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Quest Diagnostics (NYSE:DGX)

Q2 2012 Earnings Call

July 19, 2012 8:00 am ET

Executives

Kathleen Valentine - Director of Investor Relations

Stephen H. Rusckowski - Chief Executive Officer, President and Director

Robert A. Hagemann - Chief Financial Officer and Senior Vice President

Analysts

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

Kevin K. Ellich - Piper Jaffray Companies, Research Division

Dane Leone - Macquarie Research

Ricky Goldwasser - Morgan Stanley, Research Division

Gavin Weiss - JP Morgan Chase & Co, Research Division

Gary Lieberman - Wells Fargo Securities, LLC, Research Division

Ralph Giacobbe - Crédit Suisse AG, Research Division

Isaac Ro - Goldman Sachs Group Inc., Research Division

Amanda Murphy - William Blair & Company L.L.C., Research Division

Gary P. Taylor - Citigroup Inc, Research Division

Alexander Y. Draper - Raymond James & Associates, Inc., Research Division

Darren Lehrich - Deutsche Bank AG, Research Division

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Lisa C. Gill - JP Morgan Chase & Co, Research Division

Operator

Welcome to the Quest Diagnostics Second Quarter 2012 Conference Call. At the request of the company, this call is being recorded. The entire contents of the call, including the presentation and question-and-answer session that will follow are the copyrighted property of Quest Diagnostics with all rights reserved. Any redistribution, retransmission or rebroadcast of this call in any form without the expressed written consent of Quest Diagnostics is strictly prohibited.

Now I'd like to introduce Kathleen Valentine, Director of Investor Relations for Quest Diagnostics. Please go ahead.

Kathleen Valentine

Thank you, and good morning. I am here with Steve Rusckowski, our President and Chief Executive Officer; and Bob Hagemann, our Chief Financial Officer. During this call, we may make forward-looking statements. Actual results may differ materially from those projected. Risks and uncertainties that may affect Quest Diagnostics' future results include, but are not limited to, those described in Quest Diagnostics' 2011 Annual Report on Form 10-K, 2012 quarterly reports on Form 10-Q and current reports on Form 8-K.

A copy of our earnings press release is available, and the text of our prepared remarks will be available later today in the Investor Relations Quarterly Update section of our website at www.questdiagnostics.com. A PowerPoint presentation and spreadsheet with our results and supplemental analysis are also available on the website.

Now here is Steve Rusckowski.

Stephen H. Rusckowski

Thanks, Kathleen, and thanks, everyone, for joining us today. Over the last 2 months, I've had an opportunity to meet with many of you. And for those of you that I have not had an opportunity to meet, I'd like to spend just a minute explaining why I joined Quest Diagnostics. First of all, this is a company that has an impact on healthcare. We touch about 150 million patients each year, and I believe there's an opportunity to touch more lives.

Second, this is the high-quality company in many ways. Healthcare professionals particularly have high regard for Quest Diagnostics. And then finally and most importantly, I believe there is a significant opportunity to drive shareholder value. So over the past 2 months, I've met with many of our stakeholders. I've met with employees, customers and investors. I visited many of our operations, and I'm rounding out my perspective on Quest Diagnostics, where the company is today, and how it can grow stronger. I really appreciate the feedback I've received. Now I'd like to share the results for the second quarter.

In our Q1 call, we cautioned that despite our positive volume performance, the underlying market conditions remain sluggish, and that it was premature to conclude that the market was recovering. Our caution was warranted. In the second quarter, our volume growth slowed. Sluggish market conditions continue to affect our business, and we saw softness across many of our businesses. We also could have executed better in the quarter. For example, we did not see the benefits we expected from actions we have taken to drive revenue growth in areas like women's health and the benefit from the narrowing of certain health plan networks. As a result, we intensified our actions to manage our costs, allowing us to deliver bottom line growth and margin expansion of the quarter and maintaining our earnings outlook for the year.

Specifically, despite essentially flat revenues, we increased adjusted earnings per share by $0.05 or 4.5%. We expanded adjusted margins by 70 basis points to 18.4%, and we generated $251 million of operating cash flow. Clearly, it is imperative that we continue to be vigilant in improving productivity, reducing costs and improving quality. We are executing a plan in this regard, and we now call it Invigorate. It is expected to deliver $500 million in run rate cost savings versus 2011 as we exit 2014. And I will share with you that we are firmly on track. Well, this is a top priority for me. From my first week on the job, I've been personally involved in Invigorate. I've shared with the organization that I'm personally chairing this effort. I've met with the teams focused on the biggest priority, the areas like lab operations, procurement, general administration, IT, to name a few. We will continue to meet on a regular operating rhythm. Each of these teams are required to manage their projects with structured, disciplined and rigorous program management approaches, and I am assuring that proper resources are properly deployed to these efforts. Finally, I am challenging the teams to additional -- to look for additional opportunities and to accelerate the pace at which we implement the program.

An opportunity we've already acted on was to accelerate the launch of a voluntary retirement program offered to certain qualified employees. We expect this program to deliver $40 million in annualized cost savings, a portion of which will be realized this year, with the full amount realized as we exit the first quarter of 2013. Now as we look at the market, we continue to see weakness in the near term. We believe that this industry will grow 4% to 5% in a normal economy, and that Quest Diagnostics should be able to grow at or above the market growth rate. One thing that we believe will enable growth is the Affordable Care Act, which we expect will have a positive net impact on the company in the industry's growth rate beginning in 2014. The act will increase covered lives, which will drive diagnostic testing volume. But at the same time, many of the newly insured will be covered by insurance products with lower price points and, therefore, the full impact on our business is still unfolding.

