Labcorp Holdings Inc (LH) 2002 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Laboratory Corporation of America Holdings fourth quarter and year-end 2002 earnings conference call. During the presentation, all participants are in listen-only mode. Afterwards, we will conduct a question and answer session. At that time, if you have a question, please press the one followed by the four on your telephone.

As a reminder, this conference is being recorded Wednesday, February 19th, 2003.

I would now like to turn the conference over to Mr. Tom Mac Mahon, Chairman and Chief Executive Officer. Go ahead, sir.

Thank you, Tracy. Good morning and welcome to LabCorps's fourth quarter conference call. Joining me today from LabCorp are Brad Smith, Executive Vice President of Public Affairs, Wes Elingburg, Executive Vice President and Chief Financial Officer, Ed Dodson, Senior Vice President and Comptroller and Pam Sherry, Senior Vice President, Investor Relations.

On this conference call, I will again address what I think are the most frequently asked questions about the company. I'll also discuss LabCorp's strategy and how we are implementing this strategy. As I've mentioned previously, our strategy is simple, effective, and based on sound fundamentals. That strategy is to nationally serve all major geographical areas and to continue developing as the leading gene-based testing laboratory in the United States.

This approach has particular focus on the introduction of new cancer tests and specialized anatomical pathology services, and is the foundation for what we believe will continue to be industry-leading results over the next several years.

I'd now like to introduce Brad Smith, who has a few comments before I begin. Brad?

Before beginning, I would like to point out there will be a replay of this conference call available via the telephone and internet. Please refer to our press release dated February 18th for replay information.

On February 18th, the company filed an 8-K, which included additional information on it's business and operations. This information is also available on our website. Analysts invested are directed to this 8-K and our website to review this supplemental information. I would also like to point out any forward-looking statements made during this conference call are based upon current expectations and are subject to change based upon various important factors that could affect the company's financial results. These factors are set forth in detail in our 2001 10-K and subsequent filings and will be available in our 2002 10-K when filed.

Thank you, Brad.

Now to fourth quarter results. Fourth quarter results as outlined in our press release last night, continued to set industry standards. Overall revenues increased 15.3% to $650.1 million. Volume increased 13% and price was up 2.3%. Organic volume growth, including a negative impact of 1% due to severe weather in December, primarily in the Carolina area, was 2.6%. EBITDA, including earnings from equity investments, was $123.9 million, where 19.1% of revenues, which represents an 18.1% increase over fourth quarter 2001. Diluted earnings per share were 36 cents. DSO for the quarter was 54 days, the lowest in our company's history. Bad debt was 8.4% compared to 8.8% last year in the fourth quarter. Cash flow from operations was continued to be strong, $105 million. During the quarter, we re-paid $120 million in debt borrowed in connection with the acquisition of Dynacare. Our total Dynacare debt of $200 million was fully re-paid by the end of the year.

Now, for the 2002 full-year results. Revenues for the period of approximately $2.5 billion increased 14% as a result of a 10.7% increase in volume and a 3.3% increase in price. Organic volume growth was 5.6%. EBITDA for the year increased 20.3% to $563.8 million, were 22.5% of revenues before the $17.5 million restructuring charge in the third quarter related to Dynacare. This compares to margins of 21.3 percent in the 2001 period. 2002 diluted earnings per share were $1.84, a 21.9% increase over 2001. Cash generated from operations increased 36% to $431.5 million. At the end of the year, our cash balance was $56.4 million.

I would now like to mention several important accomplishments, which are directly related to the implementation of our strategic plan. A plan that continues to provide both short and long-term growth opportunities for LabCorp. First, the acquisition of DIANON. DIANON is an excellent strategic combination for LabCorp. We announced our plans to acquire DIANON on November 11th and completed the transaction on January 17th. We expect to achieve synergy savings of approximately $7.5 million in 2003, $25 million in 2004, and the full $35 million in 2005. More compelling, however, the combined company net is now in an exceptional position to nationally offer the broadest range of leading-edge, anatomic, genomic and clinical testing technology for the large and rapidly-growing cancer diagnostics market.

As I have said before, LabCorp believes anatomical pathology and gene-based cancer testing are the most important growth opportunities over the next three to five years, and DIANON compliments LabCorp extremely well. The DIANON name has very strong brand recognition. Our integration plans call for intensifying LabCorp's commitment to the anatomic pathology testing segment and incorporating DIANON's anatomic pathology business model into the larger company, or as we call it, "Dianizing" LabCorp. With the addition of DIANON, we believe no other clinical laboratory in the industry will be able to provide it's clients with the breadth of services LabCorp now offers, particularly in specialized anatomic pathology.

