Quest Diagnostics Incorporated
Q2 2010 Earnings Call Transcript

Published: 21 Jul 2010

[Operator:]

Welcome to the Quest Diagnostics Second Quarter Conference Call. At the request of the company, this call is being recorded. The entire content of the call including the presentation and question-and-answer session that will follow are the copyrighted property of Quest Diagnostics with all rights reserved. Any redistribution, retransmissions or rebroadcast of this call in any form without the express written consent of Quest Diagnostics is strictly prohibited. Now I’d like to introduce Kathleen Valentine, Director of Investor Relations for Quest Diagnostics; go ahead please.

[Kathleen Valentine:]

Thank you and good morning. I’m here with Surya Mohapatra, our Chairman and Chief Executive Officer and Bob Hagemann, our Chief Financial Officer. Some of our commentary and answers to questions may contain forward-looking statements. You are cautioned not to place undue reliance on forward-looking statements, which speak only as of the days 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 investigations, 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 2009 form 10-K, quarterly report on form10-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 update section of our website at www.questdiagnostics.com. A PowerPoint presentation and spreadsheet with our results and supplemental analyses are also available on the website. Now here is Surya Mohapatra.

[Surya N. Mohapatra:]

Thank you Kathleen. As you saw in our press release this morning, we saw a further slowdown in physician office visits and our revenues declined. Still, we are able to grow our earnings in this environment. During the quarter, earnings per share increased 7% to $1.07, revenue decreased 1.4% to $1.9 billion, cash flow was $209 million. While our business continues to perform well in a number of areas including gene-based and esoteric testing, revenue softness experienced in the first half has made us cautious in our outlook for the full year. We now expect full year revenues to decline by approximately 1% and earnings per share to be between $3.90 and $4.00. Revenue growth continues to be a top priority; we have implemented a number of targeted plans and I will share some elements of these plans later. As you know, we generate significant cash. We continue to explore acquisitions to strengthen our business in the areas of cancer, cardiovascular and infectious disease. We also pursue opportunistic deals which can add scale and be immediately accretive. When acquisitions are not available, we’ll buy back shares as a means to drive shareholder value, which along with dividends is what we have done historically to return cash to shareholders. Now Bob will discuss our financial performance and I will return with additional comments. Bob?

[Robert A. Hagemann:]

Thanks Surya. As you’ve heard, revenues during the quarter were impacted by continued softness in the market place. Despite this earnings per share grew 7% in the quarter to $1.07. Revenues for the quarter were $1.9 billion, 1.4% below the prior year. Our clinical testing revenues which account for over 90% of our total revenues were 1.6% below the prior year compared to our first quarter decline of 0.4%. Note the first quarter growth was reduced by an estimated 1% due to weather. Revenue per requisition was 0.3% below the prior year. Year-over-year revenue per requisition continues to benefit from an increased mix of gene-based and esoteric testing and increases in the number of test quarter per acquisition. This benefit has been offset by some business and pair mixed exchanges, the Medicare fee decrease and pricing changes in connection with several large contract extensions. Typically, we will comment just on the year-over-year change in revenue per requisition. But in this quarter it is also important to understand how it has performed sequentially. Revenue per requisition was approximately 1% below the first quarter level with about half of the change due to business and pair mixed exchanges including a rebound in drugs-of-abuse testing and a decline in anatomic pathology testing and about half due to the contract changes referenced earlier. All these contract extensions have involved price adjustments. They have provided us with multi-year visibility in reimbursement rates and have reduced the uncertainty associated with contract expirations. In comparing the year-over-year increase in revenue per requisition reported in the first quarter of 2.3% to the decrease of 0.3% in the second quarter. About 1% of the difference is accounted for by the change from Q1 to Q2 which I just explained. The remainder is principally due to easier comps in the first quarter than in the second. We expect changes in revenue per requisition will continue to be modest for the first half of next year with an anniversary of the business mix, pair mix and contract changes which are currently offsetting the benefits of the increasing proportion of gene-based and esoteric testing. Volume in the second quarter was 1.3% below the prior year and continues to be pressured by the general slowdown in the provisional office business. This compares to a 2.6% decrease in the first quarter. Again, note that weather contributed an estimated 1% to the first quarter decrease. Excluding the first quarter weather impact, volume performance reflected modest improvement in the second quarter principally due to drugs-of-abuse testing which has began to rebound and grew approximately 5% in the quarter. Revenue in our non-clinical testing businesses which includes risk assessments, clinical trials testing, point-of-care testing and healthcare IT was comparable to the prior year level. Operating income as a percentage of revenues was 19.5%, a 60 basis point improvement from the prior year. Margin improvement was realized despite the slower revenue growth due to progress we are continuing to make in managing our core structure and driving quality improvements. Contributing to the year-over-year margin improvement are reduced costs for performance-based compensation, improved experience associated with professional liability claims and continued progress in reducing bad debt. We continue to see strong performance in our billing and collection metrics. Bad debt expense as a percentage of revenues was 3.8% in the quarter compared to 4.2% last quarter and 4.4% a year ago. BSOs at 42 days are within a day both the year end and a year ago. Cash from operations was $209 million and compares to a $9 million net outflow in last year’s second quarter. Last year’s second quarter contained the NID settlement payment of $308 million, $258 million net of associated tax benefits realized in the quarter. Capital expenditures were $49 million in the quarter and created $36 million a year ago. During the quarter, we purchased 3.3 million shares at an average price of $53.36 for a total of $175 million. We now have $324 million remaining under the $750 million share repurchase authorization granted in January of this year all of which we expect to utilize prior to year end. Our cash balance coupled with our unused lines of credit provides us with significant liquidity and positions us extremely well to capitalize on growth opportunities and take other actions like share repurchases and drive shareholder value. Now let’s turn to our full year outlook from continuing operations. Based on our results through the first half, we’ve become more cautious in our outlook for the remainder of the year and now expect full year revenues to be approximately 1% below the prior year due principally to our changing outlook for volume. Keep in mind our guidance excludes any acquisitions which may be completed in the second half. We expect operating income to approach 18% of revenues. We now expect cash from operations to be between 1.1 billion and $1.2 billion compared to $1.3 billion previously. We continue to expect capital expenditures to approximately $200 million. And lastly, diluted earnings per share are expected to be between $3.90 and $4.00 compared to a range of $4.00 to $4.20 previously. While not all of our records through accelerated growth have yet produced results we expected, we are making progress. We have refocused our sales efforts in markets where we believe we have the greatest opportunities, we’ve improved service levels, we have launched, or ready to launch a number of exciting tests and we have added new talented sales personnel. We fully expect these efforts to accelerate growth but they will take time to deliver results. Until then, we will continue to closely manage our costs. In addition, we will continue to explore acquisitions both strategic and opportunistic which we believe will enable us to accelerate long term revenue and earnings growth. Now I’ll turn it back to Surya.

