Quest Diagnostics Incorporated
Q2 2008 Earnings Call Transcript

Published: 23 Jul 2008

[Operator:]

Welcome to the Quest Diagnostics Second Quarter 2008 Conference Call. At the request of the company, this call is being recorded. The entire contents of this call, including the presentation and question and answer session that will follow are copyrighted property of Quest Diagnostics with all rights reserved. Any redistribution, retransmission, or rebroadcast of this call, in any form without the expressed 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.

[Laure Park:]

Thank you and good morning. I am here with Surya Mohapatra, our Chairman and Chief Executive Officer and Bob Hagemann our Chief Financial Officer. Some of our commentary and answers to questions may contain forward-looking statements. You're cautioned not to place undue reliance on forward-looking statements, which speaks only as of the date they are made and which reflects management's current estimates, projections, expectations or beliefs and which involves risks and uncertainties, that could cause actual results and outcomes to be materially different. Risks and uncertainties that may affect the future results of the company include, but are not limited to adverse results from pending or future government investigations, lawsuits, or private actions; the competitive environment, changes in government regulation, changing relationship with customers, payers, suppliers and strategic partners and other factors described in the Quest Diagnostics 2007 Form 10-K, 2008 quarterly reports on Form 10-Q, and current reports on Form 8-K. A copy of our earning's press release is available and the text of our prepared remarks will be available later this morning in the quarterly updates section of our website at www.questdiagnostics.com. A downloadable spreadsheet with our results and supplemental analysis is also available on the website. Now, here is Surya Mohapatra.

[Surya N. Mohapatra:]

Thank you, Laure. We've delivered another strong quarter and I am pleased with our progress. Our business is performing well, executing our plans has enabled us to deliver double-digit top and bottom-line growth. Revenues grew 12% to $1.8 billion, earnings per share increased 14%, cash flow improved to $213 million, volume increased by 5%. And we exercise strong cost discipline which contributed to our margin improvement and positions us well to respond to changing economic conditions. After we hear from Bob, I will share details of our progress. Bob?

[Robert Hagemann:]

Thanks Surya. As you heard we reported another strong quarter and are firmly on track to meet the goals we established for the year. As I take you through results, I'll highlight a number of key initiatives and our progress in each area. Before I do, a quick comment regarding NID; we are continuing our discussion with the government to attempt to settle this matter. We have made no adjustments to our reserve and have no further updates to share with you. Now, let's turn to the results for the second quarter. Revenues were $1.8 billion, 12% above the prior year, with AmeriPath contributing about 8% growth. Revenues for our clinical testing business, which account for about 90% of our total revenues, were 12.4% above the prior year, and about 4% above without AmeriPath. Volume was 4.9% above the prior year and about 1% above the prior year before the AmeriPath acquisition. Over the last three quarters, we have consistently seen growth in our underlying volume of between 1% and 2%. This is despite a significant decline, almost 10% in pre-employment drug testing, which accounts for about 7% of our total volume. Given that this tends to be very low-priced business, the impact to revenue and profitability is generally much less. Our employer business which is predominantly pre-employment drug testing and our risk assessment business, which serves life insurers, are our two businesses most subject to a slowing economy. Yet the profits for both businesses are above the prior year level due to aggressive actions we have taken to manage their costs. These businesses combined account for less than 10% of our total revenues and we do not expect their performance to alter our consolidated revenue or earnings expectations for the year. Revenue per acquisition increased 7.1% with 4.5% of the increase due to AmeriPath. The balance of the increase in revenue per acquisition about 2.5% continues to be primarily driven by a positive mix, partially offset by price reductions on various health plan contracts. And is consistent with what we saw in the first quarter. As we previously indicated, all of our all of our largest health plan contracts have now been renegotiated for multi-year periods, and we believe there is much more stability in pricing than a year ago. And lastly, on the topic of revenue growth we saw strong double-digit growth in our point-of-care and healthcare IT businesses in the quarter. You'll hear more from Surya on the point-of-care business. Included in footnote four to the earnings release is a table, which summarizes the impact of various revenue measures, for a number of the items discussed. Operating income as a percentage of revenues was 16.8% for the second quarter and reflects continued improvement from both the prior year and this year's first quarter, principally due to revenue growth and the progress we are making with our cost reduction program. That program which we expect to reduce our cost structure by $500 million as we exit 2009, delivered over $100 million in savings as we exited last year. And we expect another $200 million as we exit this year, with the final $200 million in 2009. Last quarter I outlined the major elements of our program, which include, using Lean Six Sigma to streamline our processes and increase productivity in our labs, driving more of our purchasing through mass of contracts that take advantage of our scale. Driving efficiencies in other areas like better aligning our service capacity with patient and sample flows, improving the efficiency of our logistics routes, using the advanced route optimization tools and more fuel efficient vehicles. And, the point enhanced connectivity to our customers and patient service centers, to reduce costs and specimen data entry and billing and lower our bad debt. We're making good progress across all of these areas particularly in billing and collections, where we have accelerated a number our efforts to reduce bad debt, day sales outstanding, and the cost of our billing operation. Bad debt expense as a percentage of revenues was 4.4%, four tenths of a percent lower than the first quarter, and three tenths of a percent lower than last year, before the inclusion of AmeriPath. DSOs were reduced to 46 days, down from 48 days at the end of Q1 and 51 days a year ago. As you know AmeriPath carries a higher bad debt rate than the rest of our business and is one of the opportunities we have identified. During this last quarter we've began to see solid progress in this area. With our disciplined approach and the acceleration of our efforts, we now expect to see continued strong performance in our billing and collection metrics despite a slowing economy. Diluted earnings per share from continuing operations were $0.83 compared to $0.73 in the prior year, a 14% increase. About $0.01 of the increase is due to a lower tax rate than a year ago, as result of a favorable resolution to certain tax contingencies. When we initially provided guidance for 2008, we indicated that we expected to make investments in systems and our start-up in India, which together would reduce full-year EPS by about $0.20. We incurred $0.04 of the impact in Q2 bringing the total for the first half to about $0.07 and now expect to incur about $0.17 per share for the full year. Our lab in India became operational towards the end of the first quarter. We are still in the very early days of ramping up our selling efforts and other support functions. While this market is expected to be a significant contributor to our international operations, we are not expecting it to contribute material revenues this year. Our revised estimate for startup losses this year is about $0.04 per share compared to an initial estimate of about $0.07. We've incurred $0.02 for the first half of the year with $0.01 realized in each of the first two quarters. Our systems investments totaling $0.13 per share associated with developing and deploying standard systems across AmeriPath, and our clinical labs are on track. The deployment of upgraded AmeriPath lab and billing systems is on track and the linking of Care360 with the AmeriPath systems for test results is going well. Additionally, we have made good progress in the development associated with standardizing our clinical lab systems. Through the first half we incurred roughly $0.05 per share, $0.03 in quarter two of the $0.13 per share we expect to spend this year on systems enhancements. Cash from operations increased to $213 million for the quarter compared to $129 million last year. During the quarter we reduced debt by $168 million bringing our total debt reduction since the AmeriPath acquisition to about $700 million. Cash at the end of the quarter was $143 million and capital expenditures were $48 million in the quarter. Turning to guidance from continuing operations, we continue to expect revenue growth of about 9%. We expect operating income as a percentage of revenues to approach 17%. We expect cash from operations, to approximate $900 million and we now expect capital expenditures of between $240 million and $260 million. And lastly we have increased the mid-point of our estimate for diluted earnings per share and now expect between $3.10 and $3.20 excluding any potential special charges. While we're in challenging economic times, we continue to make solid progress and reported strong results for the first half. And we expect our continued focus on executing our plans will position us well to achieve both our financial and strategic goals for this year. Now I'll turn it back to Surya.