In a connection with our acquisition of DIANON, on January 31st we completed a private placement of $350 million in senior notes. Which was used to re-pay the $350 million bridge loan we entered into to fund part of the DIANON purchase.

Second, the acquisition of Dynacare. We completed the acquisition of Dynacare on July 25th and continued to be extremely excited by this opportunity. It directly supports our strategic objectives of strengthening our national presence by expanding our geographic reach, which allows us to expand our position in the introduction and commercialization of important genomic tests. On February first, we closed one of the largest Dynacare facilities, Houston. To date, the integration is on schedule. We achieved $4 million in synergy savings by the end of '02, and are still on track to a savings of $36 million in '03, and a full $45 million in 2004. This acquisition supports our position as the leading low-cost producer and provides us with significant further cost-saving opportunities.

Next, our pending acquisition of assets in northern California. In early February, we announced an agreement to pay $4.5 million in cash to purchase certain assets in northern California. The purchase price will be paid over a period of up to 18 months following the closing of the asset purchase by LabCorp. The purchase includes the assignment of four contracts with Independent Physician Associations. As well as leases for 46 patient service centers, five of which also serve as rapid response laboratories.

Quest diagnostics has indicated that approximately $27 million in annual revenues is generated by capitated fees under the IPA contracts and importantly, associated fee per service testing for physicians who use these patient service centers as well as from specimens received directly from the IPA physicians. The IPA's have already consented to the assignment of the contracts. The assets' sale is subject to approval by the FTC and will close after the completion of the Quest Diagnostics UniLab transaction.

Acquiring these assets provides LabCorp an immediate competitive presence in northern California for the very first time. The assets include personnel needed to service the contracts and support other sales activities, provided through the facilities. Including current LabCorp sites in the region, we will have 65 service sites in this market. Using excess testing capacity at our Immuno Diagnostics Lab in San Liendro and our San Diego laboratory, we will have the infrastructure to immediately compete for important genomic business in the San Francisco market, something we have not had previously.

LabCorp has a focused licensing team of people to identify and commercialize medically-important new genomic tests. A solid advantage in executing our genomic strategy. As a result of our genomic strategy, LabCorp is well positioned to continue to benefit from the growth in genomic testing.

In November, we announced an agreement with Correlogic Systems to commercialize their ovarian cancer protein blood pattern test for the detection of ovarian cancer, which offers the prospect of accurate and early detection of ovarian cancer. This is a common disease often diagnosed too late to be effectively treated. If caught early enough, it is readily treatable and often curable.

In October, we announced a collaboration with Celera, to establish the clinical utility of laboratory tests based on novel diagnostic markers. The initial areas of collaboration include efforts to improve the diagnosing of Alzheimer's patients, to identify prostate cancer patients with aggressive tumors, and to determine the risk of breast cancer patients for metastasis. This exclusive relationship is a continuation of LabCorp's strategy to develop a broad genomic testing menu for cancer.

As we officially come to the close of 2002, we remain excited about the progress of licensing activities. Licensing agreements with EXACT, Myriad and Celera, all-exclusive and Correlogic, which is a co-exclusive, will provide important tests to help ensure LabCorp continues to be first in providing physicians with important cancer tests.

Existing genomic tests also continue to grow dramatically for the year in the fourth quarter. Cystic fibrosis testing continues to increase monthly, as more physicians adopt CF testing as standard of care. Our fourth quarter cystic fibrosis testing volumes significantly increased compared to the same period last year and we are now performing in excess of 11,000 CF tests per month. We also continue to see significant growth in HPV testing. HPV testing has increased 67% compared to the fourth quarter 2001.

I hope this brief summary of results and significant strategic accomplishments demonstrates to you that LabCorp's plan is highly effective and that genomics is a key strategy for LabCorp's future growth.

Now, I'd like to review a few frequently-asked questions, and our specific answers to those questions. First; Can you provide an update on your efforts to stabilize the competitive situation in the Carolinas?

As discussed on our third quarter call, we initiated a reinvestment program that included adding individuals and facilities to better service our customers. As expected and built into our guidance, this reinvestment moderately increased our fourth quarter expenses. Since September, we have seen an improvement in the ratio of new to lost accounts in the region. As I've said during the third quarter conference call, our goal has been to stabilize the region in the fourth quarter and to return to growth in the first quarter of 2003. We believe we achieved our fourth quarter objective.