[Surya N. Mohapatra:]

Thanks Bob. I would like to elaborate on some of the actions we have taken to drive growth. Last quarter we mentioned that we launched programs to improve our self effectiveness and get closer to our customers. Here is what we have done so far

[Operator:]

Thank you. (Operator Instructions). Our first question comes from Ralph Giacobbe with Credit Suisse.

[Ralph Giacobbe:]

Thanks, good morning? Can you really give more details on the pricing from the contract extensions; with these larger deals or a bunch of smaller deals? Any color there?

[Robert A. Hagemann:]

Ralph, this is Bob. Yeah as I said they were several large contracts and the impact in the quarter was about 0.5%. And as you saw…as I indicated earlier, the change in revenue in per acquisition from this quarter to the last is only about 1%; not a significant change but that was one of the factors certainly impacting the comparisons.

[Ralph Giacobbe:]

Sure. And just to be clear, were these contracts coming up for and all or is this a proactive approach by either you or manage care to sort of extend out the deals?

[Robert A. Hagemann:]

That’s right.

[Surya N. Mohapatra:]

Well, first of all it is actually a pro-active strategy for us. We have now contracts extended beyond 2012 and it has really made us strong and it has given us the visibility to do imbursement and it has taken over the uncertainty from the market place.

[Ralph Giacobbe:]

Okay, and so you said sort of beyond 2012 is that sort of and are these again sort of timings, I would’ve bought more sort of front end loaded in terms of beginning earlier this year as opposed to Q2 it just seems kind of all your typical contracts cycle’s in terms of the beginning of they year or do they sort of renew throughout the year and is this sort of a further risk as we kind of move through out the year

[Robert A. Hagemann:]

Ralph there is really no typical cycle as to when in they year they occur, we have contracts coming up all the time. They key is though at this point we have no significant contracts coming up either this year or next year in fact here is really nothing significant coming up for the next 18 to 24 months and even when I look out beyond that at this point, 2012, 2013 the amount of contracts coming up in those periods is less than you typically have in a normal year.

[Ralph Giacobbe:]

Okay, and then just shifting to the you know AP side things, anything more there that would have caused sort an acceleration in the deterioration, I mean its some thing that we have talked about in the past, just wondering sort it seems to have a more impact in this quarter than maybe in the past so, what would you say is there anything specific, that you think its driving that.

[Robert A. Hagemann:]

Nothing new we should have continued in sourcing of the PC and the PC components of anatomic pathology and that was as I indicated one of the drivers of the change in revenue per requisition as well, that’s a richer priced wreck and yes that business as impacted, if does impact the total revenue per requisition because of the mixed change there.

[Ralph Giacobbe:]

Okay great and then just my last one, you were able to obviously meet the bottom line this quarter, based on consensus numbers despite the top line weakness you took down the guidance you had sort of 19.5% plus margins and you are sort of targeting the 18% levels, so I guess the question what is it that you can’t sort of replicate cost going forward and kind of continue what you did sort of in the second quarter, is it more that the top line is going to get maybe a little bit weaker is there something on the core side that you think is unsustainable.

[Robert A. Hagemann:]

Yeah, with respect to the cost there are several things that took place in this quarter that while we expect them to continue to benefit us we won’t have the same benefit that they did in the second quarter. For example as I said we made changes to the incentives or performance based come across we did see very good experience in our professional liability claims and we hand very good experience and bad debt. I expect the experience and bad debt will continue and I think we’ll continue to benefit from the changes we’ve made to reduce professional liability claims, but we are not going to have the same benefits over the back half of the year that we saw in the second quarter.

[Ralph Giacobbe:]

Okay, alright thank you.

[Operator:]

Thank you the next question is from Bill Quirk with Piper Jaffray.

[William Quirk:]

Yeah thanks, good morning guys, was wondering if you could comment Surya just on the recent FDA meeting on laboratory developed test, what that means for Quest, and how we should think about some of your own laboratory developed tests that you are going to be looking at moving to a manufactured kit or would you actually consider taking some of your products to FDA, thank you.

[Surya N. Mohapatra:]

Now that’s a good question, our goal is the same as FDA goal we want to really create Test which are clinically tested and analytically valid and the only concern we have and we are working with our trade association and working with FDA that most of the test are laboratory developed test which brings innovation to the market place and we are regulated by clear and if we are not careful we don’t want FDA to over regulate us which will stop innovation and also not bring test to the market place so we are working with them to make sure what test are risky and obviously it has been exaggerated because some of these companies none are providing genetic testing. So I believe that we’ll come to a place where there will be a balanced between laboratory producing not very high quality test and the test which are not validated and the test which are high risk verses the majority of test which are safe and helping patients. Now as far as our company is concern we are very fortunate that we have lots of experience in creating products like H1N1 and other tests which we know how to go through the FDA, so obviously what about the position FDA takes we are very well positioned with the laboratory developed test and the test which might become caves because of our experience to focused diagnosing.

[William Quirk:]

And so just as a quick follow up Surya, is it safe to say it is little too early from your perspective to start ticking down a list of what test we might transition to a kit verses what we might take to FDA.

[Surya N. Mohapatra:]

It is too early and I think there’s quite a bit of work to be done and I think FDA is having this hearing and we are working with them.

[William Quirk:]

Okay, very good thank you.

[Operator:]

The next question is from Tom Gallucci with Lazard Capital Markets. Tom Gallucci - Lazard Capital Markets. Good morning thank you, I guess I was just hoping we could maybe frame the manage care renewal issue a little bit more. Bob can you talk a little may be what percent of the business was renewed so that we can understand the magnitude of the impact here.