[Surya N. Mohapatra:]

Thanks, Bob. We differentiate ourselves and drive profitable growth by providing a superior experience for our patients, physicians and hospitals. This focus is producing results. Now I will provide a brief update on three key areas driving profitable growth, expanding our margins, and building a sustainable platform for long term growth. Our approach to driving profitable growth is to leverage our sales, service and science. We provide value to our new and existing customers with our superior service offering and innovative tests and technologies. Gene-based and esoteric testing revenues increased about 20% in the quarter. We saw double-digit growth in a number of esoteric and gene-based tests including Vitamin D and testosterone testing, Chlamydia and Gonorrhea tests, and ImmunoCAP allergy testing. In addition to our leadership position in gene-based and esoteric testing, we are also the clear leader in Anatomic Pathology. These are the two fastest growing areas of our industry. We perform esoteric and gene-based testing at four major sites; our two Nichols Institute Labs; Focus Diagnostics and specialty laboratory. We are the laboratories laboratory receiving unusual or difficult cases for not only hospital labs, but also academic institutions and other commercial laboratories. Our hospital business is growing and accounts for more than $1 billion in revenue. An example of how we think about solutions to difficult diagnostic challenges is in ovarian cancer. We believe a number of tests based on various markers will be required to help detect and monitor various stages of cancer in different categories of patients. Ovarian cancer is the fifth most common cause of cancer related death among women in the U.S., with more than 15,000 deaths and nearly 22,000 new cases diagnosed per year. We are developing test through relationship with three pioneers in proteomics and biomarkers, Fujirebio Diagnostics, Vermillion and CoreLogic. Tomorrow we are launching the first FDA cleared blood test based on Fujirebio's HE4 biomarker. We are the first commercial lab to make this test available to monitor ovarian cancer patients. In addition we are also evaluating the OVA1 ovarian cancer tumor tryst test from Vermillion which filed an application with the FDA in late June. Similarly we are taking a portfolio approach to expand our leadership in colorectal cancer screening. Given that patients compliance with colorectal screening guidelines is poor, tests need to be easy and convenient to take. For several years now we have offered our proprietary InSure FIT test and FDA clear test for colorectal cancer screening with the patient friendly sample collection process. During the quarter, we introduced a clear wave of version of this test called InSure Quick FIT that can be performed in a doctors office. We are also developing the first blood based test to detect colorectal cancer using the Septin 9 methylated biomarker from Epigenomics. Our important cardiac test using Iron Mobility Technology, is the first and only test that directly measures lipo-protein particle size, which is critical to accessing cardiac risk. We're excited about the potential for this unique test, which was a subject of a study of this online recently in the General Clinical Chemistry. In addition, we continue to enhance the patient's experience, our collaboration with Google and Power Spacing to manage their own health information. Using Google Health, people can store their diagnostic test results and other medical information online. We are expanding our operating margins through top line growth and cost savings. We improved underlying margins in each of the last four quarters, and are on track to meet our commitment to reduce our cost structure by $500 million by the end of next year. We have reengineered many of our processes using Six Sigma and Lean principles. We improve efficiency and remove unnecessary work. As a result, we have 1300 fewer people than 12 months ago. We increased productivity while continuing to deliver unmatched service levels to our patients and physicians. Our employees are driving a strong culture of continuous improvement. The quality of our people and their dedication to excellence is a strong differentiator for Quest Diagnostics. Growth is being driven by our physician, hospital and our anatomic pathology businesses. This growth will be supplemented over the longer term by expense on our some near patient testing and international businesses. We continue to see double-digit growth in near patient or point-of-care testing. During the quarter, our HemoCue business obtained a clear waiver for the first quantitative micro albumin point-of-care test. This test enables doctors to detect and monitor a marker for chronic kidney disease that affects 26 million Americans. Also our focused diagnostic business received the CE mark for a new test kit that enabled doctors for the first time to simultaneously detect and differentiate three major parasites connected to diarrhea disease. These parasites are found worldwide, we plan to distribute this kit in Europe and developing nations and to apply for FDA clearance in the U.S. Internationally we continue to build our service capability and add customers in India, which we see as a long term opportunity. In addition, based on our quality and service, the government of Ireland has selected us to perform all five testing for Ireland's first nationwide cervical cancer screening program. We are entering the decade of diagnostics and have tremendous opportunities to use laboratory tests to help Doctors and their patients better manage health and reduce costs. It is gratifying over the past few weeks to see the U.S. Congress recognize the value and importance of laboratory testing. As I am sure you noted, Congress last week passed legislation that deployed [ph] Medicare competitive bidding for laboratory services, eliminated cost cuts from physician fee schedule for 2008, and provided for a 1.1% increase for 2009. In addition, next year the clinical laboratory fee schedule used to determine government reimbursement, will contain a CPI increase of approximately 4.5%. Based on the preliminary analysis, this could increase our revenues up to $40 million in 2009. This is the first CPI increase in five years and only the second in the past 11 years. In summary, diagnostic testing is a very attractive industry. While it is not immune to economic challenges they are far outweighed by the opportunities. Demographics and pace of innovation will continue to drive growth. We are the clear leader and continue to differentiate ourselves from our competitors through our superior service, Six Sigma quality, innovative tests and advanced information technology solutions. Our business is performing well and we are executing our plan. We are bi-focal doing what is right for the business in the short term and planning for the long-term. We're on track to deliver our commitments for 2008 and are well positioned for the future. We'll now take your questions. Operator. Question And Answer