In parallel with Invigorate, we have work to do to restore growth and be in a stronger position when the market recovers. Over the past 2 months, we have been conducting a thorough review of our businesses and our operations. This effort includes an evaluation of our selling and marketing efforts, how we prioritize our innovation investments, and our ability to leverage our unique assets to bring diagnostic solutions to the market. We do have some good examples of what we need to replicate to grow this business. Specifically, our expanding prescription drug monitoring business, our introduction of neurological tests at Athena, and our launch of new companion diagnostics like STRATIFY JCV test are a few good growth examples. So I look forward to sharing with you later this year the growth plans that results from this process.

Now I'd like to turn it over to Bob for more detailed analysis of the numbers. Bob?

Robert A. Hagemann

Thanks, Steve. Starting with revenues. Q2 revenues of $1.9 billion reflect growth of 20 basis points over the prior year. In the second quarter, comps were more challenging than in the first quarter. Specifically, we anniversaried the acquisitions of Athena and Celera, and did not experience the favorable weather impact we saw in the first quarter. These 2 factors combined contributed just over 5% growth in Q1. Excluding the impact of acquisitions, Q2 revenues were down about 0.5% from the prior year. This compares to about 1% underlying growth in Q1.

As Steve noted, market softness continued to impact our business. We didn't execute as we had planned and, as a result, our volume growth slowed. Our clinical testing revenues, which account for over 90% of total revenues, were about 1% for the quarter, all attributable to volume. Revenue per requisition was essentially unchanged from the prior year, with reimbursement pressure offset by favorable test mix and an increased number of tests per requisition. Recall that year-over-year growth in revenue per requisition we reported in Q1 was principally due to the increased esoteric mix contributed by Athena and Celera, and we have anniversaried that benefit this quarter.

Drugs of Abuse Testing volumes have continued to rebound and grew about 5% in the quarter, in line with the growth of the last 2 quarters. Q2 revenues in our nonclinical testing businesses, which include risk assessment, clinical trials testing, products and healthcare IT, were about 5% below the prior year. As you've heard, despite what was an essentially flat top line, we expanded margins -- earnings and margins in the quarter as a result of disciplined expense management and beginning to realize the benefits of our Invigorate program. Adjusted EPS of $1.17 was $0.05 above the prior year, and adjusted operating income at 18.4% was 70 basis points above the prior year. The restructuring, integration and CEO transition costs totaling about $16 million reduced reported operating income by 80 basis points and reported EPS by $0.06.

Last year's second quarter included $20 million of acquisition-related transaction and integration costs, which reduced reported operating income by a full percentage point and reported EPS by $0.10. Our Invigorate program continues on-track to deliver roughly $100 million in run rate savings as we exit this year. This represents about 20% of our $500 million goal, with the remainder expected in 2013 and 2014. As you heard from Steve, we're continuing to evaluate opportunities, which could potentially increase our goal for this program.

As we previously shared, common themes across most areas include standardizing systems, processes and databases, increased use of automation and technology and centralizing the selective outsourcing. As we noted last quarter, over the next few years, this will require some increased level of capital spending to standardize systems and upgrade IT infrastructure. In addition, as we disclosed in last quarter's 10-Q, our high-level estimates of charges we expect to incur over the next several years in connection with this program are between $100 million and $175 million, consisting primarily of employee separation costs, facility-related closure costs, asset impairments and systems conversion and integration costs.

As Steve mentioned, in connection with the Invigorate initiative, we have offered a voluntary retirement program to certain qualifying employees. We estimate this program will contribute approximately $40 million of annualized savings once fully implemented, which we expect by the first quarter of next year. The program will allow us to reduce the size of our workforce, reduce our average wage bill and update the skills of the workforce. In connection with the program, we expect to record charges estimated at about $50 million over the course of the next several quarters as employees leave the workforce. An area which is already benefiting from Invigorate is billing and collections. We have consistently produce industry-leading metrics in this area, but still have room to improve. Bad debt expense, as a percentage of revenues, was 3.5% in the quarter and reflects improvement from both Q1 and in the prior year. DSOs were 44 days, unchanged from last quarter.

Cash from operations was $251 million in the quarter compared to $60 million in the prior year. Note last year's cash flow was reduced by the net impact of the Medi-Cal settlement payment. Capital expenditures were $47 million in the quarter compared to $40 million a year ago. During the quarter, we repurchased 882,000 common shares at an average price of $56.70 for a total of $50 million. We also repaid $112 million of outstanding debt in connection with our stated objective to delever by $500 million to $700 million this year.

Turning to guidance. Based on our performance in the first half and our latest view of the market, we now expect results from continuing operations before special items as follows: revenue to grow between 1% and 2%; operating income to approximate 18% of revenues; cash from operations to approximate $1.2 billion; capital expenditures to approximate $200 million; and lastly, diluted earnings per share to be between $4.45 and $4.60. Now I'll turn it back to Steve.

Stephen H. Rusckowski

Thanks, Bob. So in closing, we delivered earnings growth and margin expansion in the quarter despite flat top line growth. We are accelerating our efforts to improve productivity, reduce costs, improve quality and restore top line growth. I want to reaffirm our commitment to increasing shareholder returns and improving our ROIC. This includes our intention to return the majority of our free cash flow to investors upon achieving our targeted leverage ratio.

