Quest Diagnostics Inc. Q2 2009 Earnings Call Transcript

| About: Quest Diagnostics (DGX)
This article is now exclusive for PRO subscribers.

Quest Diagnostics Inc. (NYSE:DGX) Q2 2009 Earnings Call July 21, 2009 8:30 AM ET

Executives

Dr. Surya N. Mohapatra - Chairman and Chief Executive Officer

Robert A. Hagemann - Chief Financial Officer

Laure Park - Vice President Communications and Investor Relations

Analysts

Ralph Giacobbe - Credit Suisse

Adam Feinstein - Barclays Capital

William Quirk - Piper Jaffray

Charles Rhyee - Oppenheimer & Co.

Darren Lehrich - Deutsche Bank Securities

Kevin Ellich – RBC Capital Markets

Shelley Gnall - Goldman Sachs

Amanda Murphy – William Blair

Anthony Vendetti – Maxim Group

Robert Willoughby - Bank of America-Merrill Lynch

Gary Taylor – Citigroup

Operator

Welcome to the Quest Diagnostics second quarter 2009 conference call. At the request of the company, this conference is being recorded. The entire contents of the call including the presentation and question-and-answer session that will follow are copyrighted property of Quest Diagnostics with all rights reserved. Any redistribution, transmission, or rebroadcast of this call in any form without the expressed written consent of Quest Diagnostics is strictly prohibited.

Now I would like to introduce, Laure Park, Vice President of Communications and Investor Relations for Quest Diagnostics.

Laure Park

Good morning. I'm here with Dr. Surya Mohapatra, our Chairman and Chief Executive Officer and Bob Hagemann, our Chief Financial Officer. Some of our commentary and answers to questions may contain forward-looking statements. You are cautioned not to place undue reliance on forward-looking statements which speak only as of the date that they are made and which reflect management’s current estimates, projections, expectations, or beliefs and which involve risks and uncertainties that could cause actual results and outcomes to be materially different.

Risks and uncertainties that may affect the future results of the company include but are not limited to adverse results from pending or future government investigations, lawsuits or private actions, the competitive environment, changes in government regulations, changing relationship with customers, payers, suppliers and strategic partners, and other factors described in the Quest Diagnostics 2008 Form 10-K, quarterly reports on 10-Quarter, and current reports on 8-K.

As noted on the last call, a new accounting rule went into effect January 1st, FAS 160. This requires minority interest be renamed net income attributable to non-controlling interest and companies present consolidated net income that includes an amount attributable to such non-controlling interest for all periods presenting. This change did not impact our previously reported numbers, but did change how our P&L was presented.

A copy of our earnings press release is available and the text of our prepared remarks will be available later this morning in the quarterly updates section of our website at www.questdiagnostics.com. A Powerpoint presentation and spreadsheet with our results and supplemental analysis are also available on the website.

Now, here is Dr. Surya Mohapatra.

Dr. Surya N. Mohapatra

We made good progress executing our 2009 plan and drove strong financial performance during the second quarter. Total revenues increased 3.5% to $1.9 billion, earnings per share grew 20% to $1.00 per share, and based on our strong performance, we have raised our full year EPS guidance to between $3.70 to $3.80.

Diagnostic testing will play an ever greater role in helping to improve healthcare quality and manage cost. The evidence is clear. Diagnostic testing accounts for less than 3% of total healthcare spending; yet, it drives more than 70% of clinical diseases. Diagnostic testing is essential to detect diseases and monitor therapy. If diseases are detected early, actions can be taken to avoid painful and costly complications.

Lab tests are increasingly being used to identify one’s predisposition to disease allowing individuals to make healthcare lifestyle changes. In areas such as cancer and infectious disease, diagnostics are helping physicians personalize treatment and care for each patient, and diagnostic testing provides critical evidence for evidence-based medical diseases. The current healthcare reform discussions recognize the value of early diagnosis, and we are supportive of the President’s key goals for healthcare reform, expanding coverage, enhancing early detection programs, promoting health and wellness, and reducing overall healthcare costs.

In addition to benefiting from this positive trend, we continue to differentiate our company in a number of ways including our patient-centric culture, six sigma quality, unparalleled access and distribution, and innovative science, medicine, and information technology to help drive growth. I will discuss our growth drivers after we hear from Bob on our financial performance.

Robert A. Hagemann

As you heard, our business continues to build momentum. Revenue growth has accelerated, our profitability has continued to improve, and cash flow continued to be strong. Earnings per share from continuing operations for the quarter were one dollar, 20% above the prior year, with the increase principally driven by strong operating performance.

Included in our second quarter results are several non-recurring items which for the most part offset each other. Included in “other operating income, net” is a $15.5 million gain contributing $0.05 per share, associated with an insurance recovery, which we disclosed when we reported first quarter results and included in our guidance. That benefit was essentially offset by two charges totaling $13.3 million, or $0.04 per share, reflected in “other expense, net,” which sits below “Operating Income” on the face of the income statement. These two items consist of a $7 million charge associated with an investment write-down, and a $6.3 million charge associated with the early extinguishment of debt in connection with our recently completed tender.

Consolidated revenues were $1.9 billion, 3.5% above the prior year, and are net of a 1.3% reduction associated with foreign exchange and fewer business days in the quarter; each contributing about half of the reduction. Revenues for our clinical testing business, which accounts for over 90% of our total revenues, were 4% above the prior year, and about 5% above, before the impact of our pre-employment drug testing business, a strong improvement from the first quarter. Volume was about half a percent below the prior year, driven by a 24% decline in pre-employment drug testing, which reduced consolidated volume by 1.7%. In addition, last year’s exit from several lab management agreements which did not meet our profitability criteria, reduced volume by close to 1%.

