solutions to the market that will generate additional growth.

To give you an example, our new women's health clinical franchise established our new strategic relationship with Hologic which provides us an opportunity to ignite new business opportunities with a leader in women's health.

This collaboration will focus primarily on cervical cancer and breast cancer.

In addition, following the landmark Supreme Court decision on BRCA 1 and 2, we're working to introduce a solution for breast cancer pre-disposition testing later this year.

And then finally, our hospital professional services team continues to see interest building from integrated delivery networks.

We have increased activity at all phases of the pipeline, from initial discussions to sharing data to diligence and contracting.

All these factors give us confidence we will see results from our efforts build throughout the remainder of the year.

Our third strategy is to simplify the organization.

We have deployed our new organization, shared corporate priorities, established new behaviors and are implementing a new management process with rewards and incentives.

With our new organization, we now have a new Senior Management team comprised of executives from the Company when they joined in addition to the five new members since last year.

These individuals all come from senior positions at major publicly traded companies and bring significant leadership experience.

Notably, we have just announced our new Chief Financial Officer, Mark Guinan.

He comes to us with strong financial operational experience, and we look forward to him joining us later this month.

I'm confident that this new Senior Management team will instill the behaviors that we're looking for throughout the Company.

Our fourth strategy is to refocus on the core Diagnostic Information Service business.

Last year, we sold OralDNAs dental diagnostic business.

During the first half, we sold HemoCue and began the process to evaluate the Celera drug assets and Celera's products business.

We are pleased to complete today the sale of ibrutinib royalty rights to Royalty Pharma for $485 billion in cash.

We continue to hold royalty rights for assets licensed to Pharmacyclics and Merck.

Our portfolio review is resulting in asset sales that are providing additional flexibility for our fifth strategy, which is delivering disciplined capital deployment.

Our plan is to return the majority of our free cash flow to our shareholders in the form of dividends and share repurchases.

The sale of HemoCue provided proceeds that helped us repurchase $405 million of shares in the second quarter, bringing year to date share repurchases to $467 million.

We plan to use the after-tax proceeds from the sale of ibrutinib royalty rights to drive shareholder value consistent with our capital deployment strategy.

In addition, we completed the acquisitions of the lab outreach business at Dignity Health and Concentra's toxicology business, consistent with our goal of contributing 1% to 2% revenue growth per year through strategically aligned accretive acquisitions.

Well, despite the difficult operating environment, this progress gives us confidence that we are making the appropriate investments -- improvements needed and that we will see the benefits build throughout the remainder of this year and thereafter.

Now let's turn it over to Dan, and he will go through the detailed analysis of the numbers.

Dan.

Thanks, Steve.

Starting with revenues, Q2 consolidated revenues of $1.8 billion were 3.3% below the prior year but 1.6% better than Q1 2013.

Our Diagnostic Information Services revenues, which account for over 90% of total revenues, were 3.6% below the prior year.

Volume was essentially flat, 0.1% better than a year ago.

The three acquisitions completed this year, UMass, Dignity Health and Concentra's toxicology business, contributed approximately 1.6% in the quarter to volumes and are all on track versus our growth plan.

The contribution from acquisitions was essentially offset by softness in our underlying volumes of approximately 1.5%.

While underlying volumes were softer than a year ago, they're approximately 0.5% better than what we experienced in Q1 of this year.

As we have shared previously, we expected to see continued volume softness in the first half of the year with improvement in the second half due to more favorable year-over-year comparisons and building momentum on our efforts to restore growth.

Revenue per requisition in Q2 was down 3.7% compared to the prior year.

The impact of our two recent acquisitions, principally Concentra's toxicology business, lowered revenue per requisition by approximately 0.5%.

Excluding the impact of these acquisitions, our underlying revenue per requisition was lower than the prior year by approximately 3.2%.

This 3.2% reduction in underlying revenue per requisition is largely due to the Medicare fee schedule reductions, including pathology reductions that went into effect on January 1, plus the 2% Medicare sequestration reductions implemented on April 1, as well as certain commercial fee schedule changes.

Consistent with the first quarter, positive test mix is essentially being offset by business mix.

We shared previously we continue to expect that for the full year, the underlying reimbursement decline will average about 3% with about 1% of the year-over-year impact we saw in the first half of the year expected to anniversary later in the year.

And over the next several years, we continue to plan for average annual reimbursement pressure of 1% to 2% through 2015.