In the near term, we do not expect to complete any large acquisitions. However, we will continue to consider value-creating, fold-in acquisitions. We are being thoughtful and disciplined in developing our plan to restore top line growth and improve shareholder returns, and are performing a thorough review of our businesses and operations as part of this process. I'll share with you that I believe we're moving with the appropriate speed and intend to share our plan with you in the fall. Now we'd be happy to take your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today is from Tom Gallucci with Lazard.

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

I guess, I have 2 questions. Steve, when you had met with some of the analysts recently in a breakfast in New York, I think, you had mentioned that you were sort of meeting with a lot of different constituencies within the company and outside the company. And I think, specifically, you had talked about maybe having some upcoming meetings with some of the payers like in Aetna, for example. The lack of pricing sort of, of late has stood out. So can you discuss any takeaways maybe that you've had thus far with your interactions with major payers? And how they are viewing you and what your -- what, again, your key takeaways may be so far?

Stephen H. Rusckowski

Yes, sure. I appreciate the question, Tom. First of all, I have done that. I've met with a number of payers. And specifically what I'd share with you is they're thinking about our business and specifically us to help them manage their cost structure. And yes, that will be a discussion around price at some point. But more importantly, more at a strategic level, is what we can do to help manage plans together to improve quality and lower cost. And specifically, some of that conversation has lended itself to what we have from information, what they have from information and how we can provide more helpful insight into managing overall cost with the lives that they're managing. In parallel with that, they're also understanding that the U.S. market will go through tremendous change with the Affordable Care Act. They're trying to prepare themselves for the change. We obviously are preparing ourselves for the change. And in that context, they believe that they need to do a better job of working with us on narrowing their networks for what would they provide. So therefore, they hope to work more closely with us to make sure that we work together because we're both incented to do that. So the conversations I've had so far, Tom, have been very, very good conversations with the spirit of cooperation. We are working together to do what's right for this industry, improving quality, lower cost and at the same time, we find some opportunities to help our businesses.

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

Okay, great. And then my other quick question was just on healthcare reform. Sorry, I jumped on a couple of seconds late so if you covered it, I apologize. But just wanted to see if you had any takeaways at this stage on sort of how you think about the impact and what some of the moving parts are for Quest in particular?

Stephen H. Rusckowski

Yes, so healthcare reform, the Affordable Care Act, we do expect to have a -- excuse me, a net positive impact on our company and the industry growth rates. And we believe this will start in 2014. First of all, the number of lives will increase. We know that, and that will drive volumes. That's good news. But at same time and what's not clear yet is what will happen with those newly insured lives and what insurance products they will move to. And our sense is that some, if not a large majority, will go to lower-price-point products and, therefore, it's not quite clear at this point how this will all unfold. So we have not put together specific indication of what it will mean for our business. We're watching it carefully. There are some positive sides of it, and there's clearly some negative sides of it. And in collective perspective, it will have an effect. We believe, again, it's net positive impact for our business and for the industry, but it still has to be cleared up over time.

Operator

Our next question is from Kevin Ellich with Piper Jaffray.

Kevin K. Ellich - Piper Jaffray Companies, Research Division

Steve, just wondering if you could provide a little bit more color on some of the reimbursement pressure that you saw this quarter. Is that coming from any specific contracts? Or what's going on, on that front?

Stephen H. Rusckowski

Yes, first of all, we don't share specifics on what's going on with our contracts, but we have shared in the past that we are seeing pressure on price. And let me give the microphone over to Bob to share some of the specifics of what we have shared in the past and how that is folded through our numbers.

Robert A. Hagemann

Kevin, yes, I would tell you that this is nothing new. I mean, we've been talking about increased reimbursement pressure for a while, and what we're seeing was fully contemplated in the guidance that we put together at the end of the year. So there's no change from our perspective there. And essentially what you're seeing is that reimbursement pressure now is being offset though by a number of tests per requisition and a continued favorable test mix. And as we go forward, we expect that those dynamics will continue, continued reimbursement pressure to a large degree offset, if not fully offset, by test per rec and positive mix.

Kevin K. Ellich - Piper Jaffray Companies, Research Division

Sure. And then, I guess, since I have you, Bob, just wondering what are your thoughts on the Medicare pricing headwinds that you face in '13? And also the impact of the new Molecular Diagnostic codes that are likely to go in effect in '13?

Robert A. Hagemann

Yes, Kevin, the Medicare change for 2013 is estimated to be about 5% or so. I think we've shared with folks in the past that we've got roughly $1 billion in Medicare business. The vast majority of that reimbursed off of the clinical lab fee schedules. So we're looking at a $40 million to $50 million impact next year. And as you think about that, we're hoping that much of that now is going to be offset by the actions that we've taken at the Voluntary Severance Program, which kick in -- fully kick in by the time we exit the first quarter of next year. And with respect to the impact of the changes around Molecular Diagnostics and the new coding there, we don't expect that to have a significant impact to us. There are a number of codes which are impacted, but the total revenues that are subject to those changes are less than 5% of our total revenues. And as we've said in the past, the objective there is really to get better visibility into what's being billed, making sure that what's being billed is medically necessary. And we do feel very good about the tests that we have in our profiles, and the medical necessity attached to them.

Kathleen Valentine

And Kevin, as you know, CMS hasn't determined yet how they're going to reimburse for these new molecular codes and also which fee schedule they will be placed on. And at this stage, based on the meetings they had earlier this week in Washington, it sounds like we won't hear anything definitively until later in the fall, some time on that.

