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Operator
Welcome to the Quest Diagnostics third quarter conference call.
At the request of the Company, this call is being recorded.
The entire contents of the call, including the presentation, and question & answer session that will follow are the copyright and 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 would like to introduce Kathleen Valentine, Director of Investor Relations for Quest Diagnostics.
Please go ahead.
- Director IR
Thank you, and good morning.
I'm here with Surya Mohapatra, our Chairman and Chief Executive Officer, and Bob Hagemann, our Chief Financial Officer.
Some of our commentary and answers to questions may contain forward-looking statements.
You are cautioned not to place undue reliance on forward-looking statements which speak only as of the 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 result and outcomes to be materially different.
Risks and uncertainties that may affect the future results of the Company include but not limited to -- adverse results from pending or future government investigation, lawsuits or private action, a competitive environment, changes in government regulations, changing relationships with customers, payers, suppliers and strategic partners and other factors described in the Quest Diagnostics 2009 Form 10-K, quarterly 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 web site at www.questdiagnostics.com.
A PowerPoint presentation and spreadsheet with our results and supplemental analysis are also available on our website.
Now, here is Surya Mohapatra.
- Chairman and CEO
Thank you Kathleen.
We grew earnings in the third quarter despite continued softness in physician office visits.
While revenue was down we are confident in the future and are making progress executing our plans to accelerate profitable growth by promoting new gene-based and esoteric tests, enhancing sales effectiveness and improving operational efficiency.
During the quarter, earnings per share increased 11%, to $1.13, revenue decreased 1.7%, to $1.9 billion, and cash flow was $330 million.
We are committed to using our substantial cash flow to generate value for our shareholders through both acquisitions and share repurchases.
So far this year, we have returned $750 million to our shareholders through share repurchases and now have flexibility to make $250 million of additional repurchases in the fourth quarter.
We continue to focus on sales, service, and signs to drive organic growth and believe we are doing the right things to strengthen our foundation for revenue growth, increase profitability, and enhance shareholder value.
We continue to promote new genetic and esoteric tests, and healthcare IT services.
We are upgrading our sales organizations and enhancing their capabilities.
We are working closely will health plans and employers to gain a larger share of their business by reducing their high cost out-of-network leakage.
We are taking actions to make our business more efficient and we are putting our substantial cash flow to work to drive shareholder value.
I will update you on our progress after Bob discusses the financial results.
Bob?
- CFO
Thanks Surya.
Revenues for the quarter were $1.9 billion, 1.7% below the prior year.
Our clinical testing revenues, which account for over 90% of our total revenues, were also 1.7% below the prior year.
Revenue per acquisition was 1.3% below the prior year, and essentially unchanged from the second quarter level.
While year-over-year revenue per acquisition continues to benefit from an increased mix of gene-based and esoteric testing and increases in the number of tests ordered per acquisition.
This benefit has been offset by some business and payer mix changes, Medicare fee decrease, and pricing changes in connection with several large contract extensions executed last year and earlier this year.
The business and payer mix changes which continue to pressure revenue per acquisition include a further rebound in drugs of abuse testing, and weakness in our higher priced anatomic pathology testing.
We expect changes in revenue per acquisition will continue to be modest through the first half of next year with the anniversary of the business mix, payer mix, and contract changes which are currently offsetting the benefits of the growth in gene-based and esoteric testing.
Volume in the third quarter was 0.3% below the prior year, and continues to be pressured by the general slowdown in physician office visits.
However, the third quarter volume reflects some improvement from the first and second quarters of the year which were below the prior year by 2.6% in Q1, 1.6% below adjusted for weather, and 1.3% in Q2.
Drugs of abuse testing has continued to rebound and grew 7.5% in the quarter, and contributed modestly to the improved volume trend.
Revenue in our non-clinical testing businesses which includes risk assessment, clinical trials testing, point of care testing and healthcare IT was about 2% below the prior year level principally due to the performance in our risk assessment business.
Operating income as a percentage of revenues was 18.1%, compared to 18.4% in the prior year.
We continue to make progress in managing our cost structure and driving quality improvements.
We are currently evaluating a number of new opportunities to further improve our efficiency and service quality which we believe will further streamline our cost structure.
This will not only support margins during this period of market softness but also will allow us to disproportionately take advantage of a market rebound.
We continue to see strong performance in our billing and collection metrics.
Bad debt expense as a percentage of revenues was 4% in the quarter compared to 4.4% a year ago.
DSOs at 43 days are unchanged from the beginning of the year.
Earnings per share were $1.13 in the quarter, an 11% increase from the prior year.
EPS benefited by $0.08 in the quarter as a result of a reduced tax rate, which was primarily due to the favorable resolution of certain tax contingencies.
Cash from operations was $330 million, and compared to $374 million in last year's third quarter, the difference primarily due to the coming of interest and tax payments.
Capital expenditures were $47 million in the quarter, compared to $41 million a year ago.
During the quarter, we repurchased seven million shares at an average price of $46.64, for a total of $324 million.
We have now fully utilized the $750 million share repurchase authorization granted in January of this year.
Earlier today, we announced that our Board has authorized an additional $250 million of share repurchases to provide us with continued flexibility to deploy our cash through the fourth quarter.
This incremental repurchase authorization is intended to bridge us until we complete our planning for 2011, and should not necessarily be viewed as the planned repurchase level for Q4.
The level of share repurchases in any given quarter will continue to be a function of a number of factors, most notably expected acquisition activity.
We plan to evaluate what level of authorization will be appropriate beyond the end of this year as part of our annual operating and capital plans, and expect to share that with you in January as we have done historically.
Our cash balance coupled with our unused credit lines provides us with significant liquidity and has positioned us extremely well to capitalize on growth opportunities and take other actions like share repurchases to drive shareholder value.
Turning to full year guidance, we now expect results from continuing operations before special items as follows-- Revenue, to be approximately 1.5% below the prior year.
Operating income, to be between 17.5% and 18% of revenues.
Cash from operations to approximate $1.1 billion.
Capital expenditures to approximate $200 million.
And lastly, diluted earnings per share to be between $3.95 and $4.00.
As you will hear more about this area we continue to focus our efforts on accelerating growth, including exploring both strategic and opportunistic acquisitions.
In addition, as I mentioned earlier, we are continuing to drive efficiency in our operations which together, with improved top line performance we expect will accelerate earnings growth.