[Operator:]

[Operator Instructions]. The first question is from Ricky Goldwasser from UBS.

[Ricky Goldwasser:]

Good morning. With the sequential volume improvement that you've showed in the second quarter, can you just provide us little more color on the key variables namely that you are gaining back in the business there and pull through. And also as we think about the second half of the year, are there additional tailwinds that would help continue that trend? And then secondly, just to clarify if you can repeat the breakdown of the $0.24 in cost for the year, and is the increase coming from India and if so, if you can give us more detail on that.

[Robert Hagemann:]

Hey Ricky, let me try and get each of those, but first let me clarify one thing, the $0.24 in cost that you mentioned, its $0.17. You may recall we initially indicated we expected to invest $0.20, we've now adjusted that down to $0.17, the change principally coming because we are spending less in India. We're expecting Indian investment to now be $0.04 a share versus the $0.07 that we had initially estimated.

[Ricky Goldwasser:]

Thank you for clarifying that confusion.

[Robert Hagemann:]

With respect to volume, basically this is the underlined volume. We'll try to take out the NOIs for you and as we said it has been increasing 1% to 2% over pretty much the last four quarters now. The UHC impact, we've actually decided to stop talking about that because it's less than it has been as you recall. It... we lost most of that business last year in the first quarter, by the end of the first quarter and we didn't plan on spending a lot of time talking about it principally because it's not having a significant impact on the year-over-year comparisons any longer. The impact of volume is less than 1% and the revenue impact is around 1%. With that said though we did retain over 20% of the volume and we've seen no change in the associated pull through with UHC. And in terms of volumes, as you know we don't give guidance for price and volume; but I am encouraged by the fact that we've seen nice steady trends in volume growth, over the last four quarters or so.

[Ricky Goldwasser:]

Thank you.

[Operator:]

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

[Robert Willoughby:]

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

[Robert Hagemann:]

No, I didn't Robert. We did reduce our estimate for capital spending by about $40 million for the year and mostly that's just prudent management of our capital. There is a little less spend in India, but remember we were anticipating less than 10% of our capital spend this year would be associated with India anyhow. But we already see us managing the capital spend for the year.

[Robert Willoughby:]

It's a big drop though Bob isn't it, I mean... have you deferred a project of some sort or just...

[Robert Hagemann:]

No major projects have been deferred, I think they are a lot of things that we were looking at early in the year and want to give ourselves the flexibility in our guidance to be able to do those as result of growing through the cost reduction efforts that we have been. We have been identifying not only ways to reduce the P&L spend but ways to reduce the capital spend as well.

[Robert Willoughby:]

Okay and just in a better free cash loan environment should we pay down more debts or can we expect the acquisitions sooner than may be you might have planned.

[Robert Hagemann:]

Well as you know we have never really ruled out acquisitions, but to the degree that we are generating excess cash flow, as I've said we'll first deploy it right now at least this year to pay down debt, but certainly keep our options open as it relates to potential acquisitions and frankly share repurchases as well.

