Quest Diagnostics Incorporated
Q4 2009 Earnings Call Transcript

Published: 25 Jan 2010

[Operator:]

(Operator Instructions) Welcome to the Quest Diagnostics Fourth Quarter and Full Year 2009 Conference Call. Now, I would like to introduce, Kathleen Valentine, Director of Investor Relations for Quest Diagnostics.

[Kathleen Valentine:]

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 are cautioned not to place undue reliance on forward looking statements which speak only as of the date that they are made and which reflect management’s current estimates, projections, expectations, or beliefs, and which involve risks and uncertainties that could cause actual results and outcomes to be materially different. Risks and uncertainties that may affect the future results of the company include but are not limited to adverse results from pending or future government investigation, lawsuits or private actions, the competitive environment, changes in government regulations, changing relationships with customers, payers, suppliers, and strategic partners, and other factors described in the Quest Diagnostics 2008 Form 10-K, quarterly reports on 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 quarterly updates section of our website at www.questdiagnostics.com. A PowerPoint presentation and spreadsheet with our results and supplemental analysis are also available on the website. Now, here is Surya Mohapatra.

[Surya Mohapatra:]

We drove solid earnings growth in the fourth quarter, earnings per share grew 11%, and revenues increased 2.7% to $1.8 billion. Cash from operations totaled $360 million. This completed a year of strong performance despite the challenging economic environment. For the full year we grew earnings per share 20% to $3.88, revenues increased 2.8% to $7.5 billion. Cash from operations was $1 billion. We have been expanding our pipeline of new tests and services that will improve patient care, reduce overall healthcare costs, and drive growth for our company. At the same time, we are continuing to improve the efficiency of our operations and quality of our service. For 2010 we expect continued strong performance, revenues to grow between 3% and 4% and earnings per share to be between $4.10 and $4.30. Additionally, this morning we announced that our Board of Directors has approved $750 million for future share buybacks, demonstrating confidence in our performance and commitment to increasing shareholder value. Now here is Bob to discuss our financial performance.

[Bob Hagemann:]

As you heard, our business is strong, performing well, and has a bright future. Despite continued challenging economic conditions we have again grown revenues and earnings and produced outstanding cash flow in 2009, and we remain confident in our prospects for continued growth in 2010. Turning to results for the fourth quarter, earnings per share from continuing operations was $0.97, 11% above the prior year with the increase principally driven by strong operating performance. This brings full year EPS to $3.88 an increase of 20%. In the quarter we recorded a charge of $0.04 per share associated with prepaying certain of our near term debt maturities. This $0.04 was fully offset by the favorable impact of certain non-recurring tax benefits which increased EPS by $0.04. Revenues for the quarter were $1.8 billion, 2.7% above the prior year. Our clinical testing business, which accounts for over 90% of our total revenues grew 2.3% in the quarter and about 3% before the impact of our pre-employment drug testing business. Reported volume was slightly below the prior year level. The decline in pre-employment drug testing continued to be a drag on volumes but to less of an extent then it had been. Drug testing volumes were off about 14% in the quarter compared to last year and reduced consolidated volume by 0.8%. As we enter the first quarter of 2010 we expect the impact on volumes of drug testing to anniversary. After considering drug testing volume, underlying volume grew about 0.5%, about half a point lower then the third quarter. The decrease is principally due to a general softness in the quarter and not any particular contract or customer changes. Revenue per requisition increased 2.6% with the increase continuing to be primarily driven by a positive mix and a benefit of just over 0.5% from the Medicare fee increase which went into effect at the beginning of the year. The fourth quarter percentage increase was less then we reported through the first three quarters, principally due to the very strong revenue per requisition we saw in the fourth quarter last year which impacts the comps for the quarter. The absolute level of revenue per requisition in the quarter reflects sequential improvement from the third quarter. Revenue in our non-clinical testing businesses which includes our risk assessment business, clinical trials testing business, point of care testing business, and MedPlus and contain most of our international revenues grew 7% in the quarter. A table contained in footnote seven to the earnings release summarizes the impact of various revenue metrics associated with a number of the items I just discussed. For the fourth quarter, operating income as a percentage of revenues was 17.9% up from 17.6% last year. For the full year, the operating income percentage improved to 18.2% compared to 16.9% in 2008. These improvements are due to revenue growth and the progress we have made with our cost reduction program. That program has been very successful and has now delivered over $500 million in annualized cost reductions since its inception in 2007. While we no longer plan to provide cost reduction targets, that program supplemented with new initiatives, will continue to drive further efficiencies in our operations and be an important contributor to our continued margin expansion in 2010 and the years to come. We continued to see strong performance in our billing and collection metrics. Bad debt expense as a percentage of revenues was 3.9% in the quarter and brought the full year percentage to 4.3%. DSOs at 43 days were consistent with the Q3 level and improved a day from a year ago. Our cash flow continued to be outstanding. Cash from operations for the quarter was $360 million in line with a very strong performance in last year’s fourth quarter. This brings the full year total to $1 billion even after considering the $350 million settlement payment made earlier in the year. During the quarter we fully utilized our remaining share repurchase authorization and repurchased 2.6 million shares at an average price of $58.49 for a total of $150 million. Capital expenditures were $50 million in the quarter. Cash and cash equivalents totaled $534 million at quarter end. The buildup in cash in the quarter is due to the very successful $750 million notes offering we completed in November, $600 million of the proceeds was used to repay debt maturing through 2011 with the remainder now part of our available cash balance. Our cash balance, coupled with our unused credit lines provides us with significant liquidity and positions us extremely well capitalized on growth opportunities and take other actions like share repurchases to drive shareholder value. Consistent with that objective, and in order to provide us with multiple options and continued flexibility to deploy excess cash, our Board has authorized an additional $750 million of share repurchases. There is no specific timeframe over which the additional share repurchase authority will be utilized. Given our current credit profile, we do not anticipate further debt reduction in 2010. Our first priority for us of our cash continues to be growth and other actions to enhance shareholder returns. We have consistently delivered strong performance under highly variable economic conditions. During 2009 we continued to grow our business, generate substantial cash, and grew our earnings per share by 20%. This was accomplished as we made further investments in our business and took other actions which positioned us for continued growth and strong performance. In addition, it was a year in which we met or exceeded all of our financial commitments made at the outset; those for revenue growth, margin expansion, cash flow, and EPS. Now, as we look ahead to 2010 we expect continued progress. For 2010 we expect the following from continuing operations. Revenue growth of between 3% and 4%, operating income as a percentage of revenues to approach 19%, cash from operations to approximate $1.3 billion, capital expenditures to approximate $200 million, and lastly diluted earnings per share to be between $4.10 and $4.30 excluding any potential special charges. Now I’ll turn it back to Surya.