Also, the second quarter had fewer business days than the prior year and impacted volume by about half a percent. After giving consideration to these factors, underlying volume grew about 2.5%, up from about 1.5% growth in the first quarter.

Revenue per requisition increased 4.6%, with the increase continuing to be primarily driven by a positive mix, and a benefit of about half a percent from the Medicare fee increase which went into effect January 1. Revenue in our non-clinical testing businesses, which include our risk assessment business, clinical trials business, point of care testing business and MedPlus, and contain most of our international revenues, was below the prior year by about 2%, which was more than accounted for by a 6% decrease attributable to foreign exchange. These businesses as a group reported a strong profit improvement from the prior year.

A table contained in footnote 6 to the earnings release summarizes the impact to various revenue metrics associated with a number of the items I just discussed. Operating income as a percentage of revenues was 18.9%, up from 16.8% last year. The improvement is principally due to a more profitable revenue mix and progress we are making with our cost reduction program. The insurance recovery mentioned earlier contributed 80 basis points of the improvement.

We continued to see strong and stable performance in our billing and collection metrics. Bad debt expense as a percentage of revenues was 4.4%, improved slightly from the first quarter, and consistent with the prior year. DSOs at 43 days were consistent with the Q1 level, improved one day from yearend, and improved 3 days from a year ago.

Our cash flow continued to be very strong. During the quarter we funded the $308 million settlement associated with NID while achieving a debt level which was unchanged from the previous quarter. The settlement payment was reflected as a reduction to cash from operations. Cash generation before this payment exceeded the prior year level by over $80 million.

Now, let’s turn to our full-year outlook. We continue to expect revenue growth to approximate 3%. We expect operating income as a percentage of revenues to improve to about 18%. We expect cash from operations to approximate $1 billion, excluding the NID settlement payment, or approximately $700 million after such payment. Capital expenditures are estimated at $200 million. And lastly, we have increased our estimate of diluted earnings per share to between $3.70 and $3.80.

We continue to make steady progress in growing our business and improving its profitability through effective execution of our plan. And we are making investments in our business which will further strengthen our competitive position.

Now I’ll turn it back to Surya.

Surya Mohapatra

As you just heard, we delivered strong performance in the quarter. We are bifocal –managing the business for both the short and long term. I will discuss the drivers of growth in the quarter and also the investments we continue to make for the future. Second quarter profitability was driven by topline growth and improvements in quality and efficiency. Our cost-reduction program is improving our productivity and enhancing the overall patient and physician experience. Some of these improvements include specimen tracking, and connectivity via Care360.

Second quarter revenue growth was driven by continued strong demand for gene-based and esoteric testing. Revenues for these tests continued to grow more rapidly than overall revenues and account for approximately 35% of all revenues. We are seeing strong growth in a number of disease categories.

Demand is growing for a range of cancer tests. There is particular interest in tests that drive early detection, since most forms of the disease, such as cervical, colorectal, ovarian, and skin cancers, have higher cure rates when the disease is detected early. For example, HPV testing increased more than 10% as we continued to educate physicians about testing guidelines and the benefits of HPV testing with Pap tests.

Sexually transmitted diseases remain a major public health challenge in the United States, and the medical community has responded by stressing the importance of screening. As a result, we have seen our volume of chlamydia and gonorrhea testing continue to grow at about 10% annually.

Demand is also growing for screening and diagnostics associated with chronic conditions, including cardiovascular disease, diabetes, allergies and asthma. For example, allergy testing using ImmunoCAP grew almost 20%. Also, researchers continue to find new links between Vitamin D and a range of conditions from cancer to diabetes and heart disease. As a result, we have seen a more than 50% increase in Vitamin D testing using our proprietary tandem mass spectrometry technology.

We continue to invest to build capabilities that will serve us in the future. During the second quarter we launched a number of innovative new services that will improve outcomes for patients and reduce overall healthcare costs. We were the first commercial lab to introduce a laboratory developed test to specifically identify the H1N1 virus. I am proud of our scientists, who, in response to the swine flu crisis, were able to develop and bring to market this test within a few weeks of the initial outbreak.

We added important new companion diagnostics. These can help doctors personalize medicine by selecting the appropriate therapy for patients with metastatic colorectal cancer and HIV. When it comes to diabetes, Hemoglobin A1c is the cornerstone for the long term management of diabetes patients. During the quarter we expanded our point-of-care offering to include a Hemoglobin A1c test with quality that compares to a laboratory test.

We completed a small acquisition of a highly innovative company called OralDNA that provides diagnostic testing to the dental market. Studies have shown a strong connection between periodontal disease and more serious conditions, including heart disease and cancer. We believe that the 140,000 dentists in the U.S. will play a more important role in identifying disease, and I am excited about this new platform for growth.

Healthcare IT is a tool to drive patient safety, improved outcomes and appropriate use of diagnostic testing. We are well positioned to play a larger role in our nation’s healthcare information infrastructure. We are already connected to approximately 150,000 physicians, many of whom are in small practices that have been slow to adopt healthcare IT. In addition to ordering lab tests and receiving results online, Care360 allows physicians to qualify for CMS e-prescribing incentives today and, we intend, stimulus incentives in the future. By the end of the second quarter, e-prescribing of medications using Care360 was up over 85% from yearend to an annualized rate of 8.5 million prescriptions, and 30% from the end of the first quarter.