[Robert A. Hagemann:]

Well to give you a sense over the course over the last 18 months or so we have renewed the vast majority of our manage care business. All of the large plans and as I said we have very little coming up in the second half of this year we have a negligible amount coming up in 2011 and as I look at 2012, and even 2013 the amount that is coming for renewals in those periods is significantly less than we would typically have in any one year.

[Tom Gallucci:]

Okay.

[Robert A. Hagemann:]

So we’ve renewed this for generally 3 to 5 years periods, or extended them for generally to 3 to 5 years period and as Surya said it give us very good visibility in to what reimbursement is and takes the uncertainty out of having to go through contract renewals and determine whether you are going to continue to be on contract. Tom Gallucci - Lazard Capital Markets. I guess just, go ahead.

[Surya N. Mohapatra:]

I mean this is Surya. One of the most important things you are to know that we feel very strong and very confident in this proactive strategy to get all the manage care contracts behind us and that gives the opportunity to do work with the manage care plans, work with the [Leekays] and work in the market place selling our valid propositions rather than always getting worried about the uncertainty of the manage care contract expiration. So I feel personally this is really a great achievement for us this is really positioning our company in a better place than ever before.

[Robert A. Hagemann:]

And Tom I just add one thing to as you think about manage care the real opportunity continues to be to work with the plan to drive more volume in network to lower cost providers like ourselves. Tom Gallucci - Lazard Capital Markets. Right, I guess I understand sort of all the positives I am just sort of curious how you are viewing the competitive landscape, if it we are sort of renewing things and that equals visibility, but it’s on lower reimbursement apparently. I guess how do you sort of see the competitive environment and how do you sort of see - how were you thinking about the risks that were out there that made you want to sign a contract early at a lower price.

[Surya N. Mohapatra:]

Well first of all its all about bringing stability to the market place, few years ago we went through a situation where the market was unstable and we had to do what we had to do to establish our position and bring back the market to stable condition. And yes every manage care contract is different and when you have multi year contracts you give some concession, but you also count on increasing you volume and I think the only reason why you see this price decrease this quarter because obviously there is a slow down in the volume. But when I look at the competitive landscape, first of all it’s the same as before but we have taken out a major uncertainty out which will help us move forward working with them to improve, reduce that and improve our volume. So I think in the long run this is going to help us more and I think the competitive landscape is more stable now with this contract singed.

[Tom Gallucci:]

Okay if I could just ask you two more things about this Bob you mentioned in the last 18 months you renewed a vast majority, but we saw an incremental pressure in this quarter, so was there a lot that started during the quarter or at the beginning of the quarter or can you just make us understand why all of a sudden we are starting to see and I guess the other aspect of it is what are you seeing out there in terms of exclusive verses none exclusive type contracts, thank you.

[Robert A. Hagemann:]

Okay, well first let’s remember that the change in revenue per requisition from Q1 to Q2 was not significant it was about 1% so and typically the change from any one quarter to the next quarter is not significant. Driving the change with Q1 to Q2 was business in paramedics as I mentioned so that’s about half of it and only about half of it were the contracts price changes that went into effect in this quarter. |Now as I said we had some renewals last year and some cases they were price adjustments on those as well but they’ve already been reflected in our numbers. What makes the revenue correct change in the quarter stand out is really have the comparison to the prior you change between Q1 and Q2.

[Tom Gallucci:]

Okay.

[Robert A. Hagemann:]

There was essentially a 2.6% swing comparing with a 2.3% increase that we saw on Q1 with a 0.3% decrease that we see this quarter and 1% is the absolute change in revenue per requisition in Q1 to Q2 if that I just explained.

[Tom Gallucci:]

Okay.

[Robert A. Hagemann:]

The main year is principally due to easier comps in Q1 verses the prior year and at this point we are expecting the revenue per requisition to be relatively stable over the course of the rest of the year and in to the early part of next year.

[Tom Gallucci:]

In terms of absolute dollars.

[Robert A. Hagemann:]

Correct.

[Tom Gallucci:]

Right, and just about exclusivity verses non-exclusivity there was some talk about Empire and some others out there.

[Robert A. Hagemann:]

Look, I think each plan has a different view as to what they’d like to archive some obviously like broader network some have used some broader networks and in each case we try to work with the plan to help them accomplish what there goals are and I would tell you that we do have opened contracts where we are very comfortable competing for business in open networks will be very effective where we’ve had that and we expect to continue to be effective.

[Tom Gallucci:]

Okay, thanks guys.

[Operator:]

The next question from Amanda Murphy with William Blair

[Amanda Murphy:]

Hi good morning, just another sorry another question on this mange care situation I’m just it sounds like you’ve been sort of pursuing a proactive renewal process for some time so I’m trying to get a handle on what changed since you gave guidance the last quarter for revenue is it or was it reduction in guidance driven primarily by volume this quarter.

[Robert A. Hagemann:]

Amanda the changing guidance is due principally to our change in out look for volume. We did not anticitipate the further slow down in patient visits and we expected frankly that some of the plans that we’ve put in place would have delivered more at this point.

[Amanda Murphy:]

Okay and then just how have you gone through this process just following up to a previous question were there any new contracts that you obtained that you did not have before.

[Surya N. Mohapatra:]

Well we had a new hospital contracts Novation, we extended premium contracts and also Kaiser Health so that hospital business is doing well and we are gaining ground there. And again about the manage care contracts and working with the manage care our relationship with the manage care organizations are good and as Bob we are working with the needs and what I feel very excited about is that we don’t have those worries for the next 2 or 3 years.

[Amanda Murphy:]

Okay, and then just last question you gave us some color on esoteric side of the business I am curious, could you specifically to [antonic] pathology how that business is performing maybe relative to last quarter is it sort if getting better or worser or worser or the same.

[Robert A. Hagemann:]

Well Amanda as I said earlier we saw a continued softness there and actually a little more than we had the first quarters and that was one of the contributors to the change in revenue per requisition again that business is more often a little more because if we continued in-sourcing, Harry’s higher revenue per requisition. On flip side we saw growth, drugs of abuse testing there is this which carries lower revenue per requisition so again that was one of the dynamics that you saw going on this quarter.

[Amanda Murphy:]

Okay thanks a lot.

[Operator:]

The next is from Ricky Goldwasser with Morgan Stanley

[Ricky Goldwasser:]

Yeah, good morning.

[Surya N. Mohapatra:]

Good morning.

[Robert A. Hagemann:]

Good morning.