[Surya Mohapatra:]

We continued to execute our plan and drive growth. I will discuss the drivers of growth in the quarter and also the investments we continued to make for the future. Fourth quarter profitability was driven by top line growth and ongoing improvements in quality and efficiencies. In 2009 we achieved our goal of $500 million in annual savings related to our cost cutting program launched in 2007. We will continue to drive further operating efficiencies in 2010. Revenue growth in the quarter was driven by continued strong demand for gene-based and esoteric testing including cancer diagnostics. Revenues from this test continued to grow faster then overall revenues. Gene-based, Esoteric and Anatomic Pathology testing now account for approximately 36% of all revenues. Here are some highlights of fast growing tests from the quarter. Vitamin D testing using tandem mass spec grew more than 50%, allergy testing using ImmunoCap grew more than 10%, and our Leumeta family of leukemia and lymphoma tests grew more than 40%. Our continued focus on innovation is driving growth today and preparing us for the future. We are expanding our test offerings to cover the full spectrum of diagnostic needs from screening to diagnosis to treatment and monitoring. On the cancer front we are integrating our expertise in clinical pathology, anatomic pathology, and molecular diagnostics to help physicians take better care of patients. We are excited to introduce OVA1 later this quarter. OVA1 is the first blood test cleared by the FDA that can help a physician evaluate the risk that an ovarian mass is malignant or not so the patient can be directed to the most appropriate surgeon. Last year we launched HE4 testing to monitor ovarian cancer recurrence. With OVA1 and HE4 in our portfolio we are now the only diagnostic testing company to offer FDA cleared tests for ovarian cancer in the pre and post surgical settings. Another example of innovation is what we are doing in infectious disease. Last year we rapidly developed and deployed our H1N1 test and test kit to expand the nation’s capacity to perform quality testing for the H1N1 virus. This is a great example of how we are able to respond quickly to a public health need, help patients and drive growth. We made significant strides in the area of healthcare IT which helps drive clinical testing growth. During 2009 subscription to our e-prescribing solution more than doubled. As we exited the year physicians were ordering prescriptions at a rate of more than 12 million drugs a year, nearly triple the rate at the end of 2008. Our recently launched Care360 electronic health record will help physicians improve patient care and office efficiency without changing their office workflow. We have also continued to innovate in service delivery as a way to differentiate ourselves from the competition. We introduced a number of service announcements during 2009 such as our specimen tracking capability. Innovation has also helped us drive improvements in efficiency throughout our operation. We achieved our target for reducing our cost structure by $500 million and continue to identify opportunities to drive efficiency and enhanced quality. Finally, we generated $1 billion in cash from operations. Our strong balance sheet gives us flexibility to capitalize on growth opportunities. In closing, we delivered strong results in the fourth quarter and full year. We continue to invest in growth opportunities and drive efficiency in our business. We are the leader in a growing and vital industry and are positioned for continued growth in 2010 and beyond. We’ll now take your questions.