Now I will turn it back to Surya.
- Chairman and CEO
Thank you, Bob.
Our updated guidance reflects the fact that while we are seeing progress, some of the actions we have been taking to accelerate growth are taking longer to produce results than we expected.
None of us are satisfied.
However, we are seeing encouraging signs and I want to provide you with an update on the progress we are making on some of the initiatives we shared with you earlier this year.
We're investing in our sales organization.
We are hiring and providing ongoing training to people who, over time will serve as trusted consultants to doctors and other customers who meet their diagnostic testing needs.
Over the past several quarters we have continued to add new talent to our sales force overall and in key special areas and geographies.
So far this year, we have upgraded the overall sales force and added about 100 new positions.
To make them effective sooner we have announced our training programs in various sub-specialty areas including oncology and genetic testing, and we are giving them advanced tools to better target sales leads.
As we shared with you last quarter we have been working with health plans and have extended some of our health plan contracts to give us visibility and pricing stability.
This has enabled us to turn our focus to working closely with health plans and their employer clients to reduce high costs and out-of-network lab spending known as leakage.
Health plans and large employers are considering changes in plan design that both drive business to us as a preferred provider and reduce lab costs for the health plans, employers, and their employees.
I'm pleased that some health plans have also made reimbursement policy changes to address overutilizing caused by insourcing of certain kinds of anatomic pathology.
We continue to promote new esoteric and gene-based tests that help physicians personalize care.
During the quarter, esoteric and gene-based testing grew about 4%, driven largely by sales to hospitals and physicians specialists.
We continue to see strong double-digit revenue growth from vitamin D testing, which uses the tandem mass spectrometry platform, the gold standard in our industry.
We have also driven double-digit revenue growth in ImmunoCAP allergy testing as well as testing for blood cancers particularly our Leumeta family of blood tests.
We are pleased by the increase we are seeing in the adoption of our OVA1 test for ovarian cancer.
Service delivery is a important competitive differentiator and we have announced our service levels in several ways.
We have added personnel such as phlebotomists and service reps and are opening new patient service centers to offer convenience to patients.
We are significantly reducing the time it takes to collect new clients through our Care360 connectivity solutions.
Healthcare IT, the strategic differentiator for us and Care360 is a centerpiece.
Care360 is not just a customer service; it's how we run our business.
We depend on it every day so it has met the test of time.
This month we passed a major milestone of 40 billion test results processed and transmitted via Care360 since it was launched six years ago.
We are pleased that the American Medical Association selected our Care360 EHR as one of the few EHR solutions that can be accessed from their portal.
We have partnered with Hewlett-Packard to provide an integrated system to physician practices to accelerate their [dubsome] of Care360 EHR.
Since we introduced the Care360 Electronic Health Record earlier this year, more than 1,000 doctors are using it.
We generated strong cash flow, we have committed to deploying our cash to drive growth, our preference is to invest in acquisitions primarily in genetics, esoteric testing and cancer diagnostics including anatomic pathology.
We are active in evaluating potential acquisitions that make economic and strategic sense.
When acquisitions are not available on reasonable terms, we will return cash to shareholders through share repurchases and dividends.
In closing, we are making tangible progress on a number of important initiatives.
The long-term plans for our business continue to be positive and as the industry leader we are well positioned to take advantage of these trends.
Thank you.
We will now take your questions.
Operator?
Operator
Thank you.
(Operator Instructions) One moment please for the first question.
Our first question is from Adam Feinstein with Barclays Capital.
Your line is now open.
- Analyst
Hi.
Good morning this is Brian Sekino on behalf of Adam Feinstein here.
Just wanted to ask you if you could, I guess, comment on the pricing growth in the quarter?
I know you mentioned there was some contracting things in the second quarter.
The lower growth this quarter, is it due to kind of a full quarter that-- the contracts in September quarter-- or is there something else that is going on there?
- CFO
The contract changes were fully reflected in the second quarter and just continuing this quarter.
Essentially what you see is revenue per requisition in Q3 essentially flat with where it was in Q2.
Really what's driving the change in the year-over-year comparison is really the comps at this point, but we've got stability in revenue per requisition.
We're not expecting the absolute level of revenue per requisition to change significantly from where it's at in the fourth quarter.
- Analyst
Where it's at, right, in Q3 and so you do expect a sequential flat number there?
In Q4?
- CFO
Correct.
We're not expecting it to change significantly.
- Analyst
Okay.
Then, a question on the physician insourcing.
Have you seen the dynamic there kind of pick up and, I guess, is this upgrade in the sales force somewhat of a response to some of those issues that are going on?
- Chairman and CEO
Well, when we saw this year when we observed slowness in the marketplace and less number of physicians' office visits, we said that we are going to announce our salespeople, add some people where we didn't have, upgrade people, train them in genetics and esoteric testing and cancer diagnostics and we're going to improve our salaries.
So, although the [inaudible] is down by 4.4%, our revenue decline is 1.7%.
So, we feel that we are seeing the revenue decline is moderating and now that we have surprising stability and sales force effectiveness is improving.
- CFO
While we continue to see insourcing of both the technical and professional component, there are some signs that the rate of that is beginning to slow.
- Analyst
Okay.
Is there a general sense that there are some legal issues with doing that?
Is that potentially causing that rate to slow?
- CFO
I'm not sure exactly what is causing at this point.
As we've indicated previously, we do believe that this insourcing is essentially a form of self referral which it creates unnecessary utilization, we are working through that with our lobbying group, [Ocala] and others to try and alert legislators and policymakers to that effect.
- Chairman and CEO
Some health plans have already taken in to that consideration and they're restricting the reimbursement in those insourcing.
- Analyst
Thanks for taking my questions.
Operator
Thank you.
Our next question is from Ralph Giacobbe with Credit Suisse.
Your line is now open.
- Analyst
Thanks.
Good morning.
So, just want to go back to guidance, looks like revenue and EBIT guidance seems to imply that 4Q is going to see a little bit of a drop off or worsen a little bit.
Anything particular going on that we should be aware of?
- CFO
The thing I would point out is-- I mean, you are right, the Q4 implied guidance does indicate that we will see a little further softening in revenue growth in Q4.
One of the things that's important to keep in mind is that last year's fourth quarter benefited from the flu season, the H1N1 scare.
We are not expecting this year's flu season to be anything like that.