[Robert Willoughby:]

Okay, thank you.

[Operator:]

Our next question is from Bill Quirk from Piper Jaffray.

[William Quirk:]

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

[Surya N. Mohapatra:]

It's actually 15% of Medicare right?

[Robert Hagemann:]

Medicare represents about 15% of our total revenues.

[William Quirk:]

Right, right, no, I understood, but in terms of terms of the actual managed care contracts some of which...

[Laure Park:]

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

[Robert Hagemann:]

Most of them are fixed fee schedules.

[Laure Park:]

Most of them are fixed fee schedules that are separately negotiated.

[William Quirk:]

Okay. Understood. And then secondly Bob, if I heard you correctly, it sounds like your assumptions of bad debt expense are not likely to change, given the economic conditions, did I hear that, I guess that...

[Surya N. Mohapatra:]

I don't expect the economy to have a significant impact on either bad debt or our DSO's. As you saw, they've both been improving and a lot of that has to do with our processes that we're executing to try and improve both of those areas. As I mentioned we're making good progress on the AmeriPath side, I am encouraged by that, but additionally we've been executing very well against the rest of our operations. And not only reducing the cost of the billing operations, but really driving down bad debts and DSO's. As I've said in the past, our bad debt is not principally associated with people unwilling or unable to pay, a lot of it is driven by process and when I say process, I'm talking about, we're making sure that we get appropriate and accurate information upfront, to build a patient the first time. When we get that, we have a very high rate of collections.

[William Quirk:]

Thanks very much.

[Operator:]

Our next question is from Don Brock [ph] from JP Morgan.

[Unidentified Analyst:]

Good morning. I just wanted to dig in a little bit to the revenue side. You know, you posted a really, really solid quarter on the top line. You've got a number of proprietary products that are doing well, there are higher revenue, higher margin, higher growth more on the esoteric side. Are you looking to see more strength on the top line and because of the product mix and the strength in the mix that you've been talking about actually see some potential upside in margins and earnings may be on the top end of your guidance range?

[Robert Hagemann:]

Again I would tell you that I am certainly encouraged by the fact that we're growing not only the underlying volume but the revenue per acquisition and much of that continues to be driven by test mix. The organic growth that we're estimating for the second half of the year, that's built in to our guidance is between 4% and 5%. And we would expect overtime that our goal is to drive growth at or above the rate of the industry, which right now we're estimating is in that 4% to 5% range at the moment.

[Surya N. Mohapatra:]

Yes, I just want add one thing, if you remember three years ago we started our strategy to diversify our revenue base and I am really pleased that 34% of our total revenue now comes from esoteric gene based and anatomic pathology. This is the two fastest growing sector in our industry and we have added a lot of proprietary exclusive or have some temporal advantage in the product. So you can see a number of new products that is coming on and the pipeline is going to help us in the long term to accelerate our growth.

[Unidentified Analyst:]

Surya, just as a follow up to that. Are you seeing that the esoteric testing is having a shorter shelf life as far as driving, pricing and margin i.e. that, that pricing doesn't stay as high for as long and may be that's why you're not expecting a significant increase on the revenue side for an extended period of time even though you do have a lot of products in the pipeline?

[Surya N. Mohapatra:]

Well it depends on what test and also depends on how the test are accepted by some medical society. You know the important thing, if you see we used 70% of our revenue four years ago routine testing and the most important thing and important strategy for us is to go towards professional component which is anatomic pathology and also the gene-based testing. But it is usually three to four years. They... these test remain as esoteric and then it becomes routine.

[Laure Park:]

And mind Don [ph] if you think about it, it really comes down to Surya's point on adoption. If we take HPV as a specific example, that was included in the ACOG and ACS guidelines at this point almost four or five years ago and we're still seeing a nice adoption rate on that, so it really is going to depend on the test and the rate of adoption by the practicing physician.

[Surya N. Mohapatra:]

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

[Unidentified Analyst:]

Excellent and just more on the macro side. Obviously we are not necessarily seeing on the volume side or on the pricing side a significant impact, that's at least clear from the economy, given your results; but the question remains, are you guys even anecdotally seeing any sort of pull back on physician office visits and or the potential adoption of the new products in the office simply because doctor's don't want to push it on patient's that are there for one reason they don't necessarily want to push it any further?

[Surya N. Mohapatra:]

Bob, what is your comment if you see any number then I can then tell you what I see and what I feel?

[Robert Hagemann:]

Don, listen we don't believe we have seen any impact to our volumes for the first half. As we said the underlying volumes have been pretty consistent now for about four quarters and frankly if a patient doesn't come in to a doctor's office, we don't know that. We don't... and even if we did, we wouldn't necessarily understand why. But with that said though, to the degree that volumes do get impacted here, we don't believe they'd necessarily be significant. But, yes, we would certainly be in a position then to further adjust our costs to match the volume levels.

[Surya N. Mohapatra:]

But the sluggish economy is there and we are not immune to that, but there are so many opportunities in diagnostic testing that that particular risk should not really stop our growth. There are new innovations, there's new demographics, and I am very bullish about the diagnostic testing and the value to its healthcare, and what impact it will have for the next ten years.

[Unidentified Analyst:]

Okay, thank you very much.

[Operator:]

The next question is from Ralph Giacobbe, from Credit Suisse.