[Operator:]

(Operator Instructions) Your first question comes from Robert Willoughby – Bank of America-Merrill Lynch

[Robert Willoughby:]

The cash flow guidance, if you adjust for the payment that you had this past year it’s relatively flat. Why wouldn’t we see a bit more cash flow in 2010?

[Bob Hagemann:]

You’re right. It is pretty consistent with this year’s cash flow but think about our cash flow as principally earnings driven. We’re anticipating that DSOs are going to be generally stable and in 2009 we really had the benefit of reducing DSOs and driving down some other working capital areas. We think that’s less of an opportunity in 2010 although we’re going to continue to try and drive that as well.

[Robert Willoughby:]

The revenue relative to our expectations upside came from some of the non-clinical areas. Can you give us a couple highlights what happened on that side of the business that drove some upside? Lastly, your plans for the EMR this quarter?

[Bob Hagemann:]

Those other businesses in total which are about 9% of our total revenues grew about 7% in the quarter. The clinical trials testing business grew, we had growth in point of care as well. I wouldn’t say there was anything out of the ordinary there.

[Robert Willoughby:]

Your electronic medical record that’s due out this quarter?

[Bob Hagemann:]

That was not a contributor to growth in the fourth quarter. While we’re expecting it to be an attractive offering to physicians we’re also not expecting that though to be a big driver of revenue growth in the upcoming year. As you know, we’ve always thought about EHR and e-prescribing as something that helps us imbed ourselves into the workflow in the office and make the relationship with those physicians and hospitals even stickier.

[Robert Willoughby:]

Can you break out the number of docs that are actually using the e-prescribing solution and perhaps tell us going forward how many have adopted that electronic health record?

[Bob Hagemann:]

The number of users is in the thousands at this point for the e-prescribe. We’re just ramping up with the EHR it’s certainly a smaller number at this point. That’s more than doubled since we’ve launched it.

[Operator:]

Your next question comes from Anthony Vendetti – Maxim Group

[Anthony Vendetti:]

In terms of the share repurchases you indicated another $750 million. Is that going to be spread evenly and is that built into the $4.10 to $4.30 guidance at this point?

[Bob Hagemann:]

At this point we’re not going to speculate as to when or how much of the share repurchase program that we would execute in 2010. You should expect that we’re going to put our cash to use. Whether its growth which is our first priority or share repurchases which would be the alternative, we’re going to deploy the excess cash that we generate in 2010.

[Anthony Vendetti:]

Can you talk about the types of acquisitions you’ll be looking at in 2010, is it going to be more on the gene-based and esoteric side or are you looking to just continue to expand your reach?

[Bob Hagemann:]

We’re really not looking to change our priorities at all related to growth. We’ll continue looking for opportunities which leverage our core competency and diagnostic testing whether that is domestic acquisitions or regional esoteric or hospital laboratories. We’ll look for opportunities to expand our point of care operations and then obviously investments which will give us access to new testing methods and technologies or licenses investments or acquisitions.

[Anthony Vendetti:]

On the guidance, is that figuring that the economy stays relatively flat or does that expect an up tick in the economy?

[Bob Hagemann:]

We expect that the economy had some impact on our results in ’09. We expect it will probably continue to impact us in 2010 but we’re not expecting the economic climate in 2010 to be all that different then 2009.

[Operator:]

Your next question comes from [Sidib Singh] – Deutsche Bank

[[Sidib Singh]:]

If you could talk in general about the digital pathology initiative and how you think that’s impacting your business to date.

[Surya Mohapatra:]

The cost of our digital pathology is in early state but we expect that this is going to be a very important aspect of combining clinical pathology, anatomic pathology and molecular diagnostics. Not only you could look at those images you can manipulate those images but also we can take care and take images off some of our specialists who may have been remote places. One example that we are using digital pathology is in Ireland, we get that data and then they look at the data from here over digital pathology. We are expecting to have digital pathology as a hub for integrating all the results and that’s one of the reasons why we acquired AmeriPath to combine anatomic pathology with molecular diagnostics and have digital pathology as the base.

[[Sidib Singh]:]

If you could follow up and discuss Septin 9 launch and share your thoughts with us on how you think this test will be used and adopted and any sort of update on the managed care strategy as it relates to that test.

[Kathleen Valentine:]

Septin 9 which we’ve named ColoVantage that’s our new molecular based test. It’s based on the Septin 9 biomarker and it can aid in the detection of colorectal cancer. We are offering the test currently; we will be launching the test sometime shortly after Epigenomics releases its pre-sep study which we are participating in. We expect those results to be available sometime later this year. Its still early days from a launch perspective obviously, we will be working on our reimbursement strategy and specifically related to that, establishing appropriate coverage from the health plans and the government payers.