[Ricky Goldwasser:]

I have a few thought questions first of all just to clarify for modeling purposes, on the average revenue per requisition Bob you were saying that in absolute dollar terms revenue per requisition is going to be stable in the second half of the year, but the metrics that you provided us in your report is a growth rate so from a growth rate perspective what should we expect in second half of ‘10 about the pricing metric.

[Robert A. Hagemann:]

Now Ricky as you know we don’t give the components of revenue guidance in terms of revenue per requisition in volume what I would tell though is that I don’t expect the variance from the prior years to fluctuate much more than a percent either way.

[Ricky Goldwasser:]

But again just to clarify if you think about the prior year, when you are saying that the variance is not going to fluctuate by more than 1% for example in Q3 of 09’ you recorded a 4.3% year-over-year growth number, so when you are saying that its not going to fluctuate, its not going to fluctuate from the growth rate or its not going to fluctuate from the absolute price number in the first quarter which you really don’t provide us.

[Robert A. Hagemann:]

Ricky I think I gave you the answer to both of those I said that the absolute number we don’t expect to change significantly over the course of the year and we expect that to result in a variance for the prior year which is generally not more than about 1% .

[Ricky Goldwasser:]

Okay Bob, let me ask you the question differently, if you look back in 2009 and you look at the pricing number the revenue per requisition in the absolute dollar value right you think that its 3Q 09’ on an absolute dollars basis was higher or lower than 2Q 09’.

[Robert A. Hagemann:]

Ricky I would expect that we are probably higher now but I don’t have the data as you know that’s not a metric that we disclose.

[Ricky Goldwasser:]

Alright we can turn back at the call but it really is not what it is now its more of what it was last year because if you just give us kind of like just the direction in whether 3Q 09’ revenue per requisition was higher or low in Q2 09’ revenue per requisition I think that would be just very helpful in helping us model the second half of the year but we can take that offline.

[Robert A. Hagemann:]

Okay.

[Surya N. Mohapatra:]

Okay.

[Ricky Goldwasser:]

The other question is again when you think about your top line guidance for the year what percent of the guidance provision is related to the changes of pricing verses volume.

[Robert A. Hagemann:]

Ricky as I said earlier the majority of it is related to our change in outlook for volume there is a little bit in there in terms of revenue correct but its mostly driven by the mix changes, certainly all the contracts changes we had anticipated and had built in to our earlier values.

[Ricky Goldwasser:]

And then finally just in terms of the contracts most of these recent contracts extensions are there scheduled renewals or are they kind of like midterm renewals due to a competitive environment because if I recall correctly last time we went through a large contract cycle with the 2007, 2008 period back then you guys said that most of the big contracts goes five years in turn which would take us to 2012 so was there something that was out of the normal cycle.

[Surya N. Mohapatra:]

First of all Ricky as I said this is a pro-active strategy we work with the health plans and yes it is pro-actively extended before its due cycle.

[Ricky Goldwasser:]

With the schedule cycle.

[Surya N. Mohapatra:]

Well we extended before its expiration

[Robert A. Hagemann:]

Ricky it’s a combination of both, we always have contracts coming up but it many cases as Surya said we were pro-active in extending contracts way before they were coming up for renewal.

[Ricky Goldwasser:]

Okay that’s very helpful thank you very much.

[Operator:]

Thank you, the next question is from Darren Lehrich from Deutsche Bank

[Darren Lehrich:]

Thanks good morning everybody, I guess I just wanted to follow up one more on the manage care contracting effort especially with regard to terms and we went through obviously a cycle post 2007 when there were escalators built into the contracts at various times, I am just trying to get an understanding seems like you reset some of your contracts lower or do we still have a period of time during the 3 to 5 year cycle where we are going to see positive escalators or have you built in negative escalators. Can you just give us the general frame work for terms?

[Robert A. Hagemann:]

Darren, I think we’ve said historically every contract is are little different certainly some of these we have escalators built in, others we may have further volume discounts built in to it, but in each case you know as we think about the opportunity with these health plan contracts, the real sizable opportunity for us is to drive more work into network, and the other health plans and employers are much more receptive to that than they have been in the past and I think that’s the opportunity that’s now created for us with these extensions because we have long term relationships locked up. We can begin to effectively develop plans that we can execute over the next several years to drive more work in networking and as Surya said drive volume for us.

[Darren Lehrich:]

So if I’m to understand what you are saying, in just comparing the last three years to perhaps the next three years relative to the batch of contracts, the last 3years could be characterized by slightly positive escalators on balance as you look at the manage care book and the next 3years the focus is more about volume and driving in networks as opposed to positive escalators, is that a fair statement?

[Robert A. Hagemann:]

Darren, I’m not sure that if I look back over the last few years I would characterize those renewals as having lots of positive escalators in them, I think that the opportunity that we saw now to extend contracts was similar to what we had in the past, but this was much more proactive I will tell you and given the uncertainty across healthcare associated with healthcare reform we felt that this was a very appropriate thing for us to do.

[Darren Lehrich:]

Ok, and if I could just switch gears to some of the comments you made with regard to service and some of the focus you’re making in terms of enhancing your PSE networks et cetera, it would seem to me that that may actually be investment in the business and so I’m just wondering how that plays out in the back half of the year, have you made these investments and can you just frame that a little bit more for us, how much are you expanding your network and how many (inaudible) just on a percentage basis, are you increasing to improve your service levels?

[Robert A. Hagemann:]

Danny, here is what I will tell you, first of all the investments that we’re making and plan to make over the remainder of the year are fully built into our guidance, and also the investments that we are making in sales and service are designed to accelerate growth. So these are all investments in growth, there is still a big part of the business that has opportunities for us to continue driving efficiencies which we’ll continue doing there. So as I think about it, yes there are investments in some areas they’ll increase costs but we fully expect them to be items that will help us accelerate growth as well.

[Darren Lehrich:]

Ok, and then if I would just ask a question I think I know the answer but I think helpful to get a media look at your revenue by product category just in broad brushes of growth rates, it’s very difficult for us to assess what’s really driving your revenue trends by product category especially with all the changes in drugs as abuse and would appears to be a pretty big slow down in AP. So I don’t know if you are willing to do that here but I think it would be useful for us just to in broad strokes give us a sense for where this product categories have trended on year to day basis in percentage terms.