Our performance is a direct result of the outstanding contributions of our dedicated employees. One of the ways we attract and retain the industry’s best talent is by investing in them and their health. For example, our HealthyQuest initiative has helped thousands of employees quit smoking, lose weight and adopt healthier lifestyles. As a result, we were recently recognized by the National Business Group on Health as a “Best Employer for Healthy Lifestyles.”

In closing, we delivered strong results in the second quarter and are raising our earnings guidance for the full year. We are bifocal – doing what is required for the short term and investing in our future growth. We are the leader in a vital and growing industry and are excited about the opportunities before us.

Thank you. We will now take your questions.

Question-and-Answer Session

Operator

At this time, we will begin the question-and-answer session. (Operator Instructions). Our first question comes from Ralph Giacobbe - Credit Suisse.

Ralph Giacobbe - Credit Suisse

I was wondering if you could help us a little bit with the one-timers or maybe when we anniversary some of the volume headwinds, the lab management contracts and drugs of abuse testing, I’m assuming we should get less of a pressure as we moved into the second half of the year.

Robert A. Hagemann

First on the drugs of abuse testing, that’s a business that we think has probably hit bottom at this point. If you look over the last several quarters, the volumes relative to the prior year had been down by a consistent amount, by about 24-25% or so, but we don’t see that impact anniversarying until late in the fourth quarter this year because it really wasn’t until December of last year that we saw the big drop off to where we are now. The other piece of your question had to do with the lab management agreements, and they actually anniversary in the third quarter, at the beginning of the third quarter.

Ralph Giacobbe - Credit Suisse

In terms of the operating margin guidance, 18% for the year, you’re halfway through. We’re sort of there already. Anything we need to keep in mind for the back half of the year as I would think that we should continue to see sequential improvement in that margin?

Robert A. Hagemann

I think what you’ll see is continued improvement over the prior year as we get into the back half. Remember that the first half of this year has the benefit of the insurance settlement in it which was 80 basis points in the quarter and about 40 basis points year to date so far, but in the back of the year, we do expect to see continued improvement versus the prior year.

Ralph Giacobbe - Credit Suisse

Last wee, we had the CPI release which obviously translates to a 1.9% decline for the Medicare fee schedule next year. First, is there anything you or the industry can do to change that, or it is what it is, and then secondly can you remind us how you negotiate your managed care rates, and is it hinged on Medicare and/or CPI?

Laure Park

As it relates to the CPI, as adjusted for the 50 basis points, that’s legislated by the 2008 bill, so right now that’s in effect, but what we’re working to do along with the industry is to deal with the proposal that’s sitting in one of the bills around to having a productivity adjustment as well which we’re vigorously working with on the trade association. As it relates to our health plan contracts, very few are linked directly to Medicare changes. Some are CPI, and some others have different modifiers going forward, but each contract is unique.

Ralph Giacobbe - Credit Suisse

When you say some are linked, any way to quantify that?

Robert A. Hagemann

It’s a very modest amount—a small percentage of our total contracts. Most are separately negotiated fee schedules.

Laure Park

And not linked to the Medicare fee schedule.

Operator

Your next question comes from the line of Adam Feinstein - Barclays Capital.

Adam Feinstein - Barclays Capital

With the margins and the opportunity there, you guys have done a great job. As you think about the initiatives that you’ve put in place to drive that margin growth, how much of it is still left to come? I am just curious in terms of all of the things you guys have been doing, are we at the tail end here?

Robert A. Hagemann

First, with respect to the program, we’re firmly on track there, fully committed to deliver the $500 million by the end of this year, and as I mentioned in the past, the gains that we’re getting there or the benefits that we’re getting there, are really sustainable cost reductions because of the fact that we’re taking work out of the process by redesigning the process using LEAN, six sigma and the like, so we feel very good about that. In terms of what’s next and where we go from here, we’re constantly thinking about what’s next and how to build on what’ve already established, and rather than you thinking about a new big program, I’d rather us be thinking about what we’re going to build on from the existing program to drive further improvement. The thing to remember about the program that we’ve got in place is there are not one or two really big items that are driving all the save here. This consists of many small initiatives that we’re executing very rigorously, and it’s that sort of rigorous execution that we’re going to continue to apply against all of our processes and against all of the ideas that we continue to generate, so think of this more as a continuous improvement process as we go forward, rather than announcing a big program again.

Adam Feinstein - Barclays Capital

As we think about testing, it’s helpful you breakout the impact from some of those non-core item, but as we think about the business as we separate routine from esoteric, I just wanted to get some color in terms of what you saw in another quarter. Has the volume growth help up in esoteric testing pretty well? If you’re not able to provide specific numbers, if you could just speak about it from a very high level, that would be great.

Robert A. Hagemann

Certainly the gene-based and esoteric testing continues to be the fastest growing pieces of our business, but we’ve seen improvement in both the routing testing as well as that piece of the business, so we feel good that all the aspect of the business are continuing to grow here.

Adam Feinstein - Barclays Capital

There was a question earlier on the impact from Medicare. The clinical lab fee schedule you were talking about before, but with the physician fee schedule and some of the proposed cuts there, this carries in terms of how you’re thinking about that. I know it only impacts a small percentage of your business, but still I wanted to get your thoughts. Also last quarter, there was some discussion in the industry about MUEs and the impact of that, so I was just curious in terms of whether that reverses itself in the second quarter.

Robert A. Hagemann

Adam, as you said, the physician fee schedule impact is a much less significant impact to us. It’s going to be less than $10 million the way we size it at this point, and with respect to MUEs, we’ve never identified that as a significant impact to us, and in fact many of the edits that were put in have been pulled back at this point.

Laure Park

And that modest impact was on cash timing only, not on revenue recognition.