[Surya Mohapatra:]

One of the things we used a few years ago and actually invested money to diversify our business for more to our gene-based and esoteric and anatomic pathology. I’m very, very proud of the fact that 36% of our business is how on high growth, high margin business. You will see more and more introductions of products with gene and esoteric whether it is for colorectal cancer or for ovarian cancer. We are going to work with the health plans to establish the reimbursement but more importantly to give a choice to the patient to have alternative tests which are more specific and more sensitive.

[[Sidib Singh]:]

I noticed sequentially the margins were down slightly and wanted to get your thoughts on whether there was any sort of new trend that you’re seeing with expenses that would suggest that maybe margin are closer to 18% rather than 19% in 2010.

[Bob Hagemann:]

You should look historically at our margin; it varies from quarter to quarter. The second and third tend to be the quarters with the strongest margin percentage then the first and the fourth tend to be the lowest. I think you’re just seeing the normal seasonality and behavior in our business there.

[Operator:]

Your next question comes from Ricky Goldwasser – Morgan Stanley

[Ricky Goldwasser:]

On the bad debt expense, is this 3.9% level sustainable in 2010? Around hospital and reference labs it seemed that the results for 2009 were somewhat slower then historically, is this mainly the impact of the economy or you’ve seen some increased competition in the market space? If you can discuss the potential type of acquisitions that you’re looking at, we saw some reports from local newspapers in India that you were looking at potential acquisitions there. I know there was some speculation in the marketplace that you might look at companies on the product continuance. If you can update us on what’s you’re current thinking there.

[Bob Hagemann:]

The bad debt percentage of 3.9% in the fourth quarter, don’t think of that necessarily as our new run rate for bad debt. Bad debt in any one quarter has probably 10 to 20 basis points of what I’ll call normal variability in it. Additionally, in this fourth quarter we had some very strong cash collection this year and made some concerted effort to collect some older receivables and as a result it brought the bad debt rate down a little bit in the quarter. Going forward I wouldn’t expect the bad debt rate to be significantly different then the full year rate that we had this year. I think the next question was related to hospital reference labs and whether or not there was a slowing there. There’s really nothing unusual there. One of the things that you need to keep in mind is, we have it broken out in footnote seven, that the lab management contracts that we exited a year ago are now anniversarying but they impacted the full year results somewhat, particularly on the volume side. There’s nothing in particular, I don’t see the economy impacting hospital reference work any different then the rest of our volumes at this point. Lastly, India, first of all with respect to specific discussions about an acquisition we’re not going to speculate on that, we don’t comment on rumors and speculation. We do have no plans for any international acquisitions at this point.

[Ricky Goldwasser:]

In terms of your share buyback program, what you’re factoring into the budget for 2010 is that exclusive of the potential acquisitions?

[Bob Hagemann:]

As you know, the guidance for earnings that we put out each year is an all in number. It would include the impact of any acquisitions that we might do or any share repurchases that we might do. You’ve heard us say this before that our first priority for deploying cash is into growth and if growth opportunities aren’t available or they’re not available at the right price we’ll deploy excess cash into share repurchases at that point.

[Operator:]

Your next question comes from Kemp Dolliver – Avondale Partners

[Kemp Dolliver:]

Looking at your comments around 2010 and margins you talk about the operating margin potentially approaching 19%. Not to get too literal with you but if your operating margin were to get close to 19% that performance in terms of the percentage of increase would be pretty close to 2009 which given your prior comments about the cost reduction program is actually pretty impressive. Could you speak to any changes in priorities in the cost reduction side for 2010 versus where they’ve been the last three years?

[Bob Hagemann:]

Overall don’t think of it as any dramatic changes. The program that we have in place will continue and we’ll continue focusing on the areas where we think the biggest opportunity to improve our efficiency lie. That’s going to continue to be standardizing our operations, deploying best practices across everything, using lean six sigma principles both within our laboratories and outside our laboratories, working on procurement and supply chain, obviously billing collection will continue to work on and we see opportunities there, rationalizing our real estate costs and certainly increasing electronic ordering, those are all areas that we’ll focus on but they’re just some of the areas. We will continue to touch really all aspects of our business with this program. As I think about it, hopefully we’ll start to think about it here internally less as a program and really more as a way of doing business.

[Kemp Dolliver:]

What are your observations regarding the labor market for particularly the more specialized lab technician functions?

[Surya Mohapatra:]

The reality is that we need more medical technologists, we need more histotechnologists and there are not a lot of places where they’ve been trained. We are internally training; we are working with some of the universities. This is one of the comments that I made that we need to invest in people and as we grow the company it is certainly starting up these technologies and we are training internally but there is no immediate panic, just a question of what is going to happen in five years and seven years.