[Kathleen Valentine:]

Darren, this is Cathleen. What I can tell you without giving you the explicit percentages is that team basements into our testing grew nicely and through in the quarter and through the first half. Our drugs produce business is growing up, is growing and as you heard AP is trending down. So that should give you some nice color in terms of how those businesses are performing mid year.

[Robert A. Hagemann:]

We did give some color in my prepare remarks that the drugs of abuse testing business volumes grew about 5% or so.

[Darren Lehrich:]

Right and so AP was down 1% roughly last year on an annual basis; it’s fair to say that got worse in both the first and the second quarter relative to that figure.

[Robert A. Hagemann:]

That’s true, yes.

[Darren Lehrich:]

Ok and I guess my last question will be for Surya and I’ll jump off but I just wondered – seeing your comments on MNA obviously that’s still a priority in terms of growth in deploying capital but I think what you said Surya was when MNA is not available you’re going to pursue buy back, you’ve now been three quarters pursuing buy back very aggressively. So I wanted to understand what sort of underneath that of that action which is a statement as well, is it about pricing in the MNA environment? Is it about availability of assets? What is it that’s keeping you on the sidelines?

[Surya Mohapatra:]

Ok, well it’s not keeping me on the sideline, we are a very active participant in the MNA market. What we are not going to do is get anxious buyers and as you know as Bob said that our top line growth does not include acquisitions, so it’s all organic growth. But our growth strategy has not changed, we have organic growth and inorganic growth and we are looking for acquisitions which make sense to us and it has to be either immediately accretive because it is scale and it is scale audit, we buy capability which is a long term strategic acquisition in cancer, cardiovascular disease and infectious disease. So we look at acquisition very careful, we are a disciplined buyer and when we don’t get then we know we return shareholders, return cash to share holders through share buy back and we have done those things with dividends. So our philosophy has not changed, and we continually look at what is available in the market place.

[Darren Lehrich:]

Ok, thanks a lot.

[Operator:]

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

[Kevin Ellich:]

Good morning, thanks for taking the question. Just wanted to clarify and Bob you gave a lot of good detail, but I just wanted to clarify the contract pricing, that’s not new, that was something that was previously in your guidance?

[Robert A. Hagemann:]

Correct, that was all baked into our previous guidance, there were no surprises there.

[Kevin Ellich:]

Ok, I understand and then on the volume side with the weaker position offices being the primary corporate for the lowest guidance, is any of your lower volume attributed to the contract changes like empire BlueCross BlueShield?

[Robert A. Hagemann:]

No, it’s not again, we recognized earlier on when we did the last guidance step that it was going to be an open contract so any potential changes their were built in, all those I told you, we feel very comfortable competing in an open contract and getting our fair share, not more than our fair share of the work here.

[Kevin Ellich:]

Ok, and then Surya, maybe could we get to your updated thoughts on the anatomic pathology and the histology pressure, I mean that’s been something that’s been persistent for a while with the in sourcing by position, where does this stand with the government? Are you expecting them to do anything and what can you do?

[Surya Mohapatra:]

Well, again a very good question. First of all cancer is a growth area and we have invested a lot in cancer and we know that this is going to help us to go in the market place. Now as far as AP reduction, as you know and having a lot of in sourcing both TC and PC and we are working with a number of Trade Association, American College of Pathologists and we know that when it’s in sourced the utilizism has grown up. So we are working with the Trade Association and we’ll work with the government to make our case because to do in sourcing and to have over utilized and is not good for the patient and certainly not good for our business. So we are very actively involved in this thing to provide appropriate data.

[Kevin Ellich:]

Okay and we don’t have any expectations or time frame as to when something might happen?

[Surya Mohapatra:]

Well these things takes time, but I know that it is a short term, it’s a temporary issue and we are putting proposals but it will take some time but I am very confident that it is going to be fixed. One other thing I want to add about the volume because 80% of our business comes from the doctor’s office, and as you know our volume this quarter was down by 1.3% but the doctors’ office visit was down by almost 4.5%, so obviously that has really affected us and that’s the reason why we have this four point plan to reverse the trend by increasing our sales and service and frankly going up to market share.

[Kevin Ellich:]

Got you, and do you think you know, I know that there is a question about competitive landscape, have you seen increased competition from hospital, outreach programs or where do you think that stands now?

[Surya Mohapatra:]

I don’t see any changes, in fact I see two different path, one, many hospitals those who have outreach business they want to monetize their business because they want to invest money by buying other hospitals or consolidating buying practices. So just like in the Boston area we worked with the [Caritas] hospital, so they are in outreach business, they monetize it, they got the money to improve their hospital and now we are helping them in IT and their reference testing. So one CIA, one aspect I see that the people are coming to really monetize that outreach. The other one I see that a number of hospitals are buying private practices so obviously some of them slowly forcing them to provide laboratory testing to them, price believe that that is also going to be temporary because they have to invest money if they grow; so nothing major change yet.

[Kevin Ellich:]

Understood, and then thinking about the acquisition market and the international market, just wondering where your thoughts lie in terms of expanding more broadly internationally.

[Surya Mohapatra:]

Well, we have our hands full at the moment in the US and the whole management attention is to revenue, growth and reverse the trend and we are not very happy with the second quarter results, we did not perform the way we wanted to. So almost all of our attention now is on revenue. Now having said that, we have some medium term and long term investments as you know in other businesses and one of them is India and we are focused and I think medium term it will produce, it will give us better results and but at the moment we are just focused in the US.

[Kevin Ellich:]

Ok, and then just one last follow up to Bob, going back to the contracting with manage care or something, I just want to make sure that I get this right, you guys are not seeing pricing pressured from the manage care company?

[Robert A. Hagemann:]

I’m not sure how you can conclude that based upon what I said. Now we absolutely are. I think every provider in health care is under pressure to reduce their cost and we are working with the plans to help them achieve their goals of not only reduce cost but in some cases broader access.

[Kevin Ellich:]

Understood, ok thanks guys.

[Operator:]

The next question’s from Anthony Vendetti with Maxim Group.

[Anthony Vendetti:]

Thanks, so most of the questions about I think volume have been answered, but can you just talk about the fact that drug and abuse testing trended up which is positive. Do you think that this is the beginning of a positive trend in terms of drug and abuse testing and do you believe that the impact of unemployment has stabilized to bottom down here moving forward?