Operator

Your next question comes from the line of

Laure Park

Your next question comes from the line of William Quirk - Piper Jaffray.

William Quirk - Piper Jaffray

Surya, I just wanted to talk a little bit about healthcare reform. You mentioned it briefly in your opening comments. I think most of us are probably keeping a pretty close eye on the Baucus Senate Finance Committee for guidance. I’d love your current thoughts here.

Dr. Surya N. Mohapatra

All of us know that healthcare reform is required. Healthcare itself in the US is very complex, very costly, and frankly very confusing. What is really good for this industry is that you cannot practice evidence-based medicine without evidence, and the laboratory testing is one of the main testing you do to really get objective data, so we’re actually very supportive of the President’s goal to increase expanded coverage and enhance early detection programs and also promote healthcare and wellness and also use of healthcare IT to reduce costs. One of the most difficult things at the moment whether it’s primary care or whether it’s hospitals or whether it’s rehab centers, there is a lot of inefficient handoff between the parties, so we’re strongly in support of healthcare reform, but very fortunately laboratory testing is only 3% of the total healthcare cost, but now the administration and the medical community is realizing the value of diagnostic testing, so we’re in a very good position and we’re helping the administration as much as we can as far as recognizing the value of diagnostic testing.

William Quirk - Piper Jaffray

As we think about the various bills making their way through committees and such, how should we think about them?

Dr. Surya N. Mohapatra

Here are some of the things we look at. First of all, as I said, we don’t have a crystal ball, but all we have is thoughtful consideration of some of the factors. Access is positive—expanded access. When you bring in 20 or 30 million people out of the 47 uninsured, that’s positive for this industry. Doing testing, whether it’s for illness or wellness, that’s positive. Healthcare IT for our company is positive. Obviously something is probably going to be negative which will be the reimbursement or fee schedule, but as you know as far as our company is concerned, we have gone through some of those things, so we know how to really modify some of the operating efficiencies to really have a sustainable margin.

Laure Park

And on that front, we’re also keeping to educate them that over the past several years the clinical laboratory industry has been impacted to some degree disproportionately on the negative side from the fee schedule adjustments on care to durable medical equipment or outpatient services, and we’re working to educate key members of both sides of the aisle in House and Senate on those changes.

Robert A. Hagemann

And when you think about, just about every provider is going to have some pressure as it relates to reimbursement, but if you look at the lab space, we’re 3% of the total spend, so it’s not where the big dollars are.

William Quirk - Piper Jaffray

So would it be safe to assume guys that you’re not expecting a major turn in reimbursement changes in the relatively near term—in other words, the CPI less 50 basis points deal, maybe a good thing to look at in terms of your barometer here?

Laure Park

Bill, we’re not looking at any type of draconian cuts based on what’s being discussed currently. The only thing definitively that’s under discussion right now is the productivity adjustment onto the CPI. Beyond that, it’s really I don’t think appropriate for us to speculate what type of components might be on the Senate side. We’ve not seen anything specifically outlined at this point.

Robert A. Hagemann

One other point on that, Bill. The productive adjustments, as we’re looking at those too, the incremental impact of that is not overly material either—again less than $10 million as we calculate it.

Laure Park

And maybe to put it into context, at this point in time, we’re looking at on the CPI adjustment based on what’s currently in place, we’re looking at about $25 million impact to the company which is clearly less than one half of 1%.

William Quirk - Piper Jaffray

Inventory levels continued to tighten up. Bob, is there a level here or turn ratio that you’re targeting?

Robert A. Hagemann

Not a specific turn ratio, but it’s interesting that you noticed that. This year, we have made a concerted effort to manage capital more efficiently, and in fact we have deployed a capital charge to each of our businesses to get them to more focused on managing capital very effectively, and it’s actually worked very well. I think that we have wrung out some excess capital out of the system, and obviously as you know the less capital that you need to operate your business the more that you’ve got available to grow your business. So not a specific target there per se. As you look at our balance sheet, inventory is not a big number. The big opportunity really is in DSOs, and I think we continue to do a good job there in managing those down and keeping those under control.

Operator

Your next question comes from the line of Charles Rhyee - Oppenheimer & Co.

Charles Rhyee - Oppenheimer & Co.

Just looking at the guidance relative to what you guys put up here in the quarter, particularly on the interest expense, I understand here that there is early extinguishment of debt, and should we think about the interest expense going forward sort of at this current level, and if so, it seems like you’re going to benefit by a couple of pennies per quarter. Am I thinking about that correctly, or is there something else that I should consider here as we think about the back half of the year in terms of guidance?

Robert A. Hagemann

Just to give you some perspective. We don’t provide a specific guidance on interest expense, and obviously the tender is going to help reduce interest expense in the back half of the year, but it’s not a couple of pennies in a quarter. At best, it’s a penny a quarter.

Charles Rhyee - Oppenheimer & Co.

Staying home with guidance here, just wanted to ask about the volumes. Obviously you’re doing a lot better here than maybe some people had expected, and particularly the revenue growth here in the second quarter. At what point would you feel comfortable feeling, 3% revenue growth maybe at the low end of range, and we could see something better than that, or is there anything else out there in the future that we should consider why 3% remains the target and the trajectory you’re on as we move to maybe easier comps in the back half of the year?

Robert A. Hagemann

Certainly, if you just look at the full year guidance for about 3%, it implies that the back half of the year is going to be as strong as we saw in the second quarter. I would tell you that it’s a little premature for us to be thinking about raising revenue guidance, but I’m glad that at least you’re thinking about at this point.

Operator

Your next question comes from the line of Darren Lehrich - Deutsche Bank Securities.