[Ralph Giacobbe:]

Thanks, just a couple of quick ones. Can you quantify the incremental Aetna in the quarter?

[Robert Hagemann:]

Again Aetna has been one of the contributors to our growth but we don't specifically talk about contracts and what each of them contribute but, you should rest assured that yes, Aetna's volumes have continued to grow for us.

[Ralph Giacobbe:]

Okay, in terms of the AmeriPath integration, is the deal sort of accretive at this point, neutral; I think it was a little bit dilutive last quarter, any benefit there?

[Robert Hagemann:]

Yes, with respect to AmeriPath, what I will tell you is we're actually making very good progress there. We've got good pathology retention, we've renewed or extended a number of contracts, we've got strong customer retention, as we said in the last quarter the specialty integration is complete. We've begun integrating the sales force and as you have heard earlier, we're making very good progress on the bad debt. With that said, we haven't broken out the AmeriPath impact because it's starting now to become part of one business and we haven't done that for any other acquisitions in the past and wouldn't expect to do that for this one. But with that said, overtime we expect this to be an accretive acquisition principally because we expect to accelerate growth there. We are making good progress on the cost synergy side and we are starting to get all the things in place right now to position us to accelerate the growth.

[Ralph Giacobbe:]

Okay, fair enough and then just my last one, in terms of, in India it looks like you guys are looking for a loss of $0.04 or I guess a $0.07 loss estimate. Is that just the operations there proving ahead of schedule or is it sort of something where the incremental costs are going to kind of carried over, as we think about sort of 2009?

[Robert Hagemann:]

Yes, the change for this year is really just a function of how quick we are building out the infrastructure. The business is ramping a little slower than we had initially anticipated. Therefore the investments and infrastructure are going at a slower place. But we are still targeting the break even before the end of 2010 and we're very excited about the opportunities. I wouldn't expect that next year and we haven't yet given guidance for next year, but next year's investment will be significantly different than what we initially estimated for this year.

[Ralph Giacobbe:]

Okay, fair enough, thanks.

[Operator:]

The next question is from Adam Feinstein from Lehman Brothers.

[Adam Feinstein:]

Okay, thank you, good morning everyone. Just I guess a few questions here, Bob I understand you don't want to break out AmeriPath separately because now you view it as being a part of one company, but just could you just talk roughly around the bad debt expense for... if you could give us what the standalone bad debt expense is or just a rough ballpark in terms of what the AmeriPath bad debt expense is. It sounds like you're making progress, but just trying to get better sense in terms of the magnitude. So I was just curious if you can provide any feedback about the bad debt at the AmeriPath side?

[Robert Hagemann:]

Yes, on the AmeriPath side for the quarter it contributed about four tenths of a percent increase to our bad... to our consolidated bad debt rate, and in the first quarter it was about six tenths of a percent impact.

[Adam Feinstein:]

Okay, great. And then with respect to Aetna, if I hear you correctly, that contract kicked in July 1st of last year, so should we expect a little bit lower growth in the back half of 2008, since you have now annualized that or really move the growth rate?

[Robert Hagemann:]

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

[Adam Feinstein:]

Okay, so we will factor that in. Okay, and then just on the cost cutting side, as you talked about the $200 million and I understand that you don't want to give a specific number every quarter, but just as we think about just a ramp up, should we think about being more backend loaded or pretty equal throughout the year. How are you viewing the $200 million benefit for 2008?

[Robert Hagemann:]

Without getting too specific Adam, it does tend to ramp up on... not quite as straight line basis, but it's not all backend loaded. We have to get a lot of it last year, so that we had a good solid run-rate coming in to this year and we continue to make progress on that good solid study progress on that.

[Laure Park:]

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

[Adam Feinstein:]

Got you, okay. And then just my final question, Surya you mentioned about 34% of the business now coming from the esoteric and gene-based testing, so just as you think about that, that number going forward, do you see that number moving higher and I guess, you'll probably say yes, but just curious in terms of just the magnitude?

[Surya N. Mohapatra:]

Well, you answered my question. Yes, it is going to grow and you can see from our progress. We've been adding a lot of new tests, some of them our proprietary, some of them are exclusive. We have also gone towards disease solutions rather than just one test. So when we said that we're going to do this thing, people said well we can't really grow and now we have 34% coming from two fastest growing sectors. So I expect that we are going to grow that sector as we go forward.

[Robert Hagemann:]

Adam just one another thing to keep in mind is typically a test starts out as esoteric and overtime if we're lucky actually it becomes routine because that's when the volumes pickup and it becomes much more wide to accept it. So the rate at which we've been growing, what we will call today the esoteric revenues. We'll continue at the same rate, because those things sometimes become routine in nature. So there is going to be a natural limit on what percentage of our total revenues can come from, routine... come from esoteric testing.

[Surya N. Mohapatra:]

But, the reason why we acquired AmeriPath and we said we are the clear leader and the number one cancer diagnostics company, because anatomic pathology is a very important sector and that's going to grow as you people age and so you have leadership in clinical pathology, you have leadership in anatomic pathology, and you have leadership in esoteric testing. So, I expect that our strategy is going to continue to push, that section and we will go more and more towards our goal of expanding our margins, both from top line growth and the cost reduction.

[Adam Feinstein:]

Okay, thank you very much.