In fact, we are expecting it to be a more normal flu season but that's something that we've anticipated all along in our guidance.
That's not what is driving the change in guidance.
It's really what is driving how Q4 looks relative to the other quarters.
- Analyst
Okay.
Then, maybe, Bob, if you can talk about the sustainability of the bad debt improvement going forward.
Obviously it's helped the last couple, few quarters and continues to trend down, just your thoughts there.
- CFO
Well, it's an area that we continue to pay a lot of attention to.
Despite the challenges with the economy this year and the like, we have been able to continue to drive down bad debt.
It's an area that we deploy a lot of Six Sigma resources against.
It's-- our focus is really on continuous improvement there.
While I think there are continued opportunities to further drive down bad debt, they're not as significant obviously is when our bad debt was in the high single digits, but I do think there continue to be opportunities.
There will be a function of increased use of electronic ordering and ultimately, as well, when we see more insured patients as a result of healthcare reform.
I think that's going to serve to help reduce bad debt.
- Analyst
Okay.
Just my last one on just going back to pricing.
Going forward just to be clear, do you think this is a level of a kind of baseline we should think about going forward?
- CFO
Certainly for the rest of this year we are not expecting significant changes in revenue per requisition in absolute terms.
Next year, as you know, we will likely have a Medicare fee decrease which will put some downward pressure.
But we continue to expect that growth in gene-based and esoteric testing and test mix is going to have a positive impact on revenue per req.
As we said the last quarter, and even prior to that, the big driver of our historic increases in revenue per requisition has been test mix, business mix, number of tests ordered per requisition.
We expect that that will continue to have a positive influence.
What we will see, I think going forward, is as things like the [employer] solutions where the drugs of abuse testing business grows, that puts some downward pressure on it.
But that's frankly not a bad thing to have that business growing.
It's just changing the mix a little bit.
- Analyst
And then just my last one.
Are you done -- is it fair to say you are done proactively approaching managed care to extend out the contracts or is this something we should think of as ongoing?
- Chairman and CEO
First of all, we work very closely with health plans, and all our lab contracts are done.
We have contracts beyond 2012 and now actually we turn our focus to work with them very closely to reduce the leakage.
- CFO
What we have coming up over the course of next several years is significant -- in terms of renewals-- is significantly less than we would have had in a typical year on average.
- Analyst
Okay.
Thanks very much.
Operator
Thank you our next question is from Darren Lehrich with Deutsche Bank.
Your line is now open.
- Analyst
Thanks.
Good morning everybody.
I wanted to just ask a question.
Surya, you mentioned in your prepared remarks some of the work you are doing with managed care to prevent leakage.
I guess a few questions here.
Number one, have you incorporated any of those planned design changes into your contracts at this point or is this right now an ongoing conversation about how it would be structured?
- Chairman and CEO
Well, the approval -- the most important thing, I feel very, very encouraged with the work that is going on with the health plan organized and non-organized.
When you look at how much leakage the health plans have and how much excerpt money employers are paying now we are working with the health plans and their employer clients and providing information to our salespeople and to the health plan salespeople to really reduce leakage.
So I feel pretty good about the work that's going on there.
- CFO
Darren, typically what you see in terms of contract language is that we will work together and sometimes we outline how we might work together and the like.
But planned design changes are something we can't contractually obligate the plan to do, because that involves the employer as well.
As you heard earlier, we are working jointly with health plans and employers to try and get them to understand why those plan design changes are necessary, and in some cases have been very successful in that regard.
We are encouraged by what we see and think that we will see more of it.
- Analyst
Just so I'm clear, because my understanding is that this grandfathering issue may cause large employers to -- really prevent them from making sustenance planned design changes.
I'm just wondering if you are seeing that, that's the case, and if so, can you just expand a little bit more on how you are working together differently today with the contract structures that you have?
- CFO
Well, the grandfathering question is a good question.
I think based upon the data I've seen it's probably split 50/50 as to whether companies are actually trying to keep their plans grandfathered.
There's pluses and minuses, as you know, to that.
But what we have seen and what we have been doing with the plans is-- in addition to planned design changes, making it more attractive for them to stay in network in the like, we've been working with the health plans to educate the employers and their employees about the benefits of staying in network.
Even if there is not necessarily a planned design change.
Educating them about the benefits of lower costs, educating them about the convenience that we offer with patient service centers and the like and it's resonated.
And we expect it will continue to do that.
- Analyst
Okay.
That's helpful.
And then if I could just switch gears a little bit, Bob, to the buyback.
I think you've clearly stated that buyback would be the bigger focus when deals aren't readily available.
I guess the question I have is are you sending a message here that you aren't seeing any good deals over the near term?
If that's the message, why do you think that is?
- Chairman and CEO
First of all, we are not giving any message actually.
In fact, what the message we are giving that our preference will be to have acquisitions which will make, as I said, economic and strategic sense.
We are not buying things for buying sake.
And this time -- and that's-- when things are not available on reasonable terms we are saying we are going to return money to shareholders.
- CFO
And Darren, what you see us is just following through on what we've told you in the past.
- Analyst
Okay.
That's it for me, thanks.
- Chairman and CEO
Thank you.
Operator
Thank you.
Our next question is from Dawn Brock with Kaufman Brothers.
Your line is now open.
- Analyst
Thank you.
Good morning.
Just maybe to follow up on the last question, specifically for the fourth quarter.
With an additional $250 million now authorized for specifically the fourth quarter, is that-- I guess the question is, should we assume that maybe M&A activity would not pick up in the next two months and we could look for you to give us that additional guidance come January?
Can we kind of confirm that?
- CFO
Dawn, let me clarify.
First of all, the additional share repurchase authorization is not limited to the fourth quarter.
I want to clarify that.
It's open ended in terms of time frame.
The reason that it's a relatively small authorization compared to what you've historically seen is we are thinking about this as a bridge to what we might do in the first quarter.
Because right now we are in the whole capital planning process.
We will think about the level of share repurchase authorization that we want for 2011 and beyond.
And we will inform you as to what we are doing there in January, as we typically do when we provide full year guidance.
But we are not trying to send a signal that there is no deal activity available.
In fact, I think I did mention in the prepared remarks that the big variable in any quarter is the deal activity.
So, don't necessarily assume that we are going to complete that $250 million in the fourth quarter.
We've just now got that flexibility to do it.