Darren Lehrich - Deutsche Bank Securities

I want to just go back to the volume question and wanted to get some commentary from you about what your salesforce is seeing in the physicians there. Has there been any kind of broader based recovery that’s led to your test volumes? Can you just comment on the tenor of the activity in the system throughout the quarter?

Robert A. Hagemann

First, I would tell you that it’s very hard for us to assess actually what’s happening in physician offices. Anything we get there is very anecdotal, but what I would tell you is that we’re continuing to effectively execute our plan, and this is all about blocking and tackling and effectively selling, and selling a value proposition which includes a comprehensive menu, includes superior service, and that’s what we’ve been doing over the course of the last year, and that’s why I think we’ve seen steady improvement in our underlying volumes, and that’s why we’re confident in the guidance that we’ve got out there for the remainder of the year.

Darren Lehrich - Deutsche Bank Securities

If I could maybe just shift to swine flu testing and just a couple of questions there, I know you had a release in May that Surya referenced, where do you stand with regard to how you and the industry might coordinate with public health entities? I just wanted to better understand how you think some surge in volume activity in the fall or winter may play out relative to this flu and can you just help us think about that and whether you saw any kind of activity in the quarter relative to the new PCR test?

Dr. Surya N. Mohapatra

First of all, I’m very proud of the way we’ve brought this laboratory developed test in the market very quickly, but obviously this is a pandemic, and we’re working with the State Department, CDC, and the FDA, and we’re getting ready. Hopefully it’s not required, but if required, we will be able to provide testing for the patients and the physicians, but over the last few months, we have not seen enough to move any number, and again there is a lot of discussion going on to prepare the country in case this happens, and the most important thing for us is that we have a test which can be done commercially.

Laure Park

And while the volumes, Darren, weren’t big enough to move the overall results, they were higher than what we would see in a normal off season for flu perspective.

Darren Lehrich - Deutsche Bank Securities

On the pathology front, I wanted to get some comments from you about your progress in recruiting clinical leadership for that business. I think it was a few months ago that we saw a New York Times ad for a number of posts in your pathology business, and I just wanted to put that into perspective relative to clinical leadership within that business line.

Dr. Surya N. Mohapatra

First of all, as Bob said and you have seen, we’re building this company in a number of platforms, whether it’s patient centricity, or whether it’s growth through acquisition or organic growth, or developing people, so a few months ago you saw that we hired our first chief medical officer, and he’s not a pathologist. He is Dr. Jon Cohen. He was advisor to Governor Patterson, and he is a vascular surgeon. Our head of science and innovation is Dr. Jay Wohlgemuth; he is a cardiologist, and what we’re trying to do, as we told before that we’re going to be laser focused on cancer, infectious disease, and cardiovascular disease, we’re building up this science and medical leadership in this company so that we can leverage 800 MDs and 100 PhDs we have. Now, here is what is happening to healthcare. As you saw, the demand has grown by cancer testing. Whether we like it not, every year 1.5 million people are diagnosed with cancer and also half a million people will die, but the good news is that there are 10 million who survived their cancer, so whether it’s skin cancer, breast cancer, prostate or colorectal cancer, we have the ability to do the test and provide the information, so that’s the reason why we are enhancing our medical and scientific leadership and our future is based on actually how we deliver this information to this three large categories along with chronic diseases.

Darren Lehrich - Deutsche Bank Securities

Have you completed those?

Dr. Surya N. Mohapatra

This is a continuous process, and as we go on, we will keep at it. We refine people, we add people, but you’re seeing a new structure, and one other comment I want to make is one of the reasons why we’re doing good is sales is because we changed our approach to sales and we have new leadership in sales, and for the last 10 or 12 months, we have been very focused on how to really call on various customer categories, whether it’s physicians or whether it’s hospitals or whether it is the insurers, but in the physician business, we have new leadership driving the engagement to our customers.

Laure Park

Just a point of clarification, Darren, those two ads were actually for people to out to our Nichols Institute to expand on capabilities on the cancer site there.

Dr. Surya N. Mohapatra

You will see more of this kind of activities going forward, whether it’s personalized medicine or whether it’s company diagnostics or clinical trial. We’re going to expedite some of the science and innovation hires.

Operator

Your next question comes from the line of Kevin Ellich – RBC Capital Markets.

Kevin Ellich – RBC Capital Markets

Just going back to healthcare reform, I know it’s been discussed quite a bit this morning, but I was curious if you could talk about what opportunities there are. You talk about the healthcare IT initiatives and what not, but what other opportunities and challenges do you guys see coming from healthcare reform?

Dr. Surya N. Mohapatra

Let me first talk about the challenges. We’re all supportive of the healthcare reform, but it’s a complex issue, so the most important thing is to have real appropriate thoughtfulness to figure out how do you really expand coverage, how are we going to get the money, and as you know we still have a lot of deficit as far as where the money is going to come from, but while the legislators and the regulators are trying to have a discussion, from our industry point of view, we find very positive indications of where could help to reduce healthcare costs. For example, if you diagnose disease at an early stage, the total lifecycle cost for the patient goes down. For example, you may expend $600 for diabetes to say $15000 after detection if you’re not taking care of it. Simple tests for wellness can keep people away from the hospital, so I think there is a culture required with all of us to take care of our health along with the government helping us to give some incentive on various areas, so from diagnostic testing point of view, I think it’s very positive, and we’re getting ready, as you said, continuously to really see what the government is doing. Now, one thing in this company, if you see two or three years ago, we instituted a wellness business, so there’s another opportunity on prevention and wellness, and we have a division to provide that kind of mass diagnostics required, whether it’s employer based or with a health plan. To talk a little bit about healthcare IT, the most important reason why the IT adoption has not been there is because most of the doctors are into 1- to 3- physician practice, and it’s very difficult for big companies to go and approach them, and we’re so fortunate that we have 150,000 doctors who are on Care 360, and they can get money now for e-prescriptions, and going forward, I think it’s an opportunity for us to stimulate growth when we introduce the meaningful use of some of those healthcare IT.