Q2 revenues in our Diagnostics Solutions businesses, which include risk assessment, clinical trials, healthcare IT and our remaining products businesses, were flat compared to the prior year.

This is a sequential improvement from the first quarter performance that was down about 2% compared to prior year.

Adjusted operating income was 16.9% of revenues, about 1.7% below the prior year, with the decrease principally due to lower revenues.

A significant portion of the lower revenue is being offset by continued progress with our Invigorate initiative.

Adjusted EPS of $1.06 was $0.09 below the prior year with a decrease principally due to lower revenues partially offset with cost savings realized from Invigorate.

As a result of the Company's ongoing efforts to drive operational excellence and simplify the organization, restructuring and integration costs totaling $19 million reduced reported operating income as a percentage of revenues by 1% and reported EPS by $0.07.

Last year, the second quarter included $15 million of costs associated with restructuring, integration and CEO succession which reduced reported operating income as a percentage of revenues by 0.9% and reported EPS by $0.06.

Bad debt expense as a percentage of revenues was 3.7%, or 20 basis points higher than the prior year.

DSOs were 48 days, up 2 days from last quarter.

The increase in DSOs can be principally related to payment delays in connection with obtaining new provider numbers associated with recent acquisitions.

We expect these issues to be resolved later this year.

Cash from operations was $208 million in the quarter compared to $251 million in the prior year.

Lower cash from operations is largely due to the increase in DSOs which we expect to reverse in the second half of the year.

Capital expenditures were $56 million in the quarter compared to $47 million a year ago.

During the quarter, we also repurchased 7.2 million common shares at a price of $55.92, for a total of $405 million.

As expected, we deployed the proceeds received from the HemoCue disposition to share repurchases in the second quarter.

Turning to guidance, we continue to expect results from continuing operations before special items as follows.

Revenues to be 1% to 2% below 2012.

Prior guidance was to approximate the prior-year level.

Earnings per diluted share to be between $4.35 and $4.50 compared with prior guidance of $4.35 to $4.55.

Cash provided by operations to approach $1 billion compared to prior guidance that it would approximate $1 billion.

And capital expenditures to approximate $250 million.

In considering the full-year guidance in the context of the first half performance, it is important to keep in mind several factors.

As we've previously indicated, the comps versus the prior year will become more favorable in the second half of the year.

And while the number of business days coupled with the weather affect adversely impacted revenues in the first half of the year, those same factors are expected to contribute favorable year-over-year comparisons in the second half of the year and be essentially neutral for the full year.

Underlying revenue per requisition, which was down approximately 3.3% in the first half versus the prior year, is expected to be down about 3% for the full year with about 1% of the impact we saw in the first half to anniversary later this year.

Our three acquisitions contributed approximately 1% to revenues in the first half of the year, and we expect those acquisitions to contribute approximately 2% in the second half of the year.

Our efforts to restore growth are gaining traction, and we expect to see increasing progress as the year unfolds.

We saw a 0.5% improvement in year-over-year underlying volumes from Q1 to Q2 and expect it to continue to improve in the second half.

And lastly, as Steve mentioned, we expect to see approximately twice the benefit from Invigorate in the second half as we saw in the first half.

For all these reasons, we have confidence in the expected performance improvement during the remainder of the year required to achieve our full-year guidance.

Now I'll turn it back to Steve.

Thanks, Dan.

Well, to summarize, we see 2013 as a building year as we improve operations and begin to restore growth.

We are executing well on each element in our five-point strategy.

The second half of 2013 will show improvements for many reasons, which we just discussed.

And we continue to have confidence that executing our five-point strategy will drive increased value for our shareholders over the long term.

Now with that, we'd like to see if you have any questions.

Operator?

(Operator Instructions)

Tom Gallucci, Lazard Capital Markets.

Thanks for all the details.

A few quick ones, good morning.

A few quick questions, if I could.

First on the volumes, I think, Dan, you mentioned maybe 0.5% improvement from Q1 to Q2.

I wanted to make sure we understood is there any calendar impact there that also might have helped that trend a little in terms of Leap Day in first quarter or shifting of holiday or things like that?

There's really not a material change in the calendar.

Most of the benefit that we expect to see from the differences in how we evaluate revenue days or business days comes in the back half of the year so no real impact in the second quarter.

Okay, good.