- Analyst
Perfect, thank you very much for that clarity.
I think really what I wanted to get a little bit more color is, Surya, in your prepared remarks you talked about new tests and I would -- we would love to hear I think about what you are working on there.
And secondly, EHR Connectivity solutions, obviously Care360 is out there, it's got at least the Initial Final Rule Stage 1 Certification I know that you are going for the final certification now that the rules are out.
Could you just give us an update on the enrollment and just the marketing around that and where you think that goes from here?
- Chairman and CEO
Let me first talk about the tests.
As you know that we are focused on three disease stages -- cancer, infectious disease and cardiovascular disease.
Even the current tests which are really growing double digits tests, as I said about vitamin D and ImmunoCAP allergy testing, Leumeta for lymphoma and leukemia, but the tests which are in the pipeline we are excited about just like we introduced OVA1 for ovarian cancer.
We will promote Septin 9 (inaudible), for colorectal cancer, AccuType CP which is for the Plavix therapy.
Some of the personalized-- what you call the companion diagnostics like (inaudible).
S,o there is a number of tests in the pipeline and I feel good about where our science and innovation is bringing new products.
So, that's about the tests.
Regards to EHR and Care360, as I said I was very excited that Care360 just passed 40 billion tests.
So, this is not like buying a EHR systems from an IT company who are not really using it everyday.
The advantage of our Care360 EHR is that it is a system fully tested.
Since we introduced, almost 1,000 doctors are using it.
As you know we have partnered Hewlett-Packard to provide integrated system with hardware and software and now it's promoted by AMA.
We are very encouraged about the future of our EHR.
- Director IR
Dawn, this is Kathleen, you did mention we did get preliminary [C-Chip] certification, we are expecting final C-Chip certification by the end of the year.
And as you heard in our prepared remarks, We have-- that we're pleased to see we got over a 1,000 active physicians using EHR and we just launched it at the end of Q1 this year.
So, we are pleased with the uptick in what we're seeing in the EHR adoption.
- Analyst
Okay.
That's great.
Kathleen, or actually anybody, could you just give us an idea for the physicians that are enrolling and adopting EHR, or who have been on Care360 in the past, can you give us some sort of indication as to whether or not you actually see increased utilization of testing for those physicians, for those practices?
- Director IR
We do look at that, Dawn, in terms of across all the Care360 solutions from lab orders and results on through EHR and we do see an uptick in the business we get from those existing physician customers when we either install or upgrade their solution within the Care360 product offering.
So, it truly is a stickiness benefit for us and that's one of the reasons that physicians choose it.
It makes running their practice much easier.
- CFO
Dawn to reinforce what Kathleen just said, it's not necessarily increased utilization on the part of the physician but we are getting more of that physician's work, because it's easier to deal with us.
We are more embedded in to the work flow et cetera.
- Analyst
Exactly.
That is what I was referring to, thank you so much.
Operator
Thank you our next question is from Kevin Ellich with RBC Capital Markets.
Your line is now open.
- Analyst
Good morning.
Just a couple of questions going back to comments on the M&A environment.
Surya, I was wondering if you could tell us how you view the current environment and potential opportunities?
- Chairman and CEO
We have a very active program on M&A and we constantly evaluate what is available.
We are primarily focused on M&A that's going to help us out with genetic, esoteric, and with all the tech forward that is in all laboratories of the hospitals so I think it's boils down to what makes economic sense and what makes strategic sense.
We are very encouraged what is available in cancer diagnostics and in genetic field.
- Analyst
Okay.
Thanks.
Just going back to the managed care pricing, there was in my opinion a little confusion last quarter and now that we've had more time to think about this, in my view, I think things are stable now.
And maybe you could -- I was hoping you could maybe give us more color about what you were really talking about last quarter in the managed care pricing.
Bob you made the initial comments about several large contract extensions.
I think this quarter you mentioned that they happened last year and also earlier this year.
Could you quantify that?
How many contacts are we talking about, has there been changes or switching of contracts?
- CFO
I wouldn't say necessarily switching, Kevin.
As we indicated last quarter, I reinforce this quarter, this has been something that we have been doing for probably the last 18 months or so.
And it's really designed for us to be able to change the dialogue with the health plans.
Make sure one that we have visibility in to reimbursement, make sure we have access to the health plan members, change the dialogue from one of regularly discussing contract terms and the like to one where we are working together to figure out how to capture that leakage.
As Surya said, I think we are starting to see the benefits of that now.
There are discussions with the health plans are much more focused on what we can do to drive this work in network which is beneficial obviously to us but also to the health plan, the employers and the members.
So to me that's the other real benefit associated with this.
- Analyst
What types of things can you do to capture the leakage and drive more in network utilization?
- Chairman and CEO
I think first of all, the most important thing we can do is what I call the analytics and informatics.
If we know how much the health plan is paying for an account.
There's [four/four] expenses when people go out-of-network.
So now they know that what it's doing.
We can do that analysis because we are very strong informatics group and we're looking at data with them and now we can go back and say now Dr.
X facility is spending so much money.
It's actually one X if it comes to quest and four X if it's going outside.
So that realization of that opportunity is now driving the work both by the managed care organization and by us providers and also the employers.
That is the new thing which we are getting because of our extended relationship and because how we are providing them with the data.
- CFO
Interesting enough, Kevin, sometimes in that regard you would think that the health plans have state of the art analytic capabilities.
In some cases, they don't have what you would expect.
We can provide better insights than they can as to where the testing volume is going and the like and what type of testing, et cetera, based on what type of physician, all those things.
The other thing I would tell you is without getting in to too much detail here, we can work with the employer and the health plan to make using Quest Diagnostics even more convenient and that's some of what we are doing as well which is driving business to us.
- Analyst
Sounds interesting.
I know it's early since Empire Blue Cross opened up on August 1, have you noticed any changes in volumes coming from that plan that you can talk about?
- CFO
We have, Kevin, as you expect any time you add providers to a contract, you would expect that they would pick up some business and that certainly has happened.
I would characterize it as not material to our overall results and in line with our expectations and fully built in to the guidance that we provided.
- Analyst
Understood.
Okay.
Last question, on the drugs of abuse, I think that grew 7.5% this quarter.
Is that absolute growth or is that just due to an easy comp do you think?
- CFO
Well, it is absolute growth.