Kevin Ellich – RBC Capital Markets

Thinking about the uninsured, if indeed there is some sort of mandatory coverage, what percent of your bad debt comes from the uninsured versus copays and deductibles?

Robert A. Hagemann

Most of our bad debt actually comes from the uninsured. The bad debt associated with copays and deductibles obviously is higher than the overall bad debt, but most of it comes from the uninsured. If your think about our patient bill, roughly 13% of our revenues are from patients with about a half of that associated with the uninsured, and about half of that deductibles and copays.

Kevin Ellich – RBC Capital Markets

If indeed these uninsured people all of a sudden have coverage, do you see an increased market opportunity as they are going into the physician office and maybe the doctors will be ordering more lab tests?

Dr. Surya N. Mohapatra

I think the physician should order whatever the test that is required for the patient, but obviously there are more people in the system depending on actually what kind of people that will go to the physician office, but I don’t know…

Robert A. Hagemann

If your question was do we think that the folks that are uninsured today who will be insured in the future are going to have a different level of utilization, I don’t see that necessarily.

Laure Park

But the opportunity is, if we are looking at are they come into the doctor’s office versus the ER, absolutely. That’s an opportunity for us, where most of our work does originate in the physician office setting.

Robert A. Hagemann

The broader opportunity has to do with the increased awareness of the value of diagnostics and early detection, like Surya was talking about before. When you look at what’s the essential healthcare benefit, that’s expected to include lab services, and that’s important recognition of the value that we bring.

Dr. Surya N. Mohapatra

And those people do end up in the emergency room, and that is what the administration wants to avoid because it’s very expensive. Once you have the coverage, they can have doctors and then they can be under physician care, and that’s going to reduce catastrophic illnesses.

Kevin Ellich – RBC Capital Markets

With the swine flu and H1N1, did you see any impact on volume in the quarter?

Robert A. Hagemann

Nothing that would move our numbers at all. It was very small volume, but as Laure said, higher than we typically see during a non-flu season, but certainly nothing to move the needle.

Kevin Ellich – RBC Capital Markets

Could you talk about the uses of cash, I guess where do you stand on the buyback? I don’t think you repurchased any stock during the quarter, but given where the stock is today, how attractive do you view that?

Robert A. Hagemann

I’m not going to get into making comments about the attractiveness of the share price, but as you know, all of the cash that we generate, we deploy, and it’s going to be deployed in one of three areas—either further debt repayment, share repurchases, or acquisitions, and while there’ll be some further debt repayment, most likely over the course of the year, we’re in a position now where we can give a lot more consideration to acquisitions and share repurchases, and frankly the priority between those two would be acquisitions as it always has been because those can create sustainable growth for us, and when acquisitions aren’t available either on a timely basis or at the right price, that’s when you see us deploy the excess cash into share repurchases, and while we may not be in the market every quarter for share repurchases, over the course of a year though, you should expect at a minimum we’re going to be repurchasing enough to offset the dilution associated with benefit plans which translates into about 3 million shares a year or so, but you should expect that in every quarter, we’re going to make good use of the cash that we generate and deploy it to drive shareholder value, and in this quarter unfortunately we had $300 million that we needed to fund which we did without adding incremental debt at the end of the quarter, so I feel very good about the cash flow generation and the ability to continue deploying that to drive shareholder value.

Operator

Your next question comes from the line of Shelley Gnall - Goldman Sachs.

Shelley Gnall - Goldman Sachs

I was wondering if you could share a little bit about your contracting relationship with HealthNet given the news on the United acquisition?

Robert A. Hagemann

Shelley, we don’t comment on specific arrangements with payers.

Shelley Gnall - Goldman Sachs

My question being I was wondering if there is a chance that Quest could lose some of the HealthNet lives that they could be migrating out with United with the acquisition.

Laure Park

Keep in mind, Shelley, that HealthNet has only sold their Northeast business which is a limited number of lives; therefore, the impact to us to the extent that we lose some of that volume is very limited.

Shelley Gnall - Goldman Sachs

On the CPI, I know that the administration is looking to put these productivity cuts in place as well. It sounds like that would reduce the Medicare rate by a further 1.5%, if I’m getting that right.

Robert A. Hagemann

Shelley, as I said earlier, that impact would be less than $10 million to us.

Shelley Gnall - Goldman Sachs

No, I’m wondering if that is in place, if the administration is targeting 2010, and then my question would be does that have any long-term implications on your negotiations with managed care if the administration is successful is getting some productivity cuts out of rates?

Robert A. Hagemann

Shelley, as we said earlier, our managed care contracts are all negotiated separately, and each one is a separate negotiation, and over the years as Medicare has moved either up or down or have been flat for many years, it really hasn’t impacted those discussions, and as we said earlier, it’s a very small piece of our contracted business that is linked to the Medicare schedule. Frankly, what’s driven our improvement in revenue per requisition and what continues to drive it as we look ahead is the mix of business shifting to more esoteric and gene-based test as well as the utilization—increased number of tests ordered per requisition, and we expect that that will continue to drive improvements in revenue per requisition going forward.