And then as you're thinking about the ramp on the core volume as you put it, in the second half, I mean you describe a lot, Steve of the things you've been doing on the sales force front.

Can you help us understand the visibility on some of the specifics in terms of targeted clients or targeted market share that you expect to gain or where some of that is going to come from, or do you have that sort of visibility on the ramp that you're expecting?

Absolutely.

Well Tom, let's do this, let's walk through.

Dan will walk through why we expect the second half to be stronger than the first half.

And then what are, within that discussion, our expectations for let's describe it as organic improvement in the second half versus the first half.

So Dan, why don't you walk through a bridge, if you will, between the first half and the second half.

Yes and maybe a way to think about it is if we look at the second half performance and you look at our outlook for the remainder of the year, you're looking at a range plus or minus of about 2% revenue growth in the back half of the year.

If you break down the components the way we're looking at it, we think about revenue per requisition, we said it was down about a little more than 3%, about 3.3% in the first half of the year.

It'll improve by about 1 point in the second half.

So we expect to see revenue per requisition lower than the prior year by about 2.5%, okay, and that'll get us to our full-year average of 3%.

So about 2.5% down on revenue per requisition.

We've done three different acquisitions.

We've also got the benefit of the revenue days as well as the weather impact that we expect to see turn favorable in the back half of the year due to Sandy in Q4 of last year.

And if you put the acquisitions and those easier comps together, that's worth about 3.5%, maybe a little bit more than 3.5%.

So that leaves about 1 point of growth from our underlying businesses.

And as we look at it, we are building momentum in the underlying businesses, both our Diagnostic Information Services business, through our restore growth initiatives, as well as our Diagnostic Solutions business, which is also building momentum and expected to provide a positive contribution for the full year.

So about 1 point will come from our underlying business and a combination of both Diagnostic Information Services and Diagnostic Solutions.

Great, Dan.

So Tom, to answer your question, given that as the opportunity that we really need to improve, we do have great line of sight to what we need to get done in the second half.

Let me give you a couple examples.

First of all, we are building our professional services business that I mentioned in my introductory comments.

That is building momentum.

There's a lot of interest in it, and we will see some volume from that in the second half versus the first half, number one.

Second, is we have line of sight to a number of accounts, a number of programs we're working with payers that our sales force is driving, and we have confidence, given the traction we've seen in the second quarter that will continue into the third quarter and the fourth quarter.

Dan also mentioned is we are going to see growth in the second half versus the first half from our Diagnostic Solutions business.

So without giving you all the detail, we do have good line of sight of what we need to do to deliver our guidance for the full year and the second half on the top line.

And then as far as the bottom line, we also believe that we have good line of sight given the current environment that, as indicated in my introductory comments, to be able to deliver guidance for earnings for the year as well.

So we can turn it back for any other questions.

Yes that's very helpful.

Just to make sure I understand the change in the revenue guidance, is that 1% growth that you're expecting from the core similar to what it was before and the reduction overall is just from a macro standpoint, or has that 1% core number changed in your minds as well?

Yes, it's slightly lower, Tom.

Basically the environment we see right now is not a strong as what we thought we were going to see this year.

As we entered Q2, we were actually encouraged by April numbers.

As we got further into Q2, we started to see more reports back from various sources about softening in the marketplace.

We saw that ourselves in the second quarter.

And so therefore, we thought it'd be prudent going forward that we take that in consideration with our full-year guidance, and that's reflected in what we expect to get organically out of the business.

But overall the environment is softer than we expected entering the year, and we thought it'd be appropriate at this point of the year to adjust our guidance for the top line.

However, what you also hear in remarks, we are moving very, very well against our cost improvement goals.

We're making excellent progress with Invigorate, and so what we have also said is we will balance that off with strong contributions through Invigorate in the second half.

We've also indicated in June, we are reinforcing it today, is that we expect twice as much contribution from Invigorate in the second half than we saw in the first half.

Right, right.

Last question then on cash, it sounded like some of the cash flow issues that you saw in the quarter you expect to reverse out as you get the provider numbers nailed down.

You did slightly tweak, it seems like, your cash flow expectations though for the year, down a little bit.

So wanted to make sure we could understand that.

Thanks a lot.

Sure, sure.

Why don't you bring Tom through what happened with DSOs and overall cash expectations.

Yes and two comments.