[Robert A. Hagemann:]

Anthony, I want to be careful in speculating to what this means to the broad of the economy and the like. We are encouraged by the fact that we did see an uptake there and certainly some of it is as a result of improved hiring, although as everybody knows, that’s not ramping up the way most people had hoped. So I see it as a positive indicator but I think it’s too early to tell whether or not it’s something sustainable and bodes well for the broader economy at this point.

[Anthony Vendetti:]

Ok, and then on the contracts, can you -- by saying that those significant contracts are up for renewal in the next 18 to 24 months or not even major ones in 2012 or 2013, can we infer that the [Ecna] contract has been extended and if so is that still on a somewhat exclusive basis where [Lab Corp] can’t be used?

[Robert A. Hagemann:]

It has been extended for multiple years, at this point that was extended last year and we will maintain our position as the exclusive national laboratory on that contract.

[Anthony Vendetti:]

Ok great, and in the past you’ve talked about the international expansions, are those expansions that you’re looking at internationally both internally and externally?

[Surya Mohapatra:]

Well as I said that at the moment apart from the work we are doing in India and Ireland clinical trials, we have no major plan for in any international expansion in the rest of the year.

[Anthony Vendetti:]

Ok, and just in terms of the hospital business, I know you said some of them are trying to monetize what they are doing, but where are you seeing that trending towards, are they trying to hold on to more of that business or you know or are they looking to outsource it, are you providing, you’re providing that service that they find attractive enough to do that? Or are they really trying to hold on to that business? Where is that moving in your view?

[Surya Mohapatra:]

Well I think like all of those hospitals are also looking at what will be their poison when the health care reform is fully implemented? So some hospitals over the years have been buying medical practices. That doesn’t mean that all of those practices are sending the results to them. Some hospitals have done outreach but as you know some of them are selling those things because they don’t want to invest more capital. So I think we see a number of ways to work with hospitals, first we help them in reference testing business, second we can really buy that outreach business and provide them healthcare, IT to improve their relationship with the community and the third sometime we provide support for their quality and efficiency lot. So hospital is a major player in this market and I’m glad we are doing well and we are building a relationship with them .

[Anthony Vendetti:]

Ok, but that right now is only about 20% of your business, right?

[Kathleen Valentine:]

Yeah, it’s a little less

[Anthony Vendetti:]

Okay.

[Surya Mohapatra:]

But it has grown

[Anthony Vendetti:]

Okay great, alright thank you.

[Robert A. Hagemann:]

Next question.

[Operator:]

Thank you. The next question is from Adam Feinstein with Barclays Capital

[Adam Feinstein:]

Okay thank you, good morning everyone. Maybe just back to a comment you made about the doctor office visits, you said they were down 4 to 5%, was just curious what data source you’re using for that, just want to be sure I heard that correctly in response to question Surya you made reference to it.

[Surya Mohapatra:]

We use IMS data and some analyst report also, bur IMS provides the doctor service visits.

[Adam Feinstein:]

Okay, and I guess just going into that point in more detail, I mean what are you hearing from doctors and I mean this is clearly weaker than what it typically is, it tends to be pretty stable. So what are you guys hearing in the field? I know your guidance witness fairly incorporate any sort of big tick up, but clearly since it’s more of a temporary issue but curious to get your thoughts, do you think we could have this sluggish visits for the next 12 to 24 months and just curious any feedback you guys are hearing.

[Surya Mohapatra:]

Well first of all we are using the doctors’ visits as a proxy for what is happening in our volume because we don’t have the data, but we know that 80% of our business comes from the doctors’ office and I think what we hear and what we see and we don’t know exactly what the reason why people extended have their visits between the frequency of the visits have been reduced. But having said that esoteric and gene based testing has grown. So I think the impact is in the routine testing and to be perfectly honest am glad that we started a diversification going towards our esoteric and gene and AP 4 or 5 years ago and we have invested money and we are growing. So there is no slowness, no significant slowness in gene and esoteric based testing , there is some delay in the routine testing.

[Adam Feinstein:]

Ok, alright and just to follow up on the pricing side and Surya I know you talked about it a lot, sorry to go back into it, but I guess just to frame it here, I mean we went through a big industry reprising in 2007, it was a big overhang issue and then as fairly things were very stable in 2008 and 2009 and even through the beginning of 2010, just from hearing your comments now I mean certainly you guys are being more proactive in trying to go out to renew contracts but clearly it sounds like the pressure has picked up which shouldn’t be a shocker with some of the issues in manage care here, but I guess it just kind of, the feedback has been very positive around the manage care landscape and it sounds like that changed pretty fast. So once again if you think about it that way I guess the catalyst for the change here, just curious to get some of the additional feedback there.

[Surya Mohapatra:]

Ok, well first of all it did not change fast, it is a very organized proactive strategy from Quest Diagnostics to really create a stable market for the industry and for us, but with the healthcare reform of the background, we had an opportunity to do work with the health plans like they are working with us, and we are all working together and that gives us an opportunity to drive the strategy and to take all this uncertainty away. Now having said that as Bob said there is always personal pricing, but it doesn’t really matter the results of the rest of the laboratories. These uncertainties are not there because there’s always this issue which national player are going to exclusive and non-exclusive. Now it is more or less for us, it’s a very stable industry and it’s a very stable market and we are now posting [inaudible]. So I don’t want you to understand that there is this pressure going up and it is hitting, it’s not actually. It’s actually you are now realizing because these things are now effective.

[Adam Feinstein:]

Okay so Surya if I can just go back there so you are saying we shouldn’t view this the way we would have viewed 2007 in terms of what was happening with industry pricing during that time period.

[Surya N. Mohapatra:]

Not at all.

[Adam Feinstein:]

Okay, alright. And then just finally and I know you guys don’t comment on contracts typically, but there has been a lot of focus on this Empire contract, a few people have asked about it. Can you say anything about that contract just and clearly it would be helpful since there has been a lot of chatter about it.

[Robert A. Hagemann:]

Yeah, alright I did mention something briefly before Adam that with Empire they were looking to broaden their network, we worked with them to help them achieve that. Not all the payers go that route some like more restrictive networks and in this case Empire felt that it would make their network more attractive by having it broader and we worked with them to put now a new long term contract in place that provides that to them. And as I said earlier we feel very confident that we can effectively provision this in open contracts.