I would imagine that the comps will continue to get easier but it's really absolute growth year-over-year.
- Analyst
Got you.
Okay.
Thanks.
- CFO
Thank you.
Operator
Thank you our next question is from Bill Quirk with Piper Jaffray.
Your line is now open.
- Analyst
Good morning.
I wanted to ask a little bit about the pending change out of Palmetto as it relates to code stacking and genetics and arrays that's coming up here later towards the end of the year.
I just wanted to ask how does this if at all affects logistics for some of your esoteric tests?
How do you think about this in conjunction with the pipeline tests, et cetera?
Thanks.
- Director IR
Bill, are you referring to what AMA is looking at in making changes to reimbursements for molecular tests?
- Analyst
Well, there is certainly that as well but I guess I'm specifically referring to Palmetto, a notification went out in I believe late August talking about additional paperwork and clinical data, et cetera, in order to get reimbursed for some of the tests.
- Director IR
We will certainly comply with what Palmetto has put out there in terms of submitting our claims in a way that we will get paid.
I think Palmetto is maybe getting out ahead and leading the pack in terms of what AMA is looking at.
From that perspective we certainly support the goal of just looking at reimbursement that's based on Analyte-specific reimbursement which is consistent with the other sections of the CPT manual.
Anything that gives more clarity in terms of what the payer is physically paying for, we think is a good thing but we want to make sure that we get appropriately paid for any test that we perform.
- CFO
One of the things that I reinforce as well is any of the panels that we've got out there are driven by what is medically necessary and clinically relevant in terms of code stacking and piling things on, I feel as though we are in a very good position and supported by medical necessity.
- Analyst
Understood and I -- certainly taking a look at the overall business I would argue that you guys are very well positioned compared to a lot of labs out there.
I guess if I could push on this a little bit, how do we think about this relative to, say, an OVA1 or Septin 9 where there is limited clinical evidence out there Bob, and do you see that being a barrier at all or do you think that from a back office and pay or stand point you are in pretty good shape?
- CFO
On an individual test like that, I think it continues to be education, education of the physicians, education of the health plans as to the utility that these tests have.
That's what is going to drive the utilization of them.
I don't necessarily think what Palmetto is doing is going to dramatically affect the uptick of those type tests.
- Analyst
Very good, thank you.
Operator
Thank you.
Your next question is from Tom Gallucci with Lazard Capital Management.
Your line is now open.
- Analyst
Good morning.
Thanks for the details.
I had a couple of follow-up questions.
First, Bob, on the revenue growth guidance that is a little bit lower than what you had expected before, I'm assuming that's because you were saying that some of the actions that you've taken -- they are taking a little longer to gain traction.
Is that the key behind the change?
- CFO
Absolutely, Tom.
That's what Surya referred to in his comments.
But I would tell you that we are increasingly confident that these are the right things to do.
We are seeing signs of progress and we are encouraged by that.
But we would obviously like it to be benefiting us quicker.
But as I said we are seeing some positive signs at this point and believe we are on the right track.
- Analyst
Right.
Just maybe to get understanding of what is going on there.
I think you mentioned maybe hiring 100 sales positions or something.
Is it the timing of hiring people like that or it is the ramp that you are seeing?
Can you give us a little more color on maybe what has been different so we can have the confidence that it is headed in the right direction?
- Chairman and CEO
Sure Tom.
As we move our Company to more and more esoteric and gene-based testing, the moment we have 35% to 36% of our revenue is gene-based and esoteric testing, we are moving more and more towards disease-based solutions like cancer, infectious disease and cardiovascular disease.
So the first thing we have is to upgrade our sales force.
So we have been doing this over the last 12 months.
And then as we saw the market softening and there's less number of physician office visits, we decided to put new people in new areas especially in cancer diagnostics and anatomic pathology and gene-based testing.
We have added 100 new people, and they will be selling in areas where we never sold before.
Although it's taking some time but I have seen the salespeople and I feel confident what we are doing is building up a very good sales organization which is focused on customer segments and specialty segments which is going to pay off in the long-term.
- Analyst
Okay.
Thank you.
And then maybe one or two other things here, on the pathology side I think you said that you maybe saw signs that the insourcing was slowing a bit, so directionally is your volume deterioration -- is it getting better, is that the implication there?
- Chairman and CEO
First of all, AP facility is going through a tremendous challenge, however what we are seeing is some leveling off in the insourcing and I think people are realizing that when you have insourcing you have overutilized, we are working with our (inaudible) and cap to provide the data and some health plans have now figured out actually they are paying more.
Now having said that, it is a business, we get challenged but the future is very bright because we have got unparallel asset in anatomic pathology and cancer diagnostics and we are going to build on that.
- Analyst
Okay.
On bad debt it's obviously getting better in a difficult environment.
What are some of the particular areas that you're seeing that improvement Bob?
Is it certain pieces of the business?
Is it progress from prior acquisitions or is there anything specific that you can point to there?
- CFO
Tom, we are certainly continuing to make progress with the AmeriPath bad debt.
When you think about prior acquisitions and drivers, that's certainly part of it.
If not all of it though, this is -- it's an area where it's a business of details and as I told you we are a Six Sigma organization.
We apply those principals to everything we do, there are hundreds of millions of transactions that go through billing everyday to the degree we can touch them a few less times we can save ourselves not only bad debt but we can also reduce the cost of the billing operation.
That's the way we are going to continue to approach it.
It's going to be incremental for the most part but I would say that there is no one big area.
One area that we are getting some benefit from though is a little bit of mix patient billing which is one of the biggest sources of bad debt, is down year-over-year and that's contributed a little bit to the improvement that we see as well.
- Analyst
Last one, curious you mentioned cancer testing a few different times, any thoughts on the epigenomics colorectal blood cancer tests that's starting to see development out there?
- Chairman and CEO
Septin 9 colorectal tests, we are pretty excited about it.
We are doing soft launch.
It's going to be promoted soon.
- Analyst
Thank you.
- Chairman and CEO
Thank you.
Operator
Our next question is from Gary Lieberman with Wells Fargo.
Your line is now open.
- Analyst
Thanks.
Good morning.
Thanks for taking the question.
I want to discuss the contract extensions and the insourcing, I guess can you maybe talk a little bit more detail what is it about the contract extensions that allows the managed care companies and yourselves to focus more on reducing some of the leakage?