Laure Park

I think an important illustration is that literally since 1997, the industry has received only three CPI adjustments; yet, since 1997, we’ve driven continuous improvement in our revenue per requisition.

Shelley Knoll – Goldman Sachs

That’s helpful, but I’m thinking more of on the productivity side. I am wondering if the administration sees an opportunity to trim rates further, whether the productivity piece of this could flow through to managed care negotiations. Maybe my question is how far in advance are some of your bigger contracts negotiated? Do they tend to be 1 to 3 years in duration? Have those escalators already been in place or are they at risk as the terms are renegotiated? Is there is potential for managed care to also seek productivity adjustments?

Robert Hagemann

Shelley, there is a potential for them to do anything, but there is a separate negotiation which is based upon the value that we bring to each payer, and that discussion is independent of what the government is doing.

Laure Park

To your question on contracting, all of our major contracts extend beyond 2010 at this point in time. They are multiyear in nature and very much distinct discussions.

Robert Hagemann

And the pricing in those is negotiated and predetermined. In some cases, there are scheduled increases. In other cases, there may be opportunities for the payer to get further volume discounts based upon moving work to us, and in some cases, we have no adjustments to pricing over the contracted term, but as we already said, all of our big contracts are negotiated for multiple years at this point, and the pricing in those contracts is set and is independent of what is happening with the Medicare fee schedule.

Operator

The next question comes from the line of Amanda Murphy with William Blair.

Amanda Murphy – William Blair

Just a couple of followups for you on a comment you just made about revenue per requisition growth being driven by mix shift as well as an increase in tests per requsition. I’m assuming it’s mostly mix shift at this point. Is that fair and then also in terms of the tests per requisition, what are the trends that you are seeing currently?

Robert Hagemann

Amanda, it’s really a combination of both. It continues to be obviously the mix shift, but as we introduce new tests, you have to recognize that many of those are ordered in conjunction with other tests, so that’s driving utilization and increasing the number of tests ordered per requisition. Another way to think about it is just the volume of testing is going up while the volume of patient encounters is going up at a slower rate, and I think you’ll continue to see that as we continue to introduce new tests, that will drive additional tests per requisition or test per encounter.

Amanda Murphy – William Blair

And then also you talked some about the routine side of the business. Could you provide some color on AmeriPath and where we stand there? I think in the past you had talked about some weakness on the hospital side. Are you still seeing that? Maybe just give a little perspective on how that business is going.

Dr. Surya N. Mohapatra

First of all, AmeriPath integration is going well. As you know their hospital part, the facility, is already fully integrated with our hospital business. As far as cancer diagnostics, it remains number one, and what we are trying to do now is trying to get sales leverage by cross-selling to primary care for skin cancer. Cancer diagnosis remains number one, and we still and as you said we have increased our testing on the outpatient tissue volume rather than the inpatient.

Laure Park

Absolutely, Amanda. As Surya said the outpatient has been definitely stronger than the inpatient tissue volume coming through with AmeriPath.

Robert Hagemann

What we are seeing to is increases in molecular testing associated with anatomic pathology as well, so as Surya said we really need to start thinking about it as cancer diagnostics rather than just anatomic pathology because that’s what’s growing the cancer testing.

Amanda Murphy – William Blair

On the reform issue again, one of the things that seems to keep resurfacing is this whole concept of bundling. What is your perspective on that and in your conversations with people on the Hill, is that something that you think could be incorporated into reform?

Laure Park

Amanda, we are not going to speculate on it. Obviously, we have a lot of questions in regards to how some of that would be implemented, so we are not going to speculate. We are continuing to learn more and obviously to talk to the Hill about the process.

Amanda Murphy – William Blair

If it was implemented, do you have any idea what, I guess it depends on how it’s structured, but…

Laure Park

The devil is in the details, absolutely.

Dr. Surya N. Mohapatra

Not only how it is structured, how will I administer because having _DRG in the hospital is very different than outpatient. It’s a very complicated proposition to bundle for ambulatory patients.

Robert Hagemann

There’s the practicality issue that you have to deal with.

Amanda Murphy – William Blair

Last quarter, I think you mentioned that there were some expenses that were deferred. Do you have any perspective on when those might flow through to P&L?

Robert Hagemann

As we think about that, a lot of those expenses, and I think I said this at the end of the first quarter while some of those are going to flow through the P&L later in the year, sometimes the longer you go without spending something, the more likely you’re to realize that maybe you didn’t need to spend it in the first place, and I think that’s what we are realizing here, so some of those expenses will not come back through the P&L. Others will come back later in the year, but all that’s baked into our guidance at this point.

Operator

The next question comes from the line of Anthony Vendetti with Maxim Group. Your line is open.

Anthony Vendetti – Maxim Group

On the genomic and esoteric testing, I know you said 35% was the number this quarter as a percent of the revenues. If you stripped out anatomic pathology or if you want to include it, where do you see genomic and esoteric testing going as a percentage of revenues over the next 3 to 5 years, and then the followup question is just going to be on unemployment as it approaches 10% or a little over 10% in certain states, what impact, if any, do you see in 2010 on that?

Laure Park

Well, I think as to where do we see the 35% number going to, obviously the gene based component is clearly more, and more testing is being performed using a gene base. What’s important is that number can’t grow for ever. What’s esoteric today is going to become routine tomorrow, and that’s not a bad thing. It means the test is growing in importance and more and more people are using it, so while we would see that number growing up, we don’t see it moving to being 50% or more of our business. It’s important for us to keep a good strong pipeline to keep driving new tests to be introduced so that things become more routine, that we’re introducing new valuable tests to physicians and their patients.