Two; What do you think are the overall industry volume and price growth rates?

For the industry, we expect volume growth primarily represented by routine testing in the 3% to 4% range and pricing growth in the 2% to 3% range. However, we expect about 1/3 to 1/2 of the price growth to come from the benefits of a shift towards higher-valued products.

Three; What are your plans for the use of cash going forward?

We fully plan to execute our $150 million stock re-purchase program, if prices are within an acceptable range. We also plan to pay down the $250 million incurred under our credit facility, related to the DIANON acquisition. As I have said before, we plan to fund the $150 million program out of our free cash flow. To date, we have been prohibited from executing on the program due to the blackout periods in connection with material corporate actions, either completed or under consideration. We believe our window for stock re-purchases will open in the next few days and plan to update you at the end of each quarter regarding the status of the program.

Four; Are you currently in the market for large acquisitions?

Although we don't expect to pursue -- pursue any large acquisitions over the next 18 months, while we integrate Dynacare and DIANON, we do fully intend to continue making selected small acquisitions. Such acquisitions are easily folded into our network. All of our activities will be conducted with the expressed objective of maintaining our investment grade ratings.

Five; What amount of account attrition do you generally expect with acquisitions?

Based on our historical experience with acquisitions, we generally model into the acquisition a reduction in revenues of between 5 % to 10% for account attrition following the acquisition. Obviously we include this expectation in our acquisition models and our guidance thereafter.

Six; Can you give more details about the senior note offering?

LabCorp recently sold a series of $350 million principal amount senior notes due 2013 in a private 144-A transaction. The notes in an aggregate principle amount of $350 million will bare an interest rate of 5.5% and result in net proceeds of $345.1 million. The proceeds of the offering together with cash on hand were used to re-pay the $350 million bridge loan entered into to fund part of the purchase of DIANON.

Has anything changed in the regulatory environment that you expect to negatively impact the industry?

No. We are well aware of the significance of how these types of changes can impact us and watch them closely. But we don't see anything on the immediate horizon, which will have a significant, negative impact. As a matter of fact, the 1.1% CPI increase in the Medicare national median lab fee schedule is a slight positive. As is the recent reversal in the cuts to the physician, service fee schedule.

Eight; What are your volumes from monolayered tests?

We continue to see increased conversion to monolayered Paps. In 2001, LabCorp performed approximately 8 million pap smears. The run rate for conversion to monolayer was 71.2% at the end of December, compared to 57% at the end of December, 2001. We expect that our conversion rate -- excuse me, we expect that our conversion rate will likely be approximately 80% of our Pap smears by the end of 2003. Let me correct it and say in 2002, LabCorp performed approximately 8 million Pap smears.

What is the best way to evaluate LabCorp's growth?

We believe that the best way to assess our growth at LabCorp is to analyze revenues. For several years now, we have communicated and implemented a strategy that emphasizes profitable revenues and gene-based tests. Volume and price, which are obviously important, are impacted by a variety of factors. For example: As the number of tests performed on single samples increases, the excession is negatively impacted. This phenomenon impacts our volume in one manner and price in another manner, but it doesn't impact on the overall revenues for the company. Additionally, in an industry where the leaders have relatively small market shares, consolidation and accretive acquisitions that generate added cash present a viable growth strategy to LabCorp. While it is not our strategy to be involved in significant acquisitions during the year, small acquisitions done properly provide growth.

What is your guidance for 2003?

2003 will be an active year of integration and implementation for LabCorp. We will focus on executing our integration plans for Dynacare and DIANON. We will implement the commercialization of EXACT's colorectal cancer screening tests around mid-year and expect to introduce the Correlogic tests for early stage ovarian cancer near the end of year. We also expect to strengthen our footprint in northern California, continue to work on our problems and challenges in North Carolina, working to enhance our testing opportunities in both the northern California and the North Carolina market.

Our guidance therefore for 2003 includes DIANON and is the following: Compared to 2002, LabCorp expects 2003 revenue growth of approximately 22%; We expect an adjusted EBITDA margin in the range of 24%; Diluted earnings per share growth of approximately 22.5%; A bad debt rate of approximately 8.4% in the first quarter; Capital expenditures of approximately $90 million for the year; Free cash flow, net of capital expenditures of approximately $380 to $400 million; Net interest expense of approximately $35 to $38 million and a tax rate of approximately 41.5%.