- Chairman and CEO
Okay.
First of all, it's not only the contract extension, if you just think how much time we spend trying to see every two or three years to going to contract and there's uncertainty about what is exclusive and non-exclusive and the fact that we have now worked with them.
And remember, we are working with them and if we have a longer period, we can invest together in certain activities like analytics, like informatics, like working with them.
And that has really changed the focus from just negotiating to reduce costs.
Now we're talking about how to reduce leakage.
So it's a culture change when you are a longer period.
That's the most important thing that I find and see and I'm very encouraged.
- CFO
To Surya's point, he characterized it as an investment which it absolutely is Gary.
As you think about this the health plans are introducing us more and more to the employers and if they are going to introduce us to employers have us more engrained in that employer, they want to know there is a long-term relationship there.
These longer contracts are an enabler to that.
- Analyst
But I guess the question that I have and that it raises under the prior contracts they would not have been incented enough to want to reduce the leakage and I guess that is the piece --
- Chairman and CEO
I think that's not the case actually.
We have been working with them also.
I think all we were saying is maybe everything is coming together in health care reform uncertainties like what is happening with the health care cost, all these things have come together.
I think looking back you will see some of things we done along with investment we are making in the Company.
We are in a better place to work with health plans and the employers.
So it's not a question they were not working and this contract is going to give us opportunity.
Just give us longer period to invest and work rather than every two years we spend time negotiating and introducing unit cost.
- Analyst
Okay.
And then I just -- and then just in the third quarter, did you extend additional contracts or are you just continuing to see the impact from changes that had been made prior to the third quarter?
- CFO
There was nothing significant in the third quarter, basically what you are seeing is the carryover of what we done last year and earlier this year.
- Analyst
Okay.
And then some final follow up, you gave good commentary about pricing overall on the rest of the book of business in terms of thinking about the commercial book of business, will on apples-to-apples basis pricing be the up similarly on the commercial book of business or will it be up to a lesser extent from it has in the past?
- CFO
We are expecting revenue per requisition to be relatively unchanged over the course of the remainder of the year.
- Analyst
Just for -- just on the commercial book of business or on the entire book of business?
- CFO
On the entire book of business.
- Analyst
Okay.
How about going in to 2011?
- CFO
Well, we will give you more insight in to 2011 in January.
- Analyst
Okay.
Thanks a lot.
- Chairman and CEO
Thank you.
- CFO
You're welcome.
Operator
Our next question is from Ricky Goldwasser with Morgan Stanley.
Your line is now open.
- Analyst
Good morning.
I have a couple of follow-up questions.
First one, Bob, just to clarify, guidance does not include additional buybacks, the $250 million in the fourth quarter, correct?
- CFO
What guidance always includes is us deploying our cash whether it be into acquisitions or share repurchases.
We typically, Ricky ,don't give specific guidance as to how much we will be doing in terms of share repurchases.
But generally the guidance assumes that we are putting the cash flow to work.
- Analyst
Okay.
Then the second clarification is on the top line growth metric for the fourth quarter.
The guidance negative 2.7%, growth year-over-year, I understand the sales source initiative is taking time to materialize.
But is there something that you are seeing in the fourth quarter to date that makes you think that sequentially both year-over-year but also sequentially.
Again, year-over-year I understand the flu differential, sequentially, (inaudible) deteriorates beyond the normal seasonality.
It just seems that you are factoring in a greater decline than we've seen in the past between third quarter to fourth quarter and if you can just give us some more color on that?
Is it the entire impact that you are factoring in would be very helpful?
- CFO
Ricky, there is nothing specific relative to Empire that we are factoring in that would cause Q3 or Q4 growth to look different than Q3 growth.
The principle driver of the difference as I said earlier is our view of the flu season and the fact we are not going to have the H1N1 scare that we had last year.
But I think in terms of sequential progress, we feel good about the progress that we are making there.
It doesn't have -- you don't see the results necessarily within one quarter.
It takes time for these to show up in the results.
But we do feel as though we are continuing to make progress there.
- Analyst
Okay.
But again to the point, I guess I'm trying to understand where there is the change in the fourth quarter guidance or is it just you going conservative or do you think again exclusive because that was factored in to your original guidance, you think that the overall environment is going to potentially somewhat slow down versus third quarter?
- CFO
I wouldn't say that we are expecting the overall environment to slow down.
We are expecting physician office visits to be comparable not change significantly.
The one thing that I would say is we do expect little bit of softness in our non-clinical testing business in the fourth quarter, the risk assessment business continues to be soft.
The clinical trials business we probably have good visibility at least a quarter out in to that business and we expect that to be a little softer in Q4 as well.
- Analyst
Okay.
Then lastly, Surya, on the acquisition strategy, can you prioritize for us just in terms of how you think about acquisitions based on what is out there.
Is number one folding acquisitions, followed by international, acquisitions outside like the core testing business.
If you can walk us through that, that would be great.
- Chairman and CEO
Sure.
I think you started with number one, which is the easy one with the core labs, some hospital outreach.
So those things are what I call that we do in the due course of business.
So that's number one.
Number two is anything that's going to help us in cardiovascular disease, cancer diagnostics and infectious disease.
So that means genetic and esoteric testing and cancer diagnostics, including anatomic pathology because those three diseases we are focused and as you know, that I've always said that our future is in science and innovation.
The second tier, which most of what is going on is do we have acquisition available to help in cancer diagnostics (inaudible).
And then the third one, once that's done, then we look at actually the point of care and (inaudible) testing.
We have invested in India.
It's a long-term investment, we are not looking at major international acquisitions in the short-term.
So those are the priorities.
- Analyst
Great.
Thank you very much.
- Chairman and CEO
Thank you.
Operator
Our next question is from Steven Valiquette with UBS.
Your line is now open.
- Analyst
Hi thanks.
Couple of questions here.
First, the 100 new sales reps that you're adding.
Based on my math, that would add maybe about $20 million in annualized costs.
I'm just curious, does that start in the fourth quarter or was some of that run rate already absorbed in 3Q.
Just trying to get a sense for that for modeling purposes.
- CFO
Steven, some of that -- obviously a big piece of that is already absorbed and reflected in Q3.
The interesting thing is while you get the cost upfront, you don't get the full benefit of the sales force until they're trained, they're up and running and out in the field and we are starting to see the productivity start to ramp up at this point.