One, Tom, back to the last question quickly, that approximately 1% I was giving you in that [walk] plus is a mid -- gets you to the midpoint of the range.

So a point of clarification there.

And then secondly is on the DSOs, DSOs were a little bit higher.

They were about two days higher in the second quarter compared to the first quarter, and with many acquisitions you have to file for a new provider number for certain payers.

We're filing with certain government payers right now, and we have a little bit of a delay in getting some of those provider numbers for those acquisitions.

So as a result we have some claims that we're confident we'll get reimbursed once we get those provider numbers in, and we expect that to get cleaned up in the second half.

Right, no that's -- I understood that.

I was curious though, it seemed like your old guidance was for about $1 billion of cash flow, now you're approaching $1 billion of cash.

So maybe it's a small nuance, but if that -- if the provider number issue reverses itself out, what's the reasoning for cash flow that's a little lower for the year?

Yes, and so the change in the cash flow for the full year is really just reflected in bringing down the top end of our EPS range a little bit.

And also, as we look at cash flow and managing our balance sheet, we felt that we wanted to give clearer guidance that we were going to be approaching $1 billion, the higher end of the range of approximately probably not going to go much further north of that, but approaching $1 billion we felt more comfortable with.

Okay, thank you.

Kevin Ellich, Piper Jaffray.

Going back to the pricing decrease that we've seen, you said the underlying pricing was negative 3.2%, a lot of it due to Medicare.

Wondering if you could break out how much pressure you're seeing from the commercial payers?

Sure.

So let's walk through exactly what's going on with pricing again.

We provided guidance that we would expect this year about 3%.

What we saw in Q2 was in line with that expectation, and Dan will bring you through exactly how this is phasing throughout the year, which is important.

And as you know, Kevin, it is a mix between our Medicare and our commercial payers, and some of this does anniversary throughout the year, and that's what we reflected in our second half expectations as well.

So, Dan, walk him through where we come up with the numbers.

In terms of the pricing, Kevin, there are three primary drivers of the reimbursement reductions.

One is the Medicare cuts that we I think all anticipated coming into the year, that included the middle-class tax relief act, as well as the ACA changes.

And then thirdly, we also included in that number an estimate for sequestration.

We planned for it to take place.

And if you put those components together, that's worth about 5% against our Medicare book of business, okay.

Our Medicare book of business is about a little bit north of $1 billion, approximately $1 billion in total.

So 5% off of that number is the first element.

The second element is the anatomic pathology cuts.

Again, another set of cuts from Medicare.

Specifically on a handful of codes, specifically 8305, which enjoyed the 52% reduction on the technical component.

And then the third component is really related to the commercial contracts with commercial payers.

Some of those contracts changes took place late last year, and there were some contracts that showed pricing reductions January 1 of this year, okay.

So as you think about it, the majority of the Medicare cuts took place on January 1 and will carry through the entire year.

One element of the Medicare cuts, the sequestration cut, went into effect April 1. And then the commercial payer cuts, we have some that have started on January 1, some that started late last year and will anniversary later in the year and will show that point of improvement for us.

Got it.

Do you expect to see -- once you annualize and anniversary the commercial pricing pressures, do you expect to see further pressure from the managed share payers, or do you think we're at a point where we could start to see some improvements actually?

Yes, so Kevin what we said back last fall in our investor day that we expected a 1% to 2% erosion in our price related to pricing pressure.

We also have said that we expect 3% in 2013, but we're still believing that the 1% to 2% guidance for that three-year period is a good range.

That will absorb what we knew already from the government side.

Also, we have less contract negotiations in 2014 than we did in 2013, and we think that estimate is still reasonable, where we sit right now.

Understood, okay.

And then going to the proposed Medicare fee schedule and the comment that they might look at repricing the clinical at fee schedule down the road, wondering what efforts are being made in Washington to mitigate some of these potential cuts.

And let's say it were to go through, Steve, what could you do internally to offset some of these pressures?

Well, continuing to do what we're doing.

First of all, we are working with our trade association, ACLA, proactively on this.

We actually met this week on it and are meeting weekly to talk through this with CMS.

And so all the leaders of ACLA are part of this effort.

As we said, at least on the physician fee schedule, it will have an impact on the industry and us to a lesser extent, because we have less Medicare business as a percentage of our total business than some of the other providers of our service in the marketplace.

Second is, we did anticipate, Kevin, that they'd refer the cuts, I said in this my introductory remarks, we actually assumed some further cuts in our 1% to 2%, just to be prudent.