As a result of the recent severe weather, throughout the country, including this week, we estimate the following impact on our first quarter of 2003: Revenue impact of $10 to $15 million and an EPS impact of 3 to 5 cents. Again, our 2003 annual guidance of 22% revenue growth and 22.5% earnings per share growth remains unchanged.

Today, LabCorp has in place all the key elements to successfully achieve our strategic objective of becoming the leader cancer testing laboratory in North America. With the scientific and business experience to continue building a substantial and profitable organization, I am more confident than ever about the long-term growth prospects for LabCorp. Thank you for listening. We are now ready to answer your questions.

Thank you. Ladies and gentlemen, if you would like to register a question, please press the 1, followed by the 4 on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration, please press the one followed by the 3. If you're using a speaker phone, please lift the handset before entering your request. One moment please for our first question.

Our first question comes from the line of Bill Bonello with Wachovia Securities. Please go ahead.

Good morning, actually have a couple of questions. First of all, the decline in the growth in PPA -- is that at least in part attributable to Dynacare having a lower PPA than LabCorp as a stand-alone?

I'm not really gonna get into the reasons for the decline in the PPA, Bill.

I would just make a couple comments though that I think -- that I'd like you to at least listen to. First, I've continually said that in this industry you should really expect 2% to 3%, and over the past three to four years, we've benefited from higher pricing. In other situations there are a lot of things that impact on price, for example we entered into a major agreement through our ViroMed facility to do testing for the United States government, HIV testing and Hepatitis-C testing. And we did that for a variety of reasons that make solid sense for the government, but they are very low prices, and the volumes have increased rather substantially as it appears the country is getting ready for a war. So, those kinds of things impact on price, and you will see differences from quarter to quarter in pricing, but I think we should be modeling the 2% to 3%. There are certainly areas of Dynacare where we have had to stress the organization to get better pricing.

Okay, and then can you just -- you mentioned in your comments a potentially that there was -- has been some kind of a shift -- if I heard you right -- in the number of tests per excession that could impact both volume and pricing. Can you just elaborate on that?

Well, what we do at LabCorp is we measure -- because of our systems in both our lab system and billing system -- we measure excessions by the samples that come into the company every day, mainly because of the genomic advances that the industry has made. We are performing more tests on each requisition or sample that comes into the company, and we have never looked at that or provided details to Wall Street about that, but what we are seeing is some modest increase in the number of tests per excession. As an example - the one I have used in most of my discussions is, we see doctors often now requesting a reflex under certain conditions to an HPV test, when a thin layer of Pap is run. We don't count that as a test. We do count it as a test, but it's not counted as an excession. So that's a bit of noise that goes through, and it clears itself out in revenues, but in that particular situation, you could have a negative impact on your excessions and have a positive impact on price, but it filters its way out through the revenues, and that's why I feel, and have been saying now for 6 to 8 months, that the best way to look at, I think the industry but certainly LabCorp, is revenue growth.

Perfect. And then the final question: You maintained essentially your guidance despite the potential Q1 shortfall. Just curious from your perspective, what gives you such confidence in the potential for the back half of the year?

Well, I think a couple things. Number one is when we provided the preliminary guidance back in October, we had certain information. Since that, there has been at least, it appears to be some positive news, as it relates to the physicians fee schedule, and some people thought we were too low in the guidance as it related to that.

And as we look at all the numbers, and we look at the synergy's, and we look at what's ahead for us, we continue to be confident that we can make those annual numbers, recognizing -- and I hope you probably no matter where you are in the country, you've probably seen the kind of weather we've had in the last six weeks -- that will impact on the volumes for this company.

Perfect, thanks a lot!

Thank you, Bill.

Our next question comes from the line of David Lewis with Thomas Weisel. Please go ahead.

Good morning, guys.

Good morning, David.

Tom, I know you're not comfortable kind of diving into pricing past the macro level, but I'm wondering if you could give us a little detail on specific lines of business? For example, a couple trends reversed, at least in our model, on core testing pricing, it kind of went down sequentially, but on prior genomic, pricing was actually up pretty dramatically, when you know the sequential trend has been down due to some of the CF testing mix. Could you comment on maybe the pricing trends as it relates to core and prior genomic?

Sure. I'll give it a try it and won't delve to much into it, Dave, to respect your wishes not to delve to much into it.