Kevin K. Ellich - Piper Jaffray Companies, Research Division

And then just one last quick one for Steve. As you've gone around the company and looked at the various business units and met with different people, just wondering if you've had a chance to think about some of the other businesses like India in the point-of-care, HemoCue business. If you have any opinions on those fronts, we'd love to hear what you have to think or have to say?

Stephen H. Rusckowski

Sure, well, I appreciate that. And what I've said in my opening remarks is that we are conducting a thorough review of all businesses and operations. And we have nothing to share beyond that today. What I've also shared is that sometime in the fall, we will be giving an update of our strategy and in that update we'll give you more forward-looking visibility and transparency of what we're thinking about in terms of restoring growth, improving our margins in going forward for the company.

Operator

Our next question is from Dane Leone with Macquarie.

Dane Leone - Macquarie Research

I was actually just kind of looking for some clarity on the revenue line and maybe some additional commentary on the Athena and Celera business. Maybe I just kind of misheard, I think, maybe Bob's comments. But it seems like the product line may have declined year-over-year because the revenue per rec was flat, volume was up, but overall revenues were flat. Can you just maybe add some color or provide some clarity on that?

Robert A. Hagemann

Dane, let me try and give you some more color on it. Year-over-year, consolidated revenues were essentially flat, up 20 basis points versus the prior year. In that, the clinical testing business was up about 1% or so. The other businesses, which make up about 10% of our revenues, which include clinical trials testing, risk assessment, the point-of-care business, the healthcare IT business, they in total were down about 5% versus the prior year. And when you look at the clinical testing business, the year-over-year revenue improvement was principally driven by volume. And as we indicated, the revenue per rec was essentially flat year-over-year.

Dane Leone - Macquarie Research

Okay. Was there -- I guess, the product growth had been additive up until this point for the last couple of quarters. Well, what kind of changed there?

Robert A. Hagemann

Yes, Dane, the principal contribution to product revenue growth that we had in the last several quarters was the result of the operations that we -- the products operations we acquired with Celera, which anniversaried this quarter.

Dane Leone - Macquarie Research

Okay. So okay, that's helpful. And just on Athena, the -- is that business still growing much higher than the regular business? I was just -- it closed at the end of February last year, so it still had -- thinking about the higher growth rate of that business, maybe it could have added something to revenue per rec this quarter? I was just curious if there was anything there and maybe the Celera business as well.

Robert A. Hagemann

Yes, Athena is continuing to perform very well, growing nicely, highly profitable business. And Celera, as you know, there were multiple pieces to that business. There was the products business, which continues to perform solidly. And then there was BHL, which as we noted is in a turnaround and we're still working through that, although I would tell you that we're making some progress there as we integrate that now and start to leverage the infrastructure that Quest Diagnostics has to offer to Celera.

Dane Leone - Macquarie Research

Okay, great. And then a final question for me. Just looking at the kind of working capital inventories and accounts receivable, you kind of like edged-up year-over-year even though revenues were flat. Is there anything to read into that or is it just timing?

Robert A. Hagemann

It's just timing. If you look at DSOs, they were essentially flat. We're actually down a day from year end. And if you look historically at how receivables themselves track from Q1 to Q2, that's pretty -- from year-end to Q2, that's pretty consistent.

Operator

Our next question is from Ricky Goldwasser with Morgan Stanley.

Ricky Goldwasser - Morgan Stanley, Research Division

A couple of follow-up questions here. The first one is on healthcare reform. And Steve, what percent of your book currently do you estimate is from the uninsured population today?

Robert A. Hagemann

Ricky, this is Bob. It's a small portion of our total revenues. If you look at what we describe as patient billed revenues, it's in the range of 5% to 10% of our total revenues. Roughly half of that is from the uninsured. The other half is really deductibles and co-pays and things like that.

Ricky Goldwasser - Morgan Stanley, Research Division

Okay. And when we -- when you think about the opportunity, do you expect to basically see a similar share gains that reflect your overall exposure to government business? Or do you think that you have an opportunity here to gain share above that kind of, that 15% government that you currently...

Stephen H. Rusckowski

And as we said, we do believe it's a net positive impact for our company. And as you know, this is still unfolding and so we're trying to understand it better and better every day. We'll -- there'll be more lives. There'll be more people getting tested. But the question is how will they be insured? And then, specifically, how does that factor into our business? And we have not provided a specific effect on the business because it's not quite clear yet. So can't provide you any more transparency or visibility beyond that at this point.

Ricky Goldwasser - Morgan Stanley, Research Division

Okay. And then a top line question, and I apologize if you have discussed it already. I just had to jump on a little bit late. When we think about the top line growth for the second half of the year, your guidance implied some continued decline. It sounds as if your view is based on pricing trends in the second half the year. Can you share with us your views on kind of like volume trends in the second half and how can you drive volume growth with your internal initiative?

Stephen H. Rusckowski

Yes, so first of all, what we did share is that sluggish market conditions did continue in the second quarter. It did affect our business. And in fact, in Q2, we did see the volumes -- the volume growth slow. And we saw slowness across many of our businesses. And what I also shared in my opening comments is we do have an opportunity to execute better. We missed some opportunities in Q2, and then we specifically called out that our women's health business could have executed better. And specifically, we have some opportunities around narrowing of certain health plan networks, and we didn't see the impact of that in Q2. And so what I have shared is that in the process of building our plan going forward, we do need to restore growth. And so we are looking at the effectiveness of our sales and marketing programs. We're looking at our investments. We're looking at how we product-ize solutions to the marketplace, and that work will be helping us to some extent in the second half, but we still need some help from the market.