So we had planned for this, and we -- because of it, have been really putting the accelerator down on Invigorate.

And would you should see and what we've talked about, we will see more in the second half, is continued progress on the efficiencies that we're gaining throughout our organization.

We'll see twice as much improvement from Invigorate in the second half than we've seen in the first half.

We are feeling very comfortable with our goal to get to $600 million in run rate savings by 2014.

And we're still pushing the organization to get to $1 billion at some point after 2014.

So we believe that what we're hearing is something that we somewhat expected within reason.

We don't know the details.

We obviously want to make sure that we carefully walk through the best outcome with the industry leadership that gets the best place for us.

But what we're doing about it is exactly when we have said before, we're executing our five-point strategy and we're driving as much efficiency gain as soon as possible out of our business to be able to absorb that and deliver our expectations for 2014 and beyond.

So we're working on the plan as we've shared before.

Okay and then two last quick questions here.

Bad debt, we did see that 20 basis point increase on a year over year basis.

Wondering if there's anything unusual going on behind that?

And then lastly, on the capital deployment and the $300 million after tax that you'll get from ibrutinib, do you plan to allocate that equally between acquisitions and share repurchases, or maybe you see a dividend increase?

So, Dan, let's take the -- on the bad debt question.

Yes, on the bad debt, it's slightly higher.

It's about 20 basis points higher, and from one quarter to the next, 10 to 20 basis points is really in the range of normal fluctuation for our business.

So we don't see it as a signal and don't see it as signaling a different trend at this point.

Okay.

And as far as the proceeds from ibrutinib, we're going to continue to do what we said.

That is, we're going to return the majority of our free cash flow to our shareholders, and we're going to continue to act on our disciplined capital deployment strategy that we have in place.

And the return that we've given to our shareholders have been in the form of dividends and share repurchases, and that's what we expect to do going forward.

We still have some time to complete the ASR that we put in place this spring.

We'll work through that, and then we'll cross that bridge when we get to it.

But we're standing behind our commitment of what we said and we're standing behind our strategy of disciplined capital deployment as we go forward.

Got it.

Thanks, guys.

Ricky Goldwasser, Morgan Stanley.

First of all one clarification.

Does the '13 guidance include the deployment of the cash from the sale of the royalty that you announced today?

Dan.

Yes, the cash from the proceeds we will use it at some point.

Whether or not we use it for -- we will use it in one way or another, consistent with our capital deployment strategy, but we don't see it having a meaningful impact in the back half of the year.

Okay, okay.

And then -- thank you very much for all the transparency and all the detailed comments.

Glad you find it useful.

It's very useful.

So one more clarification on the pricing side.

So when you think about your expectations for next year, longer term, for pricing to come down by negative 1% to 2%, if we factor in the proposal in the physician fee schedule, I think that accounts for about 75 basis points, based on our rough estimates.

So can you help us to better understand what are your assumptions heading into the clinical fee schedule, I think that's coming out in August, for potential rate cuts?

Understood.

So let's walk through this again.

In our estimate last fall was 1% to 2% over a three-year period.

More in 2013, less thereafter.

We assumed in that what we knew about government reimbursement, and I mentioned in my comments is that the physician fee schedule represented about 3% of our revenue in 2012.

And Dan, why don't you bring through how this is going to wash through what our assumptions are so far.

So as we've looked at this, Ricky, and there's a number of moving pieces to the latest proposal that we're still working our way through, and we continue to work with the trade association to better understand it, but as Steve mentioned, the physician fee schedule is about 3% of our 2012 annual revenues.

That number is coming down a little bit in 2013.

It's probably running closer to 2% number as the Medicare cuts on the pathology codes were implemented January 1. So that's having a drag on that number.

And we also have seen the carry over impact to some of the pathology insourcing that occurred late last year into this year that brings that number down closer to a 2% zone for the 2013 percent of revenues for the physician fee schedule.

So we -- as we've said, we still are evaluating it.

We're trying to understand it.

We have some follow-up questions on the current proposal, and when we have some more detail on that, we will share it.

And with respect to the clinical lab fee schedule question, we have contemplated government pressure in the long term 1% to 2% guidance.

In terms of splitting out our projections and our thought process beyond what we've already shared, we're not planning to do that today, not prepared to do that today.