We are expecting going forward, we're going to see a nice return on that investment.
- Analyst
Okay.
On the anatomical pathology or AP, I know you don't break down these numbers quarterly, you only give them annually, but just trying to get a sense for the range of where that trend is right now.
I know your AP revenues were down 0.5% for the full year in 2009.
Maybe they were a little worse at the end of the year.
For first half of 2010, I'm sure was (inaudible) than that trend line as well.
Should we think as right now AP volumes may be down 5% to 10% in the range ballpark and pricing flattish?
Is that the way to think of it right now?
- CFO
Steven, Surya indicated earlier that business is under significant pressure.
We aren't breaking it out at this point and we will consider providing some more information at the end of the year.
- Analyst
Okay.
Last quick question on that as far as the physician insourcing overall, was there any evidence either earlier this year, or eve now that this was ever expanding beyond AP or was that really the main area we are seeing?
There were other companies that were alluding to, they were seeing the same issue outside of AP like oncology and some other areas.
I'm curious how you see that from categorization.
- Chairman and CEO
Well, I think the main insourcing we have seen actually is in oncology, anatomic pathology actually, and GI and GU.
Did you mean whether they were going to do any clinical testing like physicians still have their physician office labs, so it refers to only AP.
- Analyst
Okay.
So you are not seeing it move down the acuity scale basically what it sounds like.
Okay, that covers it.
Thanks.
- Chairman and CEO
Thank you.
Operator
Our next question is from Amanda Murphy with William Blair.
Your line is now open.
- Analyst
Hi, good morning.
Just a few questions.
Actually, one, the first one clarity on previous questions.
In terms of the revenue guidance change, so my understanding it correctly that, that is primarily due to changes in the non-clinical testing business.
Is that fair?
- CFO
No.
Amanda, that's a component of it.
But the principal reason for the change in the revenue guidance is some of these things we are working on that we put in place are just delivering results little further out than we had anticipated.
- Analyst
So that's more on the volume side of the world, right, than pricing it sounds like?
- CFO
Correct.
You should think about adjustment in guidance as being principally due to volume.
- Analyst
And then it sounds like it's given the (inaudible) maybe on the esoteric side of the world versus the clinical routine.
Is that fair?
- CFO
No.
I think it's the esoteric business we feel good about that's continuing to grow.
As we indicated, it grew 4% in the quarter.
But just the overall business, I wouldn't differentiate between routine and the esoteric at this point in terms of what caused us to adjust the guidance.
- Analyst
Got it.
Okay, just on the revenue per requisition commentary.
I'm not sure if I'm thinking about this correctly.
So if it's flat on a dollar basis and managed care pricing environment is relatively stable, Then it sounds like you got a benefit from mix, I would have thought that the sequential, that it would have been sequentially up.
Is that -- am I thinking about that wrong or not?
- CFO
Sequentially -- well, the mix we've seen that benefit or that switch throughout the year.
We haven't necessarily gotten a benefit in mix in this quarter.
In fact, as the drugs of abuse testing business grows, that puts pressure on the mix because that's lower-priced business.
- Analyst
Okay.
Just last one, I don't know if you are willing to make any comments here, but one of your competitors made a sizeable announcement related to transaction.
Do you have any comments there?
And also just another question on M&A, in terms of focus, is it fair to say that you're more focused on the services side versus product?
- Chairman and CEO
First of all, we are not going to make announcement about what we are looking at.
I can tell you we are active in looking at assets which is going to help our Company.
As I told you, we're going to focus on cancer, cardiovascular disease and infectious disease.
We are -- our priorities is services and laboratory and licensing and getting tests but if we get appropriate assets and point of care and (inaudible) testing that's not off the radar.
- Analyst
Okay.
- CFO
Thank you.
- Analyst
Thanks.
Operator
Thank you.
Our next question is from Anthony Vendetti with Maxim Group.
Your line is now open.
- Analyst
Thanks.
Just on the general esoteric testing.
I know there is 35%, 36% of revenues, been I think, pretty much that number for most of this year.
How much do you think that's going to increase on a -- as we move through 2011 as a percent of revenues?
Is that 40% goal is that a one to two year goal or is that more like a three to five year goal?
And then if you could just talk about an update on the international revenues and how the expansion is going internationally?
- CFO
Anthony, here is the way we should think about the percentage of esoteric and anatomic pathology of the total business.
Generally a test starts out as esoteric.
If we're lucky, it actually becomes routine over time and the volumes ramp up significantly because it's becoming much more widely utilized.
So as you think about the life cycle of a test, it starts out as esoteric, over time moves to routine, so that puts a natural governor on how big a percentage esoteric business can become of your total book of business.
I would expect though that it will continue to grow over time.
But we don't have a specific target there.
- Analyst
Okay.
Internationally, could you just give us an update on how that's going?
- Chairman and CEO
Internationally, we have the clinical trials business and product business.
[HemoCue] is doing well and they're on their plan but when you think about the laboratory services, our major investment in India and we are now focused on a growth plan and it is a long-term investment.
But I think although it will take some time, that's the right thing to do, because there is a lot of opportunity in India with the 300 million middle class.
But it is very small and very early days.
- Analyst
Okay.
And then just lastly on physician volume -- physician office visits, obviously it's been weak the last couple of quarters.
Are you seeing that stabilizing or do you expect that to be weak for the remainder of this year and into 2011 until the economy recovers or employment picks up?
- CFO
Anthony as we indicated earlier, the physician office visits at least through the first two months of the third quarter were pretty much in line with what we saw in the second quarter.
That's down between 4% and 5%.
And we are not expecting that to change dramatically over the course of this year.
As we think about 2011, again, we will give you some better insights in to 2011 in January.
But at this point our guidance for the rest of this year does not anticipate any significant swing one way or the other in how physician office visits behave.
- Analyst
Okay, great.
Thanks.
Operator
Thank you.
Our next question is from Kemp Dolliver with Avondale Partners.
Your line is now open.
- Analyst
Thanks and good morning.
How much leakage is out there?
And I'm sure it would vary by plan, we have been hearing about reducing leakage for a long time yet there is not a lot of data to work with.
- CFO
It's an interesting question.
It's a significant number.
I would tell you, in some cases when you look at what is either off contract or going to the higher cost providers on contract it could be multiples of what the large commercial labs are actually realizing at this point.
So it's a big opportunity.