[Operator:]

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

[Kemp Dolliver:]

Hi thanks. Just a couple of questions on the AmeriPath related projects. First, with specialty, what functions and did you... are actually integrated now and then secondly with the sales force training, just give us some color on the sales force structure now that you've put the organizations together? Thanks.

[Surya N. Mohapatra:]

Well, first of all, specialty is part of our hospital business. So all the hospital channels, sales channel is completely integrated. Specialty is also part of the four large esoteric centers we have which is the two Nichols Institute and Focused Diagnostics. So from operation point of view and also from sales point of view, we're very pleased that integration is complete. We mentioned about how we are doing the cross selling in anatomic pathology especially dermatopathology and that particular program has started and we are training our physician sales people to bring the leads to our dermatopathology group. And as we go on we will let you know how that goes but we are very encouraged, the way the physicians respond to this and we have some oddly wins.

[Kemp Dolliver:]

That's great. Thank you.

[Surya N. Mohapatra:]

Thank you Kemp.

[Operator:]

The next question is from Bill Bonello from Wachovia.

[Bill Bonello:]

Good morning, a couple of questions. So, can you just elaborate a little bit Bob in terms of taking your guidance, raising the low end, it looks like about $0.03 of that came from the lower India cost, is the rest of that due to a better outlook for operations or is it really just a reflection of greater cash flow and lower interest expense?

[Robert Hagemann:]

Certainly $0.03 of it was the investments and as you recall, I mentioned there was another penny in the tax rate in the second quarter. But with that said, the outlook that we have for the back half of the year really hasn't changed. We are tracking our plan for the year, we feel good about the progress we are making, and some of the improvement certainly is from operations and we would hope to continue to drive the improve there as the year progresses.

[Bill Bonello:]

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

[Robert Hagemann:]

Well remember the $0.10 that we are talking about in the back half compares to $0.07in the first half, but compares to practically nothing in last year's back half. So you've got to factor that in there. And as I said, the outlook for the back half of the year really hasn't changed for us.

[Bill Bonello:]

Okay, great, but still I get the point about $0.10 verses nothing last year but if... I am just thinking about your Q3 and Q4 EPS relative to your Q2 EPS, is there a reason that we wouldn't see sequential growth from Q2?

[Robert Hagemann:]

You've got to be a little careful just looking at a quarter-to-quarter. The quarters have their own sort of seasonality attached to them and at times can be a little choppy. But I think the best thing to do now is really look at our business on a full year basis because the components of the business have changed too, and what we historically saw as some of the trends between Q1, Q2, Q3, and Q4 are starting to change a little bit.

[Bill Bonello:]

Okay. And then the last question would just be... just because someone was pressing you on that esoteric issue, did caps fall out of the esoteric bucket, is that what you were saying or once the test is classified as esoteric, does it count towards that volume forever?

[Robert Hagemann:]

Well certainly nothing fell out of the bucket this quarter. And what I was trying to say earlier was it doesn't stay... sometimes it doesn't stay esoteric for the long term. What is esoteric today might become routine in the future. So, we would classify, out of the esoteric bucket. We typically do that once a year though, we don't do that on a quarter-to-quarter basis.

[Bill Bonello:]

Okay, thanks.

[Operator:]

The next question is from Amanda Murphy from William Blair.

[Amanda Murphy:]

Hi good morning, couple of questions. In terms of the 1% to 2% underlying volume growth rate, how do you expect that to ramp or do you expect that to ramp in the longer term, and how does that compare to the overall industry growth rate?

[Laure Park:]

From an industry perspective Amanda we really don't have good industry data that would tell us between the components of revenue and revenue for acquisition and volume. Keep in mind the way we count volume is not the number of tests it is the number of patients we serve. So we think the best way to look at this is on a revenue basis. What we see right now as Bob indicated earlier, we think revenue for the industry is at about 5%. We think that we're tracking about on that and we would expect over time that you would see us to grow revenues above the industry rate.

[Amanda Murphy:]

Okay, and then in terms of volumes in the second half, now that you have reached the Aetna anniversary, what initiatives do you have in place to grow volume in U.S. in the second half?

[Surya N. Mohapatra:]

Well, as I said the way we increase our revenue that will leverage our sales, service, and science and we have made some changes in our sales tactics and most of our sales people are now selling rather than trying to reduce confusion in the marketplace. And we have number of new tests, and we are educating the doctors. We have now, most of the managed care contracts. So, in fact their productivities are higher. So, that's going to... that is helping us to increase our penetration in the marketplace.

[Amanda Murphy:]

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

[Surya N. Mohapatra:]

Well first of all, let's remember why we went to India, okay. There are 300 million middle class there and almost the same population in United States. But going to an international country and starting from scratch is going to take sometime. We've been very prudent how we establish ourselves. So we want to establish a company of highest quality and ethics and technology and we have now established our laboratories, our operations in charge, we have got a number of hospital contracts. So its moving in the right direction. Now for me it could move little faster, but obviously we're taking a course of step to establish our position in Delhi, in the Central Delhi area and once that is successful then we'll go to the other areas in India. What surprises me, it's difficult to hire the right people and the amount of people, so it's taking a little bit of time, but there are no real operational surprises and as far as reimbursement is concerned most of the payments are in out of pocket expenses. Some insurers but not like in this countries, they are not major health plans there. So it is a market which is going to be very helpful to us and as I said that as we grow our core business, India and point-of-care is going to help us in three to four years, significant to expand our position in the world.

[Amanda Murphy:]

Okay, thank you.