Yes and the other comment I'll make is the 26% that we've seen is an average.

That average we're going through it to understand what the real impact will be on us.

Based upon our mix, we think will be less than that 26%.

And so what you see is 2% of our business today, something less than what was indicated as the average, you do the math and that you can see what the impact will be for us in 2014.

As far as the clinical schedule, that is more uncertain.

We're proactively working with the trade association to understand the intentions of CMS, what the time frame is, what the logic is.

The mechanism that was discussed was a mechanism around technology and with technology it makes us more efficient.

And a large portion of our value chain, yes is running a large centralized efficient laboratories, but a large percentage of our value is the beginning of that process and the end of that process.

And so we still have a lot of our cost structure that wasn't necessarily affected by some of the technology that we're referring to.

So we're working through this one and has more question marks associated with it.

But we believe, again, based upon what we know today, based upon what we already knew going into this year with the government reimbursement changes, what we just have heard, what we see in our forecast for renegotiations with commercial players, that we'll still stay within that envelope of 1% to 2% over that three-year period that we indicated earlier.

So that's where we are today.

Okay and to help us understand, what percent of the managed care commercial book is tied to this Medicare book?

We have hundreds of managed care contracts, as we've said in the past, and we have very few that are tied to or float with Medicare rates.

Okay.

Thank you.

Dane Leone, Macquarie.

I'll leave it at one since the call is dragging on a bit.

I think one question that really could use some vetting here is the competitive landscape.

There is a smaller, I guess, national lab at this point that is public that has grown rapidly, has increased its revenue base, is centered in the northeast but is expanding nationally, and it -- when you look at the growth rates between yourself, LabCorp, and the other lab, Bio-Reference, there does seem to be some underlying share shift, some share loss.

And I guess the question here is, is that something you're seeing?

Is there a mitigation of loss strategy that you're looking to do as the new Management team here?

And really any detail about competitive offerings would be very helpful.

I appreciate that.

First of all, if you recall, in our investor day in the fall, we shared our expectations for the market.

We think this market has grown in the past, and we actually believe this market will grow going forward.

Even though we have some slowdown in utilization, we do believe that the Affordable Care Act would be a net positive for this industry and for us.

And we do believe that this market, given what I said earlier, would grow around 4%.

What I also said back in the fall is we haven't grown with the market, and therefore, we have lost share, and that therefore, we needed to do something about it.

And one of our points of our five-point strategy is to restore growth.

And so what I shared with you in my update is what we're doing to improve our performance of getting at the market and doing a better job in the competitive sense of the marketplace.

And we have three areas of priorities for this year.

First is related to our sales force.

So what we have done is reorganized our sales force.

We have put in place a better sales team than before.

We have trained those people, have equipped those people, aligned those people, and those people are very, very engaged on calling on customers every day.

So point number one is I believe that what we have in place today is better execution going at the marketplace from a sales perspective.

So that's the first point.

Second, is we believe that some of our competitors have done a better job of introducing innovative products to the marketplace.

We have changed our organization to align around the need for us to bring our innovation to the marketplace in a smarter way, a more thoughtful way, of what we've done to affect that in our reorganization has created a clinical franchise organization.

We have seven clinical franchises, each of which have a general manager.

And the example I gave you in my script is one example of that is in women's health.

That effort in women's health led to our relationship with Hologic, and that will position us well in the whole field of women's health and allow us to introduce sometime this year a solution around BRCA 1 and BRCA 2.

So introduction of solutions in the marketplace that are specific to patient problems aligned around disease and specialty is a second area of investment we are making and that we believe we'll see some of that benefit in the second half.

And I believe some of our competitors in this marketplace, not just the large players, but some of the niche players, have done a better job in the past.

And we learned from that, and we actually will respond to that with our clinical franchise organization and bringing more solutions to the market.

Third is this market is changing.

Integrated delivery networks are stronger than ever before, where there are acquisitions of physicians.

We've created a brand-new organization that we call our professional services organization.

They partnered with integrated delivery networks to understand what we continue to do with many of those around reference testing, which is the ace, if you will, if our relationships are with those organizations.

Actually, a fact, if you look at the top 100 hospitals ranked by US News and World Report, we actually do business, reference business, for about 90% of those top hospitals.

And so with those strong relationships, we are very engaged in discussions around what we need to do with laboratory management relationships or what we potentially do if they want to by taking on their outreach business.