Robert A. Hagemann

And Ricky, just a little bit more color on your question. If you look at the implied guidance for the second half, at the midpoint, it implies that revenues are sort of flat for the most part. At the high-end, it implies revenues are up about 1% and at the low end, it implies they're down about 1%.

Ricky Goldwasser - Morgan Stanley, Research Division

Okay. And at that high-end where revenues are going to be up 1%, based on your pricing comments, should we assume that most of the growth is going to come from volume in the second half?

Robert A. Hagemann

Well, again, as you know we don't give guidance relative to price or volume. And at this point, we don't necessarily see that changing. Although I don't think that the dynamics in the second half are going to be materially different than the dynamics in the first half.

Operator

Your next question is from Lisa Gill with JPMorgan.

Gavin Weiss - JP Morgan Chase & Co, Research Division

This is actually Gavin Weiss, in for Lisa Gill. You mentioned your conversations you've been having lately with payers. Do any of these conversations include discussions around different payment models? Or is it still really around a fee-for-service?

Stephen H. Rusckowski

Well, there is conversation about different payment models. We are going through this transition and the question is as we go forward with the Affordable Care Act...

[Technical Difficulty]

Operator

I apologize. If we're ready, we can go on to the next question. We do have a question from Gary Lieberman with Wells Fargo Security.

Gary Lieberman - Wells Fargo Securities, LLC, Research Division

Steve, for a long time, there was pricing stability. And it then seems like 5 to 6 years ago, the industry started to see pressure on price. I mean, given what you've seen so far, do you think there is a path back towards pricing stability and what are the challenges with getting there?

Stephen H. Rusckowski

Yes, well, first of all, that's quite an interruption. So Gary, good question. And frankly, as Bob said, we don't give guidance on price. The market is unfolding with all the different changes, and we have this mix issue going on. So we're managing it carefully. There's no question in our mind though that we need to be vigilant on productivity improvements, reducing costs and improving our operations and that's why I've been personally involved in Invigorate and will continue to be involved. We need to improve our cost structure, and that will help us offset whatever price erosion we see going forward. So Bob, I don't know if you'd like to add to that?

Robert A. Hagemann

The only thing I would add, Gary, is we're going to continue to be price disciplined as we go forward. And as Steve mentioned, the payers and our other partners are looking for ways that we can work with them to reduce their total costs. Pricing is an element of that, but there are other ways as well that we can help them manage their costs down, and we expect to use all of those opportunities.

Gary Lieberman - Wells Fargo Securities, LLC, Research Division

I guess, maybe, if I could ask it another way, Steve. I know -- without you guys commenting on price, specifically, but more generally -- with the large labs being the low-cost provider of the service, significantly less in some cases than hospitals, what's putting the pressure on the price? How did -- what was the catalyst that started the pricing pressure, and how do we get away from that?

Stephen H. Rusckowski

Well, there's price pressure in this whole industry as you know, so the catalyst is healthcare in general. Healthcare costs from a provider perspective continues to rise and that's the challenge with health plans. And they're trying to manage an aging population, sicker and sicker lives every year and, therefore, the -- and costs that continue to rise. So there's more pressure throughout this entire industry and as you know, we've been in this industry for over 28 years. That price pressure will continue. The question is how does that unfold and how does that relate to this market, specifically, with the changes that we see going forward? We are seeing people wanting to narrow their networks. Therefore, there should be more consolidation in the volumes around fewer suppliers of laboratory testing services that plays nicely into what we are all about and what this industry is all about. Second, is as hospital systems are acquiring physician practices, they're looking at what they need to do in terms of what of their capabilities are strategic and not strategic. And as they start to look at forming Accountable Care Organizations, what they do with their laboratory operations and they are starting to have more conversations with us in terms of how we can help them with laboratory management services, where we could potentially look at outsourcing, where we can look at reference testing. And so the future trend, despite price pressure, I think, lends itself to support the long-term normal growth rates we see in this industry. So I see some other dynamics that will help us offset some of the price pressure that we will see like the rest of the industry.

Robert A. Hagemann

And Gary, when we talk about price pressure, we're not talking exclusively about the commercial payers. As you see on the government side, there's continued reimbursement pressure. Medicare is a great example. The Medicaid -- each of the states is looking at how they can reduce their overall costs, and healthcare is a big element of their total cost and they're trying to manage it down. So it's not exclusively the commercial payers that we're talking about when we talk about reimbursement pressure.

Operator

And our next question is from Ralph Giacobbe with Crédit Suisse.

Ralph Giacobbe - Crédit Suisse AG, Research Division

There's been articles on benefit design, and you certainly talked about narrowing networks and particularly, we've seen or heard about changes at Aetna that could potentially push more volume your way. I guess, did you recently renegotiate with Aetna beyond the extension from a couple of years ago sort of in exchange for some of the narrowing network there?

Stephen H. Rusckowski

Yes, we don't comment on specific renegotiations or discussions with our health plan partners. But we do believe there is an opportunity to work with them to narrow their network, and you brought up Aetna as an example of that.

Ralph Giacobbe - Crédit Suisse AG, Research Division

Okay. And then going back to sort of some of the discussion around reform, can you help us right now in terms of collection on the uninsured. What percentage of what you bill do you collect?

Stephen H. Rusckowski

Yes, Bob will handle that, yes.

Robert A. Hagemann

Yes, one way of thinking about it is the majority of our bad debt, which this quarter was 3.5%, comes from patient bill. And about half of that bad debt is related to co-pays and deductibles for people that have insurance. The other half is related to the uninsured. That's the big opportunity that we have as part of healthcare reform. What we can get that down to, it's not clear at this point but certainly, there's a big opportunity to reduce that piece of the bad debt. But again, that's a little less than half of our overall bad debt.