[Operator:]

The next question is from Matthew Borsh from Goldman Sachs.

[Unidentified Analyst:]

Hi thank you, this is Shelley [ph] now on behalf of Matt Borsh this morning. A couple of quick questions, first, I was wondering if there was any specific initiatives around cost cutting that maybe were accelerated or introduced that allowed you to offset the drug screening business, may be pressure from rising fuel costs, etcetera?

[Robert Hagemann:]

A couple of things Shelley. Certainly as I mentioned we accelerated some efforts on the billing and collection side which have improved both bad debt and DSOs during the last quarter. And we feel very good about that and that's across the company, that's not just in the drugs-of-abuse testing business. In the drugs-of-abuse testing business we had identified a number of areas that we wanted to target even prior to the slowdown as part of our program to reduce costs by $500 million and some of those are frankly when we saw a slowdown we looked to accelerate. In fact, we consolidated the number of laboratories that we do our drugs-of-abuse testing in and we've actually adjusted some of the other costs as well, as we saw changes in the volume. So it's not as though it's easy to do but I think we took... we made the difficult decisions and took quick action there when we saw the volumes changing and accelerate some of the things that we had already keyed up.

[Unidentified Analyst:]

And that's, and more broadly said we saw some pretty significant improvement in both cost of sales and the SG&A lines. Despite a slowing economy, despite some slowdown in volumes from the drug screening business, we had highlighted some potential pressure from fuel costs, and so I was just wondering if some of those initiatives had been accelerated on purpose because of the slowing economy and in particular are there other levers that could be pulled if volumes see any slowdown in the back half of the year?

[Robert Hagemann:]

Well you mentioned fuel, let me just comment on that. Our fuel consumption is actually down about 10% from what it was a year ago principally because of all the actions that we have been taking, which is to basically restructure some of our routes to convert to what fuel efficient vehicles, to eliminate non-productive staffs. So that was actually a big save for us but I wouldn't say that we accelerated that. That is something that we had planned and it turned out that we had a point that a good time given the rising costs of fuel at this point. But, yes I would tell you that the plans that we've got laid-out, for the most part the timing of them is a pretty much set, although there are things that we can continue to do. You recall last year in the first quarter when we had to pull out some significant costs associated with the volume changes from United we did that over the course of about two quarters. And by the time we got to the third quarter of last year the underlying margins were back to where they were the year before. So this is something that we can do if required to, but yes, as we do it obviously we want to keep an eye on the service levels and make sure that we continue to maintain the service levels that we have, just like we have over the course of the last year or so, as we can pull the cost out.

[Unidentified Analyst:]

Okay, great. And then also given that there have been productivity enhancements that have... sounds like they have contributed to have reduced headcount was wondering couple of things, could you give us 1300 fewer people have been cut since the year ago, can you tell us roughly what percent of your headcount that is? And then secondarily as you've increased productivity, has there been any increase in staff turnover from the early part of 2007, is it... is there more pressure on the staff as they have work harder or work more?

[Robert Hagemann:]

Well one thing to give you a sense, as Surya said earlier, this isn't about asking people to do more, it's about eliminating unnecessary work and that what's Six Sigma and Lean Six Sigma are all about. And that's really what's enabled us to reduce 1300 people out of about a little over 40,000 in total, roughly 43000 employees is what we have got. With that said, we have been doing most of that through voluntary attrition. We have voluntary turnover of about 6000 people each year and that's what we're doing, what we're using to manage most of the workforce reductions where we can.

[Surya N. Mohapatra:]

But, you know as I said that our people have been really great. Their quality and their culture and their dedication to excellence is really removing the unnecessary works, but also driving the culture of continuous improvement. So credit goes to all the people who have been really working and making sure that our productivity goes up and even though we have less people. So we don't use the word cost cutting, we take away unnecessary work.

[Unidentified Analyst:]

Okay, great, that's very helpful. Thank you. And then just two more quick one's if I could; wondering if the new guidance range takes into account potential increased pressure from suppliers raising prices, we've seen thermo electronic couple [ph], we just go talking about some price hikes, could the new guidance range take... is it broad enough to take into account any increased pricing from your suppliers?

[Robert Hagemann:]

First of all the majority of our supplier contracts are fixed costs, so that the prices are fixed over the term of the contract. So there's not a lot that we see in terms of changes as a result of that. With that said, certainly our guidance would anticipate any changes that we'd expect on the cost side.

[Unidentified Analyst:]

Okay, great. And then one quick housekeeping, the tax rate was better than expected at the second quarter, run rate expectations for the year?

[Robert Hagemann:]

I wouldn't necessarily change the run rate. Remember I mentioned that we had resolved some tax contingencies in the quarter, and that's why the quarter's rate was lower than it had been.

[Unidentified Analyst:]

Great, okay, thanks very much.

[Operator:]

The next question is from Gary Taylor from Citigroup.

[Gary Taylor:]

Hi good morning. I think what you are seeing on the tax rate is we ought to a move back to where it was before this quarter, correct?

[Robert Hagemann:]

That's correct.

[Gary Taylor:]

Okay and can you provide your balance sheet allowance today or do we need to wait for the Q for that?

[Laure Park:]

The Q will be filed yes, this week which will have the reserve numbers on it, but keep in mind, DSO's came down and it was driven by collections.

[Gary Taylor:]

Okay and then finally, can you just remind us what impact you are expecting out from Lab One in the United contract?