Robert Hagemann

Anthony, with respect to the unemployment question, over the course of the last year, we have seen unemployment rise significantly, yet our underlying volume when you strip out the drugs of abuse testing business has been steady and has started to grow, and while we are not totally immune from further unemployment, I do expect that we’ll continue to grow our business.

Operator

The next question comes from the line of Robert Willoughby with Bank of America-Merrill Lynch. Your line is open.

Robert Willoughby – Bank of America-Merrill Lynch

Surys or Bob, the e-prescribing volumes you threw out there, a huge jump there, but you don’t see any economics in the actual volumes, do you? You’re not paying on a per click basis?

Laure Park

Robert, the reimbursement is a monthly reimbursement per prescribing doctor, so that’s where the revenue comes through.

Dr. Surya Mohapatra

You’ll get some, but it’s not really significant yet, but the important thing is that we have a product, people like it, and actually now we are reaching those areas where a bigger company cannot, so today they’re getting e-prescription from CMS, tomorrow they might the stimulus money, but the most important thing as I said is the stickiness which we have created with our customers.

Robert Willoughby – Bank of America-Merrill Lynch

Okay, so thoughts of ever charging on a per prescription basis that you could get a nickel or something?

Dr. Surya Mohapatra

We have a small revenue model, but it is not significant at all.

Robert Hagemann

It’s not a per click model at this point.

Robert Willoughby – Bank of America-Merrill Lynch

Can you explain the economics on that new MedPlus relationship with the New York Clinical Information Exchange? How does the money flow on something like?

Laure Park

Robert, each HIE negotiation looks a little different. With many of the HIEs what the initial streams look like is a negotiation for the creation and development of the pipe so to speak as well as the software that’s going in. As it relates to ongoing revenue models, they look a little different across the various HIEs.

Dr. Surya Mohapatra

It’s licensing and then it is service, but also we are acting as a system integrator, so we get to charge them for our work.

Robert Willoughby – Bank of America-Merrill Lynch

Okay, but still no transaction event driven revenue model. This is all license fees.

Robert Hagemann

There is the potential for that, Robert, and each one of these is a little bit different quite frankly. You’ve seen one, you’ve seen one, basically.

Laure Park

But clearly we think across the country you are going to continue to see more and more of these exchanges being developed, and those will evolve as people get more experience.

Robert Hagemann

There will be some opportunity for continuing ongoing revenue, but again those models are still developing at this point.

Robert Willoughby – Bank of America-Merrill Lynch

And did you mention what the asset write-off was, Bob, the investment write-off that had?

Robert Hagemann

I did not. It was just a small equity investment that we had made that the accounting rules at this point require us to write down.

Operator

The last question comes from the line of Gary Taylor with Citigroup.

Gary Taylor – Citigroup

It seems to me this was a pretty important quarter in terms of just looking at payer mix and capturing any change in buy-down that perhaps would have started flowing through in the Q1, and now you’ve got an additional quarter to look at it, so I just wondered if you might just comment on payer mix here to date, and it sounded like the comments you had made just about self-pay being 13% of revenues, half copays, half uninsured, it sounds like that’s pretty unchanged, so is it fair to say overall that mix and buydown really haven’t moved much on total payer mix year to date?

Robert A. Hagemann

I think that’s a fair assessment at this point. When you’re talking about mix, you’re talking about mix of patient pay versus third party pay?

Gary Taylor – Citigroup

Correct.

Robert A. Hagemann

No, that has not changed substantially over the course of the year. As always, there is a little bit more of patient pay in the first quarter prior to people hitting their deductibles and the like, and as a result, we always have a slightly higher percentage of bad debt in that first quarter, but nothing different this year from historical trends.

Gary Taylor – Citigroup

And can you give us the balance sheet allowance against AR?

Robert A. Hagemann

I don’t have t handy. It’ll be in the 10-Q when it’s filed, but it has not changed significantly.

Gary Taylor – Citigroup

Backing up to the 1Q, the bad debts have been stable, actually down a little bit in the 2Q, the DSO trend has been stable, actually down a little bit in the 2Q, but if you look at the first quarter, your allowance as a percent of gross AR dipped a couple of hundred basis points sequentially. What do you attribute that to? I mean theoretically that would suggest the mix of the gross AR had improved. Is that rate increases on the commercial side making commercial AR grow a little faster, or why would the gross AR mix have improved in the 1Q?

Robert A. Hagemann

It could be driven by a whole bunch of things. It could be driven by improvements in the agents. It could be driven by the timing of writeoffs, etc., and what I would tell you is with respect to the adequacy of that allowance and the reserves that we’ve got out there, I feel very good about that, and I do not expect there to be any surprises. We’ve got a very rigorous process around that. It’s reviewed by a dedicated team here. It gets a lot of attention from our auditors as you’d expect, and any movement that you see in that reserve would be for the most part principally driven by just the timing of writeoffs and really nothing else. At the end of the day, I think the way to get comfortable with your receivables and the adequacy of the reserve there is watch the DSOs, watch the bad debt, and if they’re going in opposite directions, there is an issue. If they’re going in the same direction, generally you should feel pretty good. The other think you need to do is watch the cash at the end of the day, and you’ve seen, the cash flow has been very strong in the quarter.

Operator

Thank you for participating in 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 will be available from 10:30 am EST on July 21, 2009, through midnight on August 22, 2009, to investors in the US by dialing (866) 395-9177. Investors outside of the US may dial (203) 369-0501. No password is required for either number. In addition, registered analysts and investors may access an online replay of the call at www.streetevents.com. The call will also be available to media and individual investors at Quest Diagnostics website. The online replay will be available 24 hours a day beginning at noon.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!