[Adam Feinstein:]

Okay, great. Alright thank you very much, appreciate it.

[Surya N. Mohapatra:]

Thank you.

[Operator:]

The next question is from Kemp Dolliver with Avondale Partners.

[Kemp Dolliver:]

Alright, thanks and good morning. A couple of questions again mainly around your thoughts on manage care, but first are you making any different assumptions about what you can do with prime mix on these contracts versus prior contracts.

[Robert A. Hagemann:]

It’s not prime mix per say, as I said earlier the plans and employers now are much more willing to take action as to drive work in network to lower cost providers like ourselves and that’s what the opportunity is with these health plans. Is to work with them and the employers to design approaches that will drive more work in network and obviously we will then be the beneficiary of that.

[Kemp Dolliver:]

Any data with regard - the subject of in network, out of network has been around I think as long as I’ve been covering the industry, but I haven’t heard any data with regard to say how much business is out of the network now versus what may have been out network 5 or 10 years ago. Do you have any thoughts on that?

[Robert A. Hagemann:]

I would tell you the vast majority of our business is contracted and as a result this whole effort by health plans to drive more into network I think is going to be a significant positive to us. I would tell you that it’s probably in terms of – in network out of network not significantly different than it was a number of years ago although I don’t have good data at my fingertips to validate that.

[Kemp Dolliver:]

Okay, good and how is this going to manifest itself because you’ve made these renewals, most people don’t go into new enrolments. The enrolment cycle for the individual doesn’t kick in until January 1st, there is talk of intra – here at least the plans are pushing narrow networks and the like, but that’s such a sea change from where employers have been for the last you know decade or so. What do you really – I guess what are the things we are likely to see with planned designed and the like that would make this a balanced strategy for you.

[Robert A. Hagemann:]

It’s hard to say and it’s continuing to evolve, but you’ve probably seen some of it already in terms of increased co pays in deductibles for out of network services, sometimes no co pays of deductibles for in network. There are also incentives to drive employees in networks. So I think yeah every employer has a slightly different approach, but those seemed to be genera themes that you see.

[Kemp Dolliver:]

Okay, super and one more mundane question is on what – how did your non clinical testing business perform this quarter?

[Robert A. Hagemann:]

As we said revenues were essentially flat with the prior year in this quarter. Some of that, the point of care testing business is affected by the same things that impact the laboratory testing business.

[Kemp Dolliver:]

Okay, currency any significant factor?

[Robert A. Hagemann:]

No, we would have broken that out if it was.

[Kemp Dolliver:]

Thanks, very much.

[Operator:]

The next question is from Gary Taylor with Citigroup.

[Gary Taylor:]

Hi, good morning.

[Surya N. Mohapatra:]

Morning.

[Gary Taylor:]

A few different questions, various topics and I appreciate your patience because I am going to go back to the prime mix thing I just want to understand that a little better. So what we saw in the 2Q here sequentially with the proactive renewals, was this a single sizeable thing? Was this several contracts or one big contract and other small ones or a few small ones, can you help us understand that?

[Robert A. Hagemann:]

As I said there are several contacts that are impacting the comparisons to the prior year. In the comparison to the prior quarter we are only talking about a 0.5% change.

[Gary Taylor:]

Correct, but is it still sequentially they were renewals or -.

[Robert A. Hagemann:]

Alright, we had one going to effect April 1 that drove much of the difference between Q1 and Q2.

[Gary Taylor:]

And I guess I’m just trying to think about the math, down 1% sequentially half of that related to contract renewals for about 50 basis points, but manage care is about half your revenue so if you had for example 10% of your manage care both renewing down 10% that would be about 50 basis point of pricing pressure on your overall revenue per session, but it doesn’t sound like you are down 10 – I’m just ball parking. But down 10 would be a pretty sizeable reduction, it doesn’t seem like you’re – I’m sure you don’t want to get into sort of discounts that you’ve given, but I’m not sure it seems like you are characterizing the way a great environment is, is that adverse. So can you help me kind of think about how a couple of contracts skew the whole book 50 basis points sequentially. Am I doing my math wrong?

[Robert A. Hagemann:]

Well if you think about what 50 basis points is on our book of business, that is in the range of $30 million or so on annual basis so that gives you some sense s to what the impact is in the quarter. I’m not sure what else I can share with you.

[Gary Taylor:]

Yeah, it’s a small number overall, but if only a small amount renewed it seemed like I guess a big hit for the percent is then renewed.

[Robert A. Hagemann:]

Yeah, I guess what you have to recognize now is as we said these big renewals are all behind us; these big renewals and extensions so in terms of going forward we feel as though we have very good stability in revenue-per-requisition. I think what continues to drive changes in revenue-per-requisition you know on the positive side we got the gene-based and esoteric testing continuing to grow. Potentially on the negative side we continue to have makeshifts, right.

[Gary Taylor:]

Yep.

[Robert A. Hagemann:]

So, those I think will be the two drivers of revenue-per-requisition going forward and much less you know contract changes and pricing changes associated with that.

[Gary Taylor:]

Is it, I guess because it’s there so these renewals have been ongoing for a year or so or more and maybe we’ve missed some of that impact because of other things influencing revenue-per-requisition. Is it fair to say that, that renewal on April 1st was I guess the worst because it’s really the only one filled out.

[Robert A. Hagemann:]

Gary I’m not going characterize that for you.

[Gary Taylor:]

Yeah, and then you have talked about your forward view a little bit, I guess maybe looking beyond what you said about the rest of the year are on a dollar basis per requisition looking pretty stable as we just kind of think about the next 2 or 3 years most of the commercial books is locked in. right now unless PPI picks up Medicare is down slightly some of your commercial contracts have some escalators some don’t. So looking out the next 2 or 3 years is there reason to feel that worse than relatively stable is the right way to characterize that or is relatively stable probably the right outlook right now.

[Robert A. Hagemann:]

Yeah, well again I want to be careful not to give long term guidance on revenue-per-requisition, but here are some of the factors that are going to drive it. I think Medicare, certainly next year we expect to see a further reduction in Medicare reimbursement and I think you’ll understand that the way that Medicare reimbursement will work over the next several years or so is that there will be CPI increases they will be off set though by productivity adjustments which can’t take them down below zero. And then whatever that number is will be reduced by 1.75% over the course of the next 5 years or so.