[Operator:]

Your next question comes from Gary Taylor – Citigroup

[Gary Taylor:]

I wanted to go back to pricing in the quarter and make sure I understood a comment that Surya made early in the call. Looking at revenue per requisition on average typically the dollar amount is down in 4Q which I think is a seasonal phenomenon presumably mix. It does look like that was down about $3.00 sequentially this year versus $2.00 last year. I think a comment was made that the absolute pricing was up sequentially.

[Bob Hagemann:]

I’m not sure how you’re doing your math but revenue per requisition is up versus the prior year and its up from the third quarter. If there’s some confusion we can catch you offline to go through your numbers.

[Gary Taylor:]

It sounds like there’s definitely confusion but I’ll see if I can straighten myself out. Secondly, on the cost side there’s not an explicit dollar amount on the cost savings for ’10 unlike what you had prior years is that correct?

[Bob Hagemann:]

That’s correct. As we told you, when we first launched this program we had some very specific targets which we wanted to lay out there for people. At this point, this program is really becoming more and more of a way of doing business. It’ll continue driving improvements in margin for us, that coupled with top line growth. No, it doesn’t make sense for us to put a target out there every year for you. Think of it as built into our operating income target.

[Gary Taylor:]

Other operating expense was a $5 million number its typically pretty de minimis even $5 million isn’t a lot for you but is that a unique thing?

[Bob Hagemann:]

If you’re taking other operating that includes an almost $4 million of foreign exchange in the quarter. If you look, a lot of this is detailed in the footnotes to the earnings release.

[Gary Taylor:]

Overall in terms of volume growth we’ve been looking at the overall requisition growth and looking at that ex the drag from the drug of abuse testing and the year started pretty weak and got sequentially stronger 2Q, 3Q and now looks to have backed off a little bit in 4Q. I understand 3Q was probably inflated a little bit because you were comping a quarter with some hurricane impact in it. When you just think about routine testing growth in the fourth quarter versus what you’ve seen the last couple quarters, any particular observations to make?

[Bob Hagemann:]

As I said, there was some general slowdown in the fourth quarter. One of the things that I think is important is not to read too much into any particular quarter. As we look at where the fourth quarter came out versus the way we’re thinking about our guidance we’re in about the same place as we were last year. You may recall that last year’s revenue growth in the fourth quarter was a little bit below the expectations that we set for the year. We’re in the same position this year.

[Operator:]

Your next question comes from Kevin Ellich – RBC Capital Markets

[Kevin Ellich:]

I know we’ve talked a lot about the 2010 guidance, I was wondering does it include acquisitions and also given the operating margin is expected to approach 19% and therefore there would be some margin expansion, how much of that is dependent upon volume growth or volume coming back?

[Bob Hagemann:]

With respect to the revenue guidance there are no acquisitions in there, that is organic revenue growth. The earnings per share number though assumes that we’ll deploy our cash either into acquisitions or into share repurchases. Think of that as an all in number. The later part of your question?

[Kevin Ellich:]

Margin expansion with operating margin to approach 19% how much of that is dependent on volume growth or volumes picking up?

[Bob Hagemann:]

Certainly in order for us to continue expanding margins we need both top line growth and we need to continue making progress on our cost reduction programs. You should assume that it does anticipate continued revenue growth and as we think about the revenue guidance, although we’re not giving guidance for the components of price and volume, we are expecting both of them to grow in 2010.

[Kevin Ellich:]

Thinking about your relationships with some of the small diagnostic testing companies like Vermillion and the launch of OVA1 actually could you give us some color and detail behind what’s going with OVA1 launch when its expected? What other diagnostic testing categories you’re interested in or looking at?

[Surya Mohapatra:]

Let me first start with the diagnostic category, we are focusing on pre-diagnostic areas infectious disease, cardiovascular disease and cancer diagnostics. One of the major reasons for acquisition of AmeriPath that we want to be the destination for cancer patients when it comes to cancer diagnostics so that’s going on as well as far as integration is concerned. Now we are working with other companies whether it is Vermillion or whether it is other companies where we are bringing in new gene-based testing. Some of these companies were for years and we are very excited that Vermillion is come up with OVA1 and we’re going to introduce it this quarter. As far as going forward you heard the same thing about Epigenomics as far as ColoVantage, colorectal cancer you will see us more and more doing gene-based and esoteric testing whether it’s for personalized medicine or whether it is just medicine to improve specificity and sensitivity almost all aspects of cancer.

[Kevin Ellich:]

Going back to the international, could you give us an update on India, how is it performing? What other opportunities are you guys looking at in the international markets this year?