[Laure Park:]

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

[Gary Taylor:]

And the timing of that was the middle of the year some time I thought...

[Laure Park:]

It was during the second quarter and as Bob indicated exiting the quarter we retained over 20% of the United business.

[Gary Taylor:]

Okay, so that includes... that's specific for Lab One or that's just total on the United?

[Laure Park:]

Its inclusive, the 20% is included.

[Gary Taylor:]

But you've already seen of that impact in these...

[Laure Park:]

Already last year.

[Gary Taylor:]

Okay, thank you.

[Operator:]

The next question is from Tom Gallucci from Merrill Lynch.

[Thomas Gallucci:]

Good morning thanks for taking all the time, nonetheless, not a lot left on my end but just a couple of quick ones. Esoteric growth, I know you talked a little bit about the percentage business, but what was the growth in the quarter?

[Laure Park:]

Almost 20%.

[Thomas Gallucci:]

And then what about, does that include AmeriPath, so is this sort of an organic number?

[Laure Park:]

The organic number is double-digit.

[Thomas Gallucci:]

Okay. And then I know you're not talking about guidance for '09, you mentioned India may be sort similar to expense as this year. IT, the resource rate and concepts rates expect that to be less next year than this year, is that on track?

[Robert Hagemann:]

You should expect it to generally be a little less next year. I mean, we're still be deploying some of the standard systems, as we get in to next year, so there still be some IT investment, but I expect that it would be somewhat less than this year's.

[Thomas Gallucci:]

Okay. And then just a last question on pathology. You're talking about some of the integration of the sales force there. We read a little bit here and there about some start ups, venture capital money, pathology seems to be sort of a hot area. Can you just talk a little bit about the competitive landscape in pathology and if you're seeing anything significant there in terms of change?

[Surya N. Mohapatra:]

Well, you know Tom pathology is a hot area. That's the reason why we went and acquired AmeriPath and added their business to our business and we have now 800 of MDs here. I think as people get older and the demographic changes, more and more going towards anatomic pathology and cancer diagnostics, so they are just keen whether it is colorectal, whether its breast, whether its ovarian cancer. So I feel very confident having the luminaries we have and having the people we have in the company, they are guiding us to do what is right thing for the patients and the health plans and the employers. So I think from the comparative spread yes there will be some venture people, there will be... some pathologists go from one place to the other, but in reality, you have to have a very strong infrastructure to serve these professional group of people. Starting from managed care contract to have strong IT, logistics, reporting, and that's the advantage of Quest Diagnostics, that we have a very strong base and foundation from which professional services can be delivered. So I am pretty excited about it.

[Robert Hagemann:]

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

[Thomas Gallucci:]

Andthen one last question Bob, you've mentioned maybe some changes in historical seasonal patterns. Could you just expand on the type of things you are seeing there as opposed to I think historically we always saw the first half was stronger than the second half revenue wise?

[Robert Hagemann:]

Yes, for example last year our fourth quarter I think from an EPS standpoint was probably our strongest quarter of the year. Now some of that was due to the fact that we were dealing with the UHC change in the first quarter. But we've added some new businesses, the AmeriPath business is a little different than the rest of our business was in terms of the way that cycles through the year. The risk assessment business is a little different and the drugs-of-abuse testing business has its own seasonality attached to it. So without trying to get in to giving you a specific quarterly guidance because you remember we got away from that a while ago, I want to caution everyone to use... to not necessarily use the historical patterns that we saw quarter-to-quarter and project that out.

[Thomas Gallucci:]

May be just to clarify that, it sounds like you described the things that are more changes in your mix of businesses as opposed to any real changes in the underlying seasonality of the historical sort of core lab businesses. Is that correct?

[Robert Hagemann:]

Correct.

[Thomas Gallucci:]

Okay, great. Thank you.

[Operator:]

Our next question is from Jason Gurda from Leerink Swann.

[Jason Gurda:]

Thank you. Most of my questions have already been answered, but I just wanted to follow up on earlier question which was related to the CPI increases for the next year. Besides Medicare, what other if any sources of revenue do you have that are tied to the... or directly tied to the like CPI type increase?

[Robert Hagemann:]

In some of our contracts we have fixed fee increases. In some cases they may be tied to CPI, in another cases they are negotiated fee increases, but I would say that there are limited changes associated with the CPI outside of Medicare.

[Jason Gurda:]

Okay, thank you.

[Operator:]

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

[Robert Willoughby:]

Just a follow up on the Google relationship. Can you speak to the economics there, I am trying to figure out why you would give somebody access to the data since that is such an attractive asset?

[Laure Park:]

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

[Robert Willoughby:]

That's true, are you paying to put the data into the Google database or are they paying you?

[Surya N. Mohapatra:]

Robert let me first of all tell you, we are doing this thing as a series of activities we're doing to empower patients, that's going to help the patients and the physician and also the health plan. Remember here we do provide some medical records, the print records to the patient in some states. And what goggle relationship is doing is actually helping the patients to go to the doctor and say interrogating a paper work can I really put it in this place. No we don't pay to put the patient data and again we do a number of things to improve our stickiness and our relationship with the patients and the payers and this is another project which we are doing to improve our differentiation from our competitors.

[Robert Willoughby:]

Okay, thank you.

[Operator:]

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 Diagnostic's website at www.questdiagnostics.com. A replay of the call will be available from 10