And the examples of Dignity Health and UMass are great examples of that.

So we're building that.

So those three initiatives this year have been our focus.

Those three initiatives have been our investments that we have made this year, and we feel, with our focus there, that allow us to make progress this year.

We have said going into this year that this year is a building year.

We believe this is an attractive market, but we need to do much better as an organization executing in that market.

And we believe we've made excellent progress in the first half, and we believe we'll see some of that in the second half, gradual improvement.

Now the other side of this is we talk a lot about operational excellence and what we're getting out of that in that terms of the efficiency.

Let me also say that we're focused on making sure we provide a superior customer experience through our customers every day.

So along with the efficiency gains in that program, we're also very focused on the whole value chain of what we're doing, our patient services centers, what we're doing with our responsiveness and our quality of our laboratories and what we're doing to improve our building capability.

So along with the efficiencies we are getting out of that program, we also expect to get improvements in our quality and our execution around superior customer experience.

So we believe we've made very good progress in the first half.

That progress will allow us to achieve what we just shared with you in second half where we'll see some of the results in the second half from all these efforts so far.

So hopefully that provides some more clarity.

Great, thank you very much.

Isaac Ro, Goldman Sachs.

Want to clarify on that earlier question regarding market share, should we assume that your guidance does imply a little bit of share gain in the back half of the year?

And if so, can you maybe quantify that in the context of the bridge that Dan went through earlier?

Yes, not sure you could apply that.

First of all, there was a question asked whether we had good line of sight of what we need to do to deliver our guidance.

We believe we do, and we believe the expectation for the second half is reasonable given what we already know about what we'll get out of acquisitions, what we'll see with our price changes, and also what's going to happen with the comparison versus the prior year.

So we have good line of sight.

Now what we also have, Isaac, is with this line of sight, we're going to see some of the benefits of the investments we have made in the first half with the sales force, with new solutions in the marketplace and also with our professional services business.

That will get to us our guidance.

When the dust settles in 2013, we'll be able to evaluate whether, in fact we stayed with the market or we actually gained some share.

We don't know that yet but we're focused on executing our plan and focused on executing.

And we think the guidance we've provided is reasonable based upon what we know and what we're doing.

Helpful.

And then as a follow up, on your point earlier about some of the cost savings initiatives that are going on, is it fair to say that we should see a sequential improvement in EBIT margins in the back half of the year, or is there a seasonality element here you want to keep in mind?

Yes, so what we've shared in June is we expect twice as much of the contribution from Invigorate than we saw in the first half.

What we shared with you today is we said the realized improvement versus 2012 is $250 million.

So you can go through the math.

And when you go through that, you'll be able to see what in fact we do expect in the second half.

And Dan, would you like to add to that?

No, I think that's right.

You've got $250 million realized in the -- it's more than $250 million realized in the current year, and we expect to see twice as much savings in the back half of the year as the first half.

So as you run through that we're not giving specific EBIT or operating income percentage guidance or anything like that, but you should see some improvement in the back half of the year.

Got it.

One last cleanup here on the ibrutinib monetization.

It sounded like you guys were leaning towards using the vast majority of that for return to shareholders, is it possible that some reasonable percentage might be used for strategic use as well?

Again, we will return the majority of our free cash flow to our shareholders.

We have a disciplined capital deployment plan and strategy.

We're standing behind that.

We'll approach this proceed with that in mind.

We believe that one way that we can continue to return the majority of free cash flow to our shareholders will be from our dividend as also share repurchases.

But also to your question, we are continuing to look for acquisitions that support our goal in that regard related to getting to 1% to 2% revenue growth from acquisitions.

I'm also pleased to say that we've got there in the second half.

We see that we're looking year on year at 2% improvement in our top line related to the acquisitions we've done so far.

We're continuing to work on those, and so therefore, there might be some portion of our capital that's used for those in the second half as well, can't speculate on that at this point.

But we're staying the course with our five-point strategy and deliver disciplined capital deployment in the back half as we've done so far.

Got it.

Okay, thanks a bunch.

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 website at www.questdiagnostics.com.

A replay of the call may be accessed on-line at www.questdiagnostics.com/investor or by phone at 800-856-2254 for domestic callers, or 402-280-9961 for international callers.

Telephone replays will be available from 10.30 AM Eastern time on July 18 until midnight Eastern time on August 16, 2013.

Good-bye.