Obviously, a lot of it's in with the hospitals and it doesn't necessarily all need to be moving off contract spend.
In a lot of cases, you can shift contracted spend to the lower cost providers and that's part of what we are looking to do as well.
- Analyst
Okay.
But in terms of just, say, a percentage of spend or the like there is no number or ballpark to think about.
- CFO
Well, when you just think about the total market, right, hospitals account for 60% of the total market and add on top of that the fact there are other providers that are not contracted.
So it gives you sense as to the total size of the opportunity.
- Analyst
Okay.
Secondly, with regard to anatomic pathology and the plans.
Can you give us some color as to whether any of these plans are the national plans and if these payment restrictions are -- how hard they are, is it a preauthorization or is it an absolute ban on payments to these arrangements?
- CFO
It depends because each plan is approaching it differently.
And it varies by national plan as well as some of the regional plans.
In some cases, they are outright denying reimbursement and they're indicating that your two physicians, they will not reimburse for certain testing performed in the office.
- Analyst
Okay.
Super.
Last question relates to the sales force renewals I think earlier on in this year the -- at least offline discussions were we are adding to the sales force but don't necessarily assume that we are at that , say, 100 is a net number.
Is 100 a net addition number
- Chairman and CEO
100 a number, new positions and new territories.
- Analyst
Okay.
But the size of your total sales force is increasing about 10%?
- Chairman and CEO
Yes.
- Analyst
Okay, thank you.
Operator
Thank you our next question is from Gary Taylor with Citigroup.
Your line is now open.
- Analyst
Hi.
Good morning.
Couple of questions.
I just wanted to make sure on the earnings guidance for the year to $3.95 to $4 that's using the $3.09 year-to-date, is that correct?
- CFO
Correct.
It has the year-to-date number it in it.
- Analyst
Can you help us think about gross margin a little bit?
I guess historically gross margins higher in the third and lower in the fourth.
This time around it was lower in the third and I think the guidance which is probably the gross margin was lower in the Q4 as well.
I know pricing was stable sequentially so can you talk about that 90 basis point drop in gross margin sequentially?
- CFO
Gary, it's -- as we've said in the past, we look principally at the operating income number opposed to the split between cost of sales and SG&A, although we do manage both of those lines.
But as you heard Surya indicate in his prepared remarks, we've made some investments in phlebotomist, whether they be in physicians office, whether they be in our patient service centers.
We've opened up new PSCs.
Those costs all go in to costs of sales.
So that's where you are seeing some investment dollars right now.
Additionally we indicated that we are accelerating the pace with which we convert physicians on to our Care360.
The cost of those conversions the training, the installation and the like also goes in to cost of sales.
So as we work down that backlog of physicians waiting to get on and we accelerate the working down at the backlog that adds to some costs in the near term.
- Analyst
And I guess as these investments are being made, when do we anniversary the pickup?
Is that second half of next year when we would expect to see that?
- CFO
Most likely, second half of next year is when you would start to see that anniversary.
- Analyst
Okay.
And the new salespeople are in the G&A line?
- CFO
Yes.
- Analyst
My next question is just on the Care360, which you guys talked a lot about and I understand potentially there is some benefits in terms of market share accruing to Quest out of that, can you talk about and you touched on it a little bit.
But can you talk about, is there any other P&L impact?
So obviously you said there is conversion costs that show up in costs of goods presumably the revenue impact is hopefully market share gains on lab testing, are there other revenue items, subscription fees, or licensing that have any material impact on the P&L?
- CFO
Gary, I would tell you that in terms of revenue from subscription fees and the like, we are not expecting that to be material.
Because that's the EHR piece of it.
But certainly as people go on to our Care3 -- our latest Care360 product, we do continue to see benefits on the billing side, we get better billing information and the like, and that has historically been one of the things that's helped us reduce and manage our bad debt levels.
So that's an area as we see more and more electronic connectivity will continue to benefit.
- Analyst
The revenue impact will be market share gains?
- CFO
Correct.
- Analyst
Out of hopefully, we will -- you will capture market share from those docs through the adoption, right?
- CFO
Precisely.
- Analyst
Okay, thank you.
Operator
Thank you.
Our final question today is from Robert Willoughby from BofA Merrill Lynch.
Your line is now open.
- Analyst
Hey.
Just listening to some of the questions, I mean, do you think you do a profound disservice breaking out the aggregate price volume metrics.
I mean, wouldn't disclosure along the lines of what your competitor reports on a quarterly basis help you better tell your story?
- CFO
Bob, look, we continue to take a look at what we think is appropriate and at this point we believe that what we are providing is appropriate to help you understand the business.
The absolute revenue per requisition and absolute pricing we think is something that is valuable information that we keep confidential at this point because it is competitive information.
We will continue to try and provide you the information that you need to understand how the business is performing without providing what we believe is sensitive competitive information.
- Analyst
But do you see what one of your competitors is doing is somewhat sensitive information?
Are you gleaning from their disclosure that is helping you in your business?
I'm not sure I understand the sensitivity to the breakouts.
- CFO
We try to understand it and use whatever public information is available to help us.
- Analyst
In a different area, do you envision at some point we've asked for it in the past as the Care360 initiatives really gained more traction, will there ultimately will be some quantitative data you can speak to of 160,000 users, X amount are [Rx] subscribers, X amount are EHR users?
- Chairman and CEO
Yes, we will do that.
And I think as we gain ground and we're getting established and I think we'll provide data as far as how many people are using prescription and how many users.
We will look at those things as we go forward.
- CFO
Bob, as Surya indicated earlier in his prepared remarks, we have over a 1,000 users on the EHR at this point.
- Analyst
Right.
But sequential builds, anything to help us understand the traction that you have there would be most helpful.
- CFO
We can do that.
As it certainly becomes more meaningful, that's something we would plan to do.
- Analyst
Okay.
Thank you.
Operator
Thank you for participating in the Quest Diagnostics third quarter conference call.
A transcript of prepared remarks on this call will be posted later today on Quest Diagnostics web site at questdiagnostics.com.
Replay at Quest Diagnostics.com/investor or by phone at 866-350-3614 for domestic callers.
203-369-0039 for international callers.
No access code will be required.
Telephone replays will be available 24 hours a day beginning at 10.30 AM Eastern time today until midnight Eastern time on November 20, 2010.
Thank you.
Good-bye.