Ralph Giacobbe - Crédit Suisse AG, Research Division

But I guess I'm getting at -- do you have sort of an average price point for the uninsured today? What's that average price point?

Robert A. Hagemann

Well, it's significantly higher than it is for the average that we have across the network. And if you look in our 10-Q, you'll see that the volumes associated with patient bill are -- the percentage of volumes associated with patient bill are about half of the revenues associated with patient bill. So it implies that the revenue per requisition is in the range of 2x or more the average revenue per requisition. So it's a very rich requisition, but it carries a significant bad debt attached to it.

Ralph Giacobbe - Crédit Suisse AG, Research Division

And Bob, just to run through the numbers though, is it fair to say that today, that you'd rather have an insured or uninsured patient walk through the door given net collectibility?

Robert A. Hagemann

Well, yes, certainly from a collectibility standpoint, an uninsured patient is much more difficult. But yes, I'm not sure that at this point we're prepared to make a call as to what sort of patient we'd rather have walk through the door. We're happy to serve all patients.

Operator

Our next question is from Isaac Ro with Goldman Sachs.

Isaac Ro - Goldman Sachs Group Inc., Research Division

First off, I realize this is somewhat of a hypothetical question, but in the event that some of those CRA royalties do become material revenue streams, would you be able to comment on whether you'd let those flow through the P&L? Or would you try and seek to monetize those assets in another way?

Robert A. Hagemann

Look, I think that we would certainly consider monetizing future royalty streams. But yes, I think we'd have to have some better visibility as to what they are before we would do that. But certainly, it's something we would consider.

Isaac Ro - Goldman Sachs Group Inc., Research Division

Sure. And then Steve, if I could just maybe ask a question on the cost savings plan. If you could maybe bucket the low-hanging fruit as you see them across a couple of major areas: labor, supply chain and then maybe vendor pricing? Just trying to think about out how you see the best opportunities in the next couple of quarters to start realizing those savings.

Stephen H. Rusckowski

Yes, so I appreciate the question. And as I mentioned in my opening comments, I am personally spending a lot of time on this. And I've shared with some of you that you really need to think about this in 2 categories. Yes, there'll be some shorter-term opportunities that we're going after, and then there will be some harder opportunities that will require investment that will take a longer period of time. And we're looking at both. In the short run, we already mentioned that we're looking at productivity. Specifically, our Voluntary Severance Program that we put together was one of those options for us to look at being more productive where we can do that. So we selectively identified qualified individuals, and that will help us some in the short-term. Second, is we're continuously looking at productivity opportunities because a large portion of our cost structure is our wage bill. And therefore, we are very, very tight on any hire we make and specifically looking for opportunities to drive productivity. Now some of this, as you would expect, happens in our operational teams throughout the company. This is in lab operations, logistics operations, patient service centers. But also, what we are looking at is what we need to do in, let's just say, broadly defined general administration areas. And there will be some opportunities to look at becoming more efficient, if you will, with our cost structure of our overhead going forward. And I also commented to that I spent some time with the procurement team. We did see some opportunities show up in Q2 related to do doing a better job of managing our purchases from outside suppliers. It is the second category to a wage bill that we will see some near-term improvement in that we will see sooner rather than later, and that will continue throughout the period of Invigorate. And then finally, there's opportunities related to a number of improvement efforts that are happening at the grassroots level. There's a number of our regional labs that are working through improvement programs, and I could tell you the support for our employees to contribute to this effort is very, very remarkable. And we're seeing some nice short-term gains from small incremental improvements at the regional level. But if you take those and you add them all up, it's real numbers. And if you take those and extrapolate it throughout entire business, it's substantial. So we will those in the short run. But as I said, there's also some longer-term, re-engineering change management programs that we'll need to invest in, and that will be in the later part of the period of Invigorate.

Isaac Ro - Goldman Sachs Group Inc., Research Division

Last question, if I could, on capital allocation. You guys certainly continue to generate pretty healthy cash flow given a tough volume environment. So can you maybe update us on the board's latest thoughts regarding how that cash will be deployed? Last year you obviously hiked the dividend quite nicely. Is there a walk to the long-term dividend profile that you can give us here, the incremental update?

Stephen H. Rusckowski

Absolutely, Bob will give you an update on that.

Robert A. Hagemann

Isaac, look, as we told you, this year our priority is to do some delevering to make sure that we can sustain the credit rating that we have. We believe that, that's critically important to us because at the end of the day, it allows us to minimize the overall cost of capital and ensure that we've got appropriate access in liquidity. So that's the priority now. As we've indicated though, beyond that, once we've gotten a delevering done, we expect to return a majority of the free cash flow to investors, whether it be through dividends or share repurchases. We did a pretty significant increase to the dividend this year. We'd expect that the dividend is going to grow with cash flows and earnings over time. And at this point, we're not prepared to make a commitment as to what the dividend rate will be. I think as we go into the fall and as we figure out what the strategy is going to be, that's going to drive the capital and allocation. So in the near term, no change; but you'll hear more about this in the fall when we come out and share with you some of the longer-term plans for the company.

Operator

Our next question is from Amanda Murphy with William Blair.

Amanda Murphy - William Blair & Company L.L.C., Research Division

Steve, I had a follow-up question for you on the sales infrastructure so if -- given the cost-cutting initiatives that you have in place, I'm just curious how you're thinking about the sales force and the patient service center infrastructure. And you talked, for example, about productivity and effectiveness. I'm curious if you can provide a little more color there? That will be helpful.