But we had been saying for a number of quarters that what really impacts on the prior genomic is the mix, and in this particular situation we're impacted negatively by HPV, because that's a lower price than our average genomic test, and we're impacted positively by cystic fibrosis, because that's a higher price than our average, and we had fully expected in the fourth quarter, as our genomic volumes for cystic fibrosis continued to creep up that we would see a reversal of previous trends, and that is exactly what's happened. We have seen now the number of cystic fibrosis tests increase substantially enough to turn that trend.

We had also seen during the first half of this year on a decline in the industry's average transaction price for the HIV viral load product, and that has caused us also to have some decline in our pricing. But that is modified in the fourth quarter. We haven't seen anymore degradation of pricing as it relates to the viral load. As it relates to the core business, and I don't know that I said it in my comments, but it is to me a more difficult environment out there than it has been in previous years. So, pricing, while we continue to expect to get the kinds of price increases that I've now talked about for three or four months, it is a little tougher now that it has been in previous time periods.

Okay. Makes perfect sense.

Maybe Wes, could you give us a sense of the gross margin, it seems to stabilize, and better than our expectations, it was still around 70 or 80 down basis points year over year. Could you quantify, Wes, what portion of that was the volume issues tied to weather and what portion may have been some regional competition issues?

Um, we've mentioned that the weather impact in the fourth quarter was 1% on volume. So, that -- that equates to a number somewhere in the $3 to $5 million range, but I think probably the thing that's, more so than anything else is the reinvestment in the Carolinas we talked about. Most of the reinvestment spend in the Carolinas related to patient service centers, information technology and additional employees falls in that cost of goods line. So that would be one thing that would differentiate itself from the fourth quarter of 2001.

Okay, and then last question: Tom, can we assume your assets you may or may not acquire in northern California will be accretive, in line with your prior acquisitions obviously?

Yes.

Okay, thank you.

Our next question comes from the line of Angela Samfilippo with US Bancorp Piper Jaffray. Please go ahead.

Good morning, this is Angie.

Hi, Angie.

Wondering if you could confirm that your guidance does not include upside from further acquisitions, the share re-purchase or improvements in bad debt expense?

It does not include anything that you just mentioned. I'll repeat them, Angie, does not include a reduction in the bad debt expense, it does not include the share re-purchase plan and it does not include acquisitions.

And then --

It includes of course DIANON -- does not include northern California.

Does not include DIANON.

Okay. And then it does.

Excuse me, it does include DIANON. It does include DIANON.

Okay, sounds like your guidance includes the give-back on the physician business, but does it also include the Medicare rate increase you got on your clinical business?

Yes, it does include the -- about a million dollar positive impact of the CPI increase on January 1st. It does include that.

Okay. Then my last question is: Are you comfortable that going forward you'll be able to grow organically in line with the industry volume growth rates?

Yes. I mean, we continue to see those kinds of numbers at LabCorp, and again, I would say that the best way to look at us is revenues, and with the integration of Dynacare, the integration of DIANON, hopefully the completion of the northern California transaction, that there will be an awful lot of noise in those volume numbers when one tries to break them out between organic and acquisitions. Particularly as you go into northern California, because if we are able to get that deal completed, that will be rolled out over a six to eight-month period, and it will be very difficult to discriminate against that.

Are you going to continue to give us organic volume growth going forward as you report?

We sure will.

Okay. Thanks.

We'll continue, Angie, to try to convince you you should look at revenues.

All right, thank you. [ LAUGHTER ]

Our next question comes from the line of Robert Willoughby with Credit Suisse First Boston. Please go ahead.

Hey, Tom, does the UniLab deal, is that material enough to prevent you from buying shares back today or before the transaction closes, and do you have a specific debt reduction plan for the first quarter? I know the goal for the year, but what does the first quarter look like?

Okay Rob, I'm gonna answer the first question. We felt that the materiality of the UniLab deal to Quest and the industry and to LabCorp prevented us from buying back shares. There is nothing -- now that deal has been announced -- and hopefully that deal will be completed. So there's nothing on the scope of the events at LabCorp that would prevent us from implementing a share re-purchase plan as early as next week. So, we fully expect to begin to re-purchase shares as early as the beginning of next week if the price is appropriate to do it.

And what was your other question?

Just debt reduction for the quarter. What component of the $250 million are you looking to take down?

I'll ask Wes to handle that.