[Surya Mohapatra:]

I just came back from India 10 days ago and that country is growing. While the Western countries are growing 2% to 3% this country is growing 7% to 8% and the Prime Minister announced that the country is growing to 10% in the future. As we said, that one of our original goals what was that we are going to have 10% of our total revenue international business. India is a very important area for us and we have started getting customers, the laboratory is working and it will take some time but we are very excited about our position in India and we are making an impact there. As far as the international growth, as Bob said, there is no immediate plan to acquire any company but we want to be very successful in India. We’re always looking for opportunities and we don’t want to speculate on those. We are working in India, we have done a good thing in Ireland as far as cyto is concerned and then we have operation in Mexico and the UK.

[Kevin Ellich:]

That cytology contract in Ireland does that come due this year?

[Bob Hagemann:]

It does and we’ll be re-bidding on that obviously.

[Kevin Ellich:]

With your Care360 EHR and the meaningful use definition that was released at the end of 2009 have you guys gone through and does your system meet those requirements now?

[Bob Hagemann:]

At this point it does not but our next release coming out later this year will and it’ll come out well ahead of when the incentives for that kick in.

[Kathleen Valentine:]

We’re very comfortable that our solution will meet all the criteria established by the meaningful use.

[Operator:]

Your next question comes from Shelley Gnall – Goldman Sachs

[Shelley Gnall:]

On pricing I was wondering if you could back out the Medicare rate component in the revenue per requisition for the fourth quarter.

[Bob Hagemann:]

As I told you that’s been about 0.5% throughout the year.

[Shelley Gnall:]

On the drugs of abuse testing I want to confirm, it sounds like it’s not expected to be a drag in 2010. Is that a change in view or is that consistent with your expectations for the last couple quarters?

[Bob Hagemann:]

It’s really not a change in view, as we said for some time now; we expect that the impact of that business will anniversary in the first part of 2010. While we don’t expect it to be a big drag on our volumes or our revenue growth year over year, we’re also not expecting it be a big contributor either.

[Shelley Gnall:]

Can you remind us historically in your EPS guidance range, has that historically been provided the same way? In other words, the revenue is organic, the EPS would include any share repurchases done or any acquisition impact for the year?

[Bob Hagemann:]

Yes, very consistent with what we’ve done historically.

[Operator:]

Your next question comes from Tom Gallucci – Lazard Capital Markets

[Tom Gallucci:]

You noted the moderating volume trends or the sluggishness that’s out there. What are your views, your growth versus the overall market growth? Do you have any thoughts as to maybe why it’s been a little slower lately?

[Bob Hagemann:]

It’s certainly hard to pinpoint it. We think that in general we’re probably growing consistent with what the market is doing. The general softness that we saw in the quarter we expect that it’s probably consistent with trends in physician office visits and drug prescriptions which were written.

[Tom Gallucci:]

Its sort of small but if you could remind us the impact of the physician cuts that could come out there depending on what happens in Washington and how you’ve handled that in your guidance?

[Kathleen Valentine:]

For 2010 we have included in our guidance is about $25 million in cuts from CMS and that’s the 1.9% reduction on the clinical fee schedule and then the RVU adjustments that are in place on the physician fee schedule.

[Bob Hagemann:]

The sustainable growth rate that they’ve talked about there’s nothing specific in there for that at this point. Any action on it has been put off until I believe its March 1st of this year. At this point we’re expecting that Congress will ultimately act to do something with that so we’re not making specific built into our guidance for it.

[Tom Gallucci:]

You mentioned pathology along with gene-based and esoteric as important areas. We’ve been seeing and hearing for a long time about a shift toward more in house operations. Can you give us an update on what your thoughts are on the pathology landscape generally?

[Surya Mohapatra:]

As you know, over the last five or six years, every year very disciplined way we are growing, now we have 800 MDs in the company. We have a number of specialists whether it is pathology or it is humanopathology. Once you build this what I call the brain power, our doctors are seeing more patients a day then some of the hospitals. One of the questions I ask the companies, who is looking at your slides? This is our really great, great strength and we want to really leverage. Another way of leveraging is really to combining clinical pathology and anatomic pathology and molecular diagnostics and you’re seeing some of these results and obviously people talk about personalized medicine, that’s what we’re doing. Once we combine with the digital pathology we think this is going to really give us a really unique advantage to really move forward. We see some in-sourcing in the hospitals and people are trying to do what I call the individual analysis that where you see some decrease in the anatomic pathology in the tissue. I don’t think it’s a long term trend because people are going to really come to us for more then just the tissue.

[Bob Hagemann:]

You’ll see out on our website that the anatomic pathology business for the year was essentially flat year over year and I think a lot of that slowdown had to do with the in-sourcing. The anatomic pathology is just a piece of the broader market for cancer diagnostics and given the molecular test that we offer which are often getting ordered now in conjunction with tissue and other AP work, we feel as though we’re very, very well positioned for the long term, particularly with the 800 pathologists that we’ve got on board to offer consultations. When you think about the broader market for cancer diagnostics we think that we’re positioned extremely well there in spite of this trend of in-sourcing which at some point given that its again a play for broader cancer diagnostics I’m not sure that that’s going to have the same impact that its had historically.