Stephen H. Rusckowski

Yes. Thanks, Amanda. Well, first of all, everything's on the table, and we are focusing on improving our productivity and reducing cost. And in that respect, we're looking at every area which includes all overhead: overhead on the backs of people in our labs, overhead on the backs of our sales force, overhead in the backs of our patient service centers. So that is critical. We're also looking at improving the workflow of how we take a sample and then eventually collect cash. And Bob will share with you one example of how we feel pretty good about some progress we've made in our billing center. But specifically to the sales force, at the same time -- and I mentioned in my introductory comments, we do need to restore growth. And so we are -- and I am personally looking into how we have gone to market; what type of investments we've made in our sales and marketing efforts, and specifically, how that has contributed to what we have done so far; how we have executed against our plans so far; and what are the right investments for this company going forward to restore growth. I don't have specific comments to make in that regard as I speak. But I'll assure you that we'll make the appropriate investments in our sales force, in our go-to-market organizations to restore growth, which may mean that we'll take some of the freed up spending that we see in Invigorate and reinvest it in portions of our organization to help with restored growth, and that may mean our sales and marketing efforts. But it's too early to share with you specifics on that, but it's being reviewed as I speak with you today.

Amanda Murphy - William Blair & Company L.L.C., Research Division

Got it, okay. And then just another comment you made earlier is just about missed opportunities when it comes to narrowing networks and women's health. I'm curious if you could provide a little more color about specifically what was missed there and has that or will that change your strategy going forward in those 2 areas? Obviously, you've talked a lot about private payer conversations.

Stephen H. Rusckowski

Well, let me take narrowing network. We do have an opportunity with some of our partners, our health plan partners to help them narrow the network, and we're working -- this a great example, working together with the health plans to get more volume and they see an opportunity in their cost structure, and we see an opportunity with our volumes to do that with them. We hoped for some in the second quarter, it did not materialize, but we still see it as a great opportunity going forward. And so that's what my comment was about, is that we hope there's some in the second quarter. And frankly, I think, if we executed it better, we would have got some pick-up in our volumes in the second quarter, but unfortunately, they did not materialize. But as I said, with -- in our view of our sales and marketing efforts, we will look at that and we will deliver more of that in the second half. And I'd like to turn it over to Bob in terms of his comments on women's health.

Robert A. Hagemann

Yes, women's health is an area that we've seen as an opportunity. It's an area that's continued to grow. But yes, as we've stated earlier, we've had some product gaps, which we filled. And we expected that after having filled those product gaps, we'd be able to start to regrow that business at a faster rate. Again, that hasn't materialized yet, but we continue to see that as an opportunity. We continue to focus on it from both the sales side and the product offering side. And again, it's an area that, while we didn't execute as well than we would have liked in the second quarter, we believe that it will be an opportunity that will drive growth as we go forward and address some of the execution issues.

Operator

Our next question is from Gary Taylor with Citigroup.

Gary P. Taylor - Citigroup Inc, Research Division

Just had 2 relatively simple questions. First on the kind of sequential slowdown in volumes, are there any takeaways in terms of geography type of testing for this in specialty? Anything that's notable that you saw sequentially?

Robert A. Hagemann

Gary, nothing specific. Obviously, we don't comment on geographies, but as Steve mentioned in his remarks earlier, we saw a slowdown across most of our businesses. So it was relatively widespread. Nothing specific to point to.

Gary P. Taylor - Citigroup Inc, Research Division

Okay. And on the growth and revenue per session, can you just remind us a little bit what's the driver behind that and it's specific -- again a specific type of physician specialty outside of primary care that's helping to drive that? Or what do you -- how do you view the sustainability of that trend?

Robert A. Hagemann

Well, certainly, physician specialists in the esoteric mix that they order contributes to improvements in revenue per requisition. But it's also the number of tests order per requisition, some of which we may think of as esoteric today, but ultimately are going to be routine, like Vitamin D, for example. The benefit of the growth in Vitamin D has really shown up in revenue per requisition to a large degree. That and other new tests that we introduce, in many cases, show up in revenue per requisition because they're ordered in conjunction with other tests. And that's an area that we believe will continue because we expect that the pace with which new tests are introduced will continue to accelerate over time.

Gary P. Taylor - Citigroup Inc, Research Division

Yes, I may have misspoken. I meant to ask about the number of tests per session or per requisition, but you kind of covered that. And is it fair to say that -- I mean, Vitamin D is still growing, but not nearly I would imagine at its growth rate we saw a year or 2 ago, is that correct?

Robert A. Hagemann

That's a very fair assessment. Yes, as you think about that, it had a really rapid ramp-up. It's become much more of a mature test at this point. And as a result, the growth rate just obviously slows down.

Operator

Our next question is from Sandy Draper with Raymond James.

Alexander Y. Draper - Raymond James & Associates, Inc., Research Division

All my questions have been asked and answered.

Operator

Our next question is from Derrick -- I'm sorry, Darren Lehrich with Deutsche Bank.

Darren Lehrich - Deutsche Bank AG, Research Division

So we've heard you comment a few times just on disappointing execution in the second quarter and in a number of areas. And I guess, my question, Steve, is just as you think about how you are setting expectations for the team and attempt to increase the accountability, can you just talk about some of the process changes you're making in running the company? And just how you sort of are managing that execution question as you move forward?