[Gary Taylor:]

Alright.

[Robert A. Hagemann:]

And then, the positive drivers of revenue-per-requisition are going to continue to be test mix, gene-based and esoteric testing and probably increased utilization so increased number of tests ordered per requisition. And then we always have the mix of business that can influence it one way or another.

[Gary Taylor:]

Real quickly any chance you could characterize how big of a business Empire is for you right now.

[Robert A. Hagemann:]

We do not give specifics on any particular contract.

[Gary Taylor:]

Okay, last question can you just help us on ending basic included obviously we have the average share count in the release, but just for modeling you have ending numbers right there.

[Robert A. Hagemann:]

It should be right on the balance sheet.

[Gary Taylor:]

Okay.

[Robert A. Hagemann:]

Underneath the balance sheet you can do the math there right just looking at the issue less the amount treasured to get to the outstanding number.

[Gary Taylor:]

Okay, alright thank you.

[Operator:]

Our next question is from Gary Leeberman with Wells Fargo.

[Gary Leeberman:]

Thanks for taking the question. I appreciate all the comments around the pricing, I guess I’m still struggling to understand though how the strategy of effectively competing on price with the contracts is going to bring more stability to the market place, because the history of it is it does the opposite and so I guess just help me understand how it actually brings stability to the market place.

[Surya N. Mohapatra:]

Gary this is Surya, first of all having extended contract guarantees us the access to the market place. Knowing that what the healthcare reform is going on and the changes and we want to just make sure that we have long term contracts and we work with health plans. So the first of all is the worry about who is the national player, who will play the worry about actually how do you really work with the health plan goes away because we don’t have those contract renewals. Now as far as pricing is concerned as you know some contracts will have escalators some contracts will not, but the most important thing is now the employers and the health plans are working with us and with the industry to drive more business to network. So these things what we are talking about here today would not have been relevant if our volume would have been higher. So obviously we feel the stability is here because we – now we are in computer based and value properties and we know what the pricing is, we know what we have to do to increase our market share, increase our volume and that’s the reason why I said I feel pretty strong about the next couple of years. Not worry about Medicare contract renewal or something.

[Robert A. Hagemann:]

There is a big difference between pursuing exclusive arrangements with very low price and extending arrangements and locking up access over a period of time.

[Gary Leeberman:]

But my fault to that point would be it’s a competitive market place so it’s great that you guys have open access to the contract, but others will as well and what’s preventing them from competing on price as well and then don’t you guys go down or risk going down, sort of the spiral that hurt the industry in past.

[Surya N. Mohapatra:]

Well that has been there all the time there is always what you call negotiation with the Medicare or hospital and everybody is looking for price, but as I said that having major contract negotiated and as Bob said not going for the lowest price to get the contract and extension is actually a much safer and much better than not having the contract.

[Robert A. Hagemann:]

And Gary just to be clear, pricing historically in many places by competitors had been used to gain access and limit our access. Once multiple providers are on contract their pricing is set by contract at that point and then you are principally competing based upon service. So you really are not – the only time you are competing on price really at the end of day is when you are competing for access to the contract.

[Gary Leeberman:]

Okay, so I guess would it be safe to say you don’t believe you are the lowest cost provider, but you are just competitive so there is less risk to kind of a pricing instability here.

[Robert A. Hagemann:]

Well as I said we are one of the low cost providers on contract and yeah as a result when you think about out of network spending what goes to hospitals, what goes to non contracted laboratories which is often at rates 2 to 3 times what we contracted at which is a real incentive for the health plans and for employers to drive more work in network. The other thing I would tell you is when the work is going to contracted providers usually the data that flows back and forth between the provider of the health plan and the employer is much better and as they are looking to do things with Wellness plans and disease management and the like that’s another advantage that in network providers get health plans on employers.

[Gary Leeberman:]

Okay, thanks a lot.

[Operator:]

Our final question will come from Robert Willoughby with Bank of America/Merrill Lynch.

[Robert Willoughby:]

Thanks, Bob or Surya you guys don’t break out your volume trends by segment on a quarterly basis as your competitor does, but I have to believe your histology trends are probably similar and I guess with the Ameri Path deal making pathology a much bigger part of business if that’s not growing isn’t that a more challenging situation for you I mean much of the guidance per revenues going forward reflects that histology volume continuing to decline and how do you stop it and do we revisit that Ameri Path deal and is there anything tangible associated with it that might be impaired.

[Surya N. Mohapatra:]

Well, first of all it is really unfortunate that what’s happening in the market place is not good for the industry not good for the patients because the TCNPC internalize is driving over utilizing so we are working with the trade associations and I hope that it’s going to – there will be some legislation or probably change, but meanwhile we are actually having difficulties because that trend has gone down, but we have taken that into account in our guidance. And the other thing we are trying to do which is combining the histology with molecular diagnostic, but we have included the deterioration of the histology market in our guidance.

[Robert A. Hagemann:]

And Bob we are not anticipating any impairment charge.

[Robert Willoughby:]

What we vision today though is that reflecting another step down in that business or was that anticipated also at the beginning of the year?

[Robert A. Hagemann:]

It does reflect a little further softness than we were expecting at the beginning of the year.

[Robert Willoughby:]

And I guess on the Empire deal that folks have mentioned I mean it isn’t exclusive going to an open contract so there will be some losses associated here and some of your competitors have positioned themselves in the market with acquisitions. Can you give us any sense of -- I mean you just said you’ll compete for your fair share of business, but you are losing something here. Any magnitude that you can or what have you assumed losses would be.

[Robert A. Hagemann:]

Bob, yeah as I said yeah and I’ll repeat I think we feel very good about competing in the market place to the degree that there is any change in volume associated with now further access to the contract by others we’ve built that into our guidance.

[Robert Willoughby:]

Okay, that’s it. Thank you.

[Robert A. Hagemann:]

Thank you.

[Operator:]

And thank you for participating in the Quest Diagnostics second quarter conference call. A transcript of prepared remarks on this call will be posted later today on Quest Diagnostics website at www.questdiagnostics.com. A replay of the call may be accessed online at www.questdiagnostics.com/investor or by phone at 866-350-3614 for domestic callers. Or 203-369-0039 for international callers no access code will be required. Telephone replays will be available 24 hours a day beginning at 10