[Operator:]

Your next question comes from Adam Feinstein – Barclays Capital

[Adam Feinstein:]

On the pricing side things still look very healthy there but we can see some slowdown in other growth. I know annual mix will play into that but just curious to get some more clarity in terms of the revenue per req on the quarter?

[Bob Hagemann:]

As I said earlier, revenue per req in the quarter actually continued to improve from the third quarter level and it’s improve sequentially every quarter this year. The reason that the percentage increase from last year’s fourth quarter is down compared to the year over year increases we saw earlier in the year was principally because of a very strong revenue per req in the fourth quarter last year. We had some big recoupments and some big reimbursement initiatives go on that really helped that fourth quarter revenue per req last year. As we look ahead we don’t expect pure pricing to be a driver of improvements in revenue per requisition, it hasn’t been historically and we’re not expecting that to be going forward, particularly with the fact that in 2010 we’ll have the Medicare fee decrease versus an increase in 2009. It will continue to be the number of test orders per requisition and test mix that drive improvements in revenue per req as we go forward.

[Adam Feinstein:]

On the acquisition side, you’ve talked a little bit about that being a priority, just curious whether you believe that multiples are getting better? This time last year things were pretty bad out there but sellers were still looking for big multiples. You guys sat on the sidelines for most of 2009. Curious whether in your conversations are you seeing more reasonable multiples for some of these transactions?

[Bob Hagemann:]

Certainly more reasonable then we saw several years ago. I think there’s probably a little more rationale which has been brought to it but each transaction is a separate transaction you need to get a buyer and seller to come to an agreement.

[Surya Mohapatra:]

We are in a very good position and I am really very proud of the work we do and we’re collecting cash. We are not going to be anxious buyers.

[Adam Feinstein:]

You said before you made your cost cutting goal and now as part of business going forward. You made similar comments in the past. As you think about margins and longer term margin trends, I’m not looking for a point on number but I’m just saying is there still more efficiency and if so what areas in one area you still there is longer term opportunity as you think about your cost structure?

[Bob Hagemann:]

Our goal to get to 20% operating income as a percentage of revenues is unchanged. If we get there and we think we can go further we’ll give you some insight at that point. Right now our goal is to get there over time. As I think about our business and I think about the opportunities here keep in mind that we keep talking about the lab a lot, only 35% or so of our costs are within the four walls of the laboratory. There are a lot of costs outside whether it is logistics, whether it is patient service centers, in getting those specimens to the laboratory. Those are areas that we’ll continue to look at in addition to the laboratory. The billing, I continue to talk about billing and bad debt. That’s an opportunity for us. It will continue to be going forward. The more and more that we can do with our customers electronically the more and more that it reduces manual effort, it reduces errors and then driving six sigma quality which is all about doing it right the first time and eliminating rework. There’s a tremendous amount of rework that’s still done in this industry in our business and to the degree that we can eliminate that we’ll improve quality and we’ll continue driving down costs and that’s our goal.

[Operator:]

Your next question comes from Ralph Giacobbe – Credit Suisse

[Ralph Giacobbe:]

In terms of the volumes, obviously you talked about general softness in the quarter, some of that attributed to just a slowdown in physician office visits as well as scripts. Given that, how comfortable are you that you mentioned that you expect volume growth, what would give you that comfort level that you will see it just given some of the recent trends we’ve seen?

[Bob Hagemann:]

We’re not looking at just any one quarter as we think about this. If you look a the full year and you look at the footnote seven that’s in the press release you’ll see that there was about 1.5% impact of various items that we do not expect to recur in 2010. When you adjust for that, the guidance that we put out there is very consistent with 2009 performance. As I said, last year in the fourth quarter the revenue growth was slower then we have projected for the full year yet we came in right on those numbers that we projected for the full year. I know people look at every quarter but it’s important not to read too much into any one quarter because things can vary.

[Ralph Giacobbe:]

In terms of the pricing mix, up 2.6% this quarter, given that we’re going to see some tough comps as we head into next year and given the Medicare rate cut, it is essentially fair to take the run rate from 4Q minus the Medicare cut as sort of a starting point to think about revenue per requisition for next year?

[Bob Hagemann:]

I said earlier, we don’t give guidance for the components of revenue growth but as you pointed out, in 2009 we had a tailwind of a Medicare fee increase and in 2010 we have the headwind of a decrease. That’s certainly something to factor in as you’re trying to make your estimates as what you think revenue per req might be. We’re not going to get into the business of providing the components because as we’ve told you in the past, sometimes we’ll take action to make sure that the business is profitable and that means oftentimes walking away from volume but it improves overall profitability. We’re driving for profitable revenue growth and not necessarily focused on one or the other metric right now.