Stephen H. Rusckowski

Sure, sure. First of all, in this review of businesses and operations, clearly, we need to look at do we have the right structure to execute any strategy we have in place. And we are looking at that. And then second is, I've been asked this before, clearly, you need to have the right leadership team in place to restore growth and improve our shareholder returns. And as everyone would expect, that's being considered as well. But specific to the approach, and I mentioned in my Invigorate comments, what I am bringing into the company is a disciplined structure and rigorous approach to deployment of strategy. And I gave the example of Invigorate, but I'll also share with you that will be my approach for restoring growth as well. So strategy is important, but it's also very important and I would argue more important to work on the deployment. And in my past experiences, what I will do going forward, and I'll share this in the fall, is we'll have a very structured rigorous deployment of each of the strategic programs we put in place, some of which will be around productivity gains and improving our cost structure going forward, but also will be equally put in place related to restoring growth. And related to that is once we agree what we're going to do, then we need to make sure we have the right proper plan that's properly resourced. So with that rigor, with that discipline and with that structure, I'm insisting once we agree to do something, that we have the resources and then those resources are held accountable to deliver. So that is my philosophy in general, and I gave Invigorate as an example of that, but it will extend itself to everything we do in the company going forward.

Darren Lehrich - Deutsche Bank AG, Research Division

That's helpful. And then if I could just ask you, you have talked about the $40 million associated with early retirements. I'm curious just to know on the senior management team, have there been any decisions made about who will take early retirement? And is that something that has been decided yet?

Stephen H. Rusckowski

No, we're not prepared to share anything related to specific individuals. What I'll share with you is the participation in the program is broad throughout the organization. And I -- Bob, would you like to share any insight into the people that opted into the program and how that ties into the savings?

Robert A. Hagemann

There's not a lot specifically, Steve. It's a very broad-based program. It's covering just about every part of the organization, although I would tell you that we very thoughtfully designed the program. There were certain parts of the organization, certain employees that we felt were critical that were not offered the plan, and we maintain the ability to not accept certain people as well, so that we could manage any potential adverse impact that the program would have. And then lastly, we maintained the ability to determine one person would actually lead the workforce. So we've been able to ourselves, I think, manage it pretty effectively, but it's a broad-based program.

Stephen H. Rusckowski

Yes, and just adding to that, we surgically looked at specific work areas and thought forward in terms of the skill mix of some of those work areas. So we used it as an opportunity to think about the workforce in general. So yes, some people will leave from this program, but also we saw it as an opportunity to affect our wage bill in specific areas where we have a skill mix going on with our operations. So it is a very comprehensive, robust program that will help reduce some costs; but at the same time, help improve our productivity as well.

Darren Lehrich - Deutsche Bank AG, Research Division

That's great. And just one last thing to clarify a comment Bob made in response to the royalty portfolio from Celera. Bob, you said you need better visibility on the revenue opportunity, I think, is sort of the comment. But does that mean that you need those products to be commercialized in the market? I'm just trying to understand sort of at what point you would seriously consider monetizing the royalty?

Robert A. Hagemann

Yes, it's a interesting question. And I don't want to be too specific at this point because it is premature to gauge what the actual opportunity will be, not only from the Merck drugs, but the other drugs that Celera has rights to as well. But I think for us to get the appropriate value for those drugs and those assets and those royalties, we have to have a pretty good view as to what they'll realize for us.

Darren Lehrich - Deutsche Bank AG, Research Division

Well, I think it's an interesting situation nonetheless, so nice position for you to be in.

Operator

Our next question is from Robert Willoughby with Bank of America.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Bob, I was just surprised the deleveraging wasn't more material in the quarter. I thought that was a bigger part of the strategy going forward. Are you kind of happy with the outstanding debt levels currently?

Robert A. Hagemann

Bob, it's pretty much as we had planned. As you know, we generate the majority of our free cash flow in the back half of the year, and the delevering is really following the way the cash flows come in. So this is pretty consistent with what we had anticipated.

Operator

Our next question is from Lisa Gill with JPMorgan.

Lisa C. Gill - JP Morgan Chase & Co, Research Division

And I apologize for earlier. That was directed at a salesperson, clearly not at Quest. I just had a quick follow-on question around acquisition opportunities and just around hospital outreach, labs and what you're seeing in the marketplace and how things have gone with your existing relationship, and if you see opportunities going forward?

Stephen H. Rusckowski

Sure, appreciate that. Well, first of all, as I said in my opening comments, we don't anticipate any large acquisitions. But we will consider what we call tuck-in acquisitions that we could fold into operations that could be reasonably accretive in the short term. That would include what we could do on a regional level. And also I made some comments about what hospital systems we're looking at and integrated delivery systems we're looking at in terms of where they add value, what's strategic and what they need to rely on others to do, and there might be some opportunities for us on that. So we are looking at all of that and there are some opportunities.

Robert A. Hagemann

And Lisa, I would to add to this. We think about hospitals and the opportunity to work with them to grow our business. Certainly, there's the opportunity to acquire their outreach business. There's still a big opportunity to gain additional reference testing from them. We look to manage some hospital laboratories. And in selective cases, we've looked at joint venture in certain markets where it makes sense. So we continue to think about multiple ways to work with hospitals to grow our business and help them compete effectively as well.

Operator

Thank you. This concludes the question-and-answer session. 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 (888) 673-3567 for domestic callers or (402) 220-6430 for international callers. No access code will be required. Telephone replays will be available from 10:30 a.m. Eastern Time on July 19 until midnight, Eastern Time, on August 19, 2012. Thank you for joining. Goodbye.

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