[Ralph Giacobbe:]

Given the new share repo authorization does that speak at all to what you’re seeing or what you’re not seeing on the acquisition front?

[Bob Hagemann:]

Not at all. If you think about what we’ve done historically this is usually the time of year that we re-up our share repurchase authorization, we’ve exhausted it in the fourth quarter. We now have flexibility to move forward with additional share repurchases. It’s not supposed to signal anything with respect to opportunities to grow the business.

[Ralph Giacobbe:]

Could you remind us either percentage of your costs to percentage of revenue is patient service centers?

[Bob Hagemann:]

We have not provided that guidance but as I’ve told you, 65% of our costs are outside the four walls of the laboratory, patient service centers being one of those costs. They’ve got 2,000 patient service centers roughly around the country; you’ve got roughly 8,000 pathologists so that’s obviously a big chunk of our costs.

[Operator:]

Your next question comes from David Claire – Piper Jaffray

[David Claire:]

Another question on volume in the quarter, what was the growth rate for your esoteric testing volume? Can you give us any color on some of the more established esoteric tests like HPV and Chlamydia and gonorrhea in the quarter?

[Kathleen Valentine:]

We don’t give any test specific information. What I can tell you is our gene-based and esoteric testing as we said earlier it did grow faster then our overall rate. I’d point you to our website; we’ve got some supplemental financial schedules that give you a nice breakdown by product category of our revenue performance in the year.

[Bob Hagemann:]

You’ll see there that the gene-based and esoteric grew at about two times the rate that routine grew in the year.

[David Claire:]

A recent filing that you guys put out you mentioned a potential acquisition of a diagnostic testing business. Can you give us an update here?

[Bob Hagemann:]

There’s really nothing to update. As I’ve explained this to several people already, anytime you do a debt offering and you discuss use of proceeds the disclosure requirements are very, very specific there. Given that we’re always talking about potential acquisition opportunities we were obligated to make some disclosures that there could be something. When you look at that disclosure, the way it’s written, it basically says that there’s the potential for us to do an acquisition anywhere from several million dollars to $250 million. In any case it would have been an immaterial acquisition, obviously nothing has closed here, there’s nothing to announce. Quite frankly, given the size of it, it’s not necessarily something that we would press release if we had completed it.

[Operator:]

Your next question comes from Amanda Murphy – William Blair

[Amanda Murphy:]

Based on the discussion it sounds like if you take out drugs of abuse and seasonality that perhaps the underlying utilization trends have gotten a little bit worse, is that a fair statement? If so, as you’re out if the field is there something specific that you’re hearing that’s driving that?

[Bob Hagemann:]

In the prepared remarks I did indicate that the underlying volume growth slowed about half a point from that we saw last quarter. Again, if you look at footnote four and you compare that to the previous quarters you’ll be able to do all the math. No, there’s no one particular thing that we’re pointing to in terms of a slowdown, we think it was the general softness. As I said, I think it’s very consistent with the trends or expected to be consistent with the trend for physician office visits and the number of drug prescriptions written.

[Amanda Murphy:]

In terms of the cost savings, PUC mentioned that specifically some new initiatives for 2010. We’ve talked a lot about it, I don’t know if you’ve already mentioned them specifically but perhaps you could give a little more color on that.

[Bob Hagemann:]

I’m not going to detail out each of the initiatives. As I told you, when we launched the previous program it literally included hundreds of initiatives. Many of those are going to continue to carry over into 2010, they’re going to be supplemented with additional initiatives but the areas that we’re focused on are really unchanged. As I said, we’re going to be looking to continue to standardizing our processes, deploying best practices; we’re looking at using lean principals throughout the business, continued big opportunities on supply chain. As I already said a couple times, billing and collections remains a big opportunity. As we increase electronic ordering I think is going to be efficiencies throughout our business. We’re obviously looking at all of our real estate costs which include footprint and all the other costs associated with real estate. Think of those as the broad categories.

[Amanda Murphy:]

As a follow up on India, now that you’ve been live there for over a year, can you also talk about how the reimbursement environment has played out and perhaps test mix in that specific country?

[Surya Mohapatra:]

First of all, most of the reimbursement there is self payer so its cash. As far as mix and other things we’re trying to meet the local requirement. Some of the routine testing but our focus there is actually esoteric testing. We talk about specific areas going to take off. We built this facility and its one of the best in the pacific and we’re going to have of the key tests there and some of them to be done in the US.

[Operator:]

That does conclude the question and answer session. Thank you for participating in the Quest Diagnostics Fourth Quarter Conference Call.