Bob we are not gonna be specific on that, but I will tell you generally what our policy is. We intend on doing the entire share-repurchase, $150 million share-repurchase, and pay down the credit facility of $250 million this year.

Now, one transaction does not take precedent over the other. We'll be doin it simultaneously. Our goal will be to try to get the share re-purchase plan done faster than paying down the credit facility, but it's gonna be done simultaneously, and a lot of it is going to be dictated upon the thresholds that we put in place as far as the share re-purchase. So that's gonna dictate a lot of how much we do in the first quarter, versus debt pay-down. That's as good as I can give you at this point.

And that is helpful. Just one last one: Where do you see - where was head count at end of the year, Tom? Do you know that number?

I don't. We'll have to get back to you. It was in the range of -- it's 22,925.

Weren't you around 28,000 with Dynacare?

With Dynacare we're probably - we've gone from about 24,000 down to 22 -- the numbers that Wes -- now, don't forget, we now have DIANON. The DIANON is not in the numbers.

Okay.

That we just quoted.

24,000 down to 22,900 plus DIANON.

Correct.

Okay, thank you.

Our next question comes from the line of Ricky Goldwasser with UBS. Please go ahead.

Good morning.

Good morning, Ricky.

Tom, you mentioned the government contract for HIV testing that had some negative impact in pricing. Do you expect to see that continuing into the first quarter? And also what was the impact on volume?

We have had a government contract. I want to make clear that everybody understands this. When we acquired ViroMed, there was significant government contracts with all of the defense units, the Navy, the Army, and the Air Force to do a certain amount of testing, mainly for AIDS, for HIV, and for Hepatitis-C. And they were at very, very low prices. What we have seen is a spike in the amount of testing. It has increased rather substantially in volumes, and it has also increased well into the January and February area. So, they are low prices. We won't tell you what the prices are.

We feel it's very responsible that we do this kind of testing for them, and the guidance that we have provided in all of the comments Ricky, that I've made during the last six months related to pricing includes that expectation. So, my 2% to 3% would expect that this would have -- is in the numbers and would negatively impact on our pricing. In terms of volumes, it does help our volumes.

Was it 50 basis points, or can you quantify it?

It's not that substantial, but I won't quantify it.

Can you comment, it seems like you had some growth in in capitated contracts, can you just give us some more color on that?

I don't have that readily available in terms of -- but we certainly we have the Aetna New York contract, we have the MAMSY contract -- and Wes, did you have that?

Yep. Year over year, our capitated revenues were up about 14%, but you know, also in looking at that as we have mentioned before, we don't do capitated contracts by themselves, unless there's associated fee for service business. If you look at the service, you can see the fee for service is up year over year by about 16 percent. So both categories, the capitated and fee for service, all increases year over year with the fee for service increase even being more at 16%.

That's really the barometer we look at. We don't like the capitated going up. We recognize it in certain situations we're gonna have to take on capitated, but it's very important to us that the fee for service go up more quickly.

With a PPA of almost $45.

Okay. And then as far as the Pap smear testing segment, you mentioned 71.2% conversion at the end of December. Can you tell us what it was at the end of this third quarter and also off the third to half-price increase from product mix shift, what percentage of that was the monolayer testing?

I think, Ricky, at the end of the third quarter it was between 68% and 69%. Now, that -- we've seen it increase in around the 2.5% to 3% range, which is a little slower than we have seen historically. We're not gonna comment on the impact of the monolayer, we never have in our core business pricing.

But that sort of contributes to some of the lower price growth reported in the fourth quarter? Is that a factor?

Absolutely. But again, I really do think that individuals that are familiar with LabCorp should expect pricing in the 2% to 3% range.

And going forward, your guidance, you basically expect the 2% conversion rate to continue in 2003?

We expect the 2% to 3% per quarter, per quarter.

Right, okay, thank you very much.

Okay.

Our next question comes from the line of Billy Deerman with Atlantis Capital. Please go ahead.

Hi, guys. I wanted to get your thoughts. I missed actually when you were giving guidance. You gave revenue growth of 22%. The adjusted, was an EBITDA margin of what?

24%.

24%. And I was curious, you mentioned that you would be buying back the $150 million at acceptable prices. Can you clarify at all what acceptable prices are?

No. We're not gonna tell you that.

Okay.

And we don't want to let that number out.

Okay. And did the guidance does not include the northern California?

No, it doesn't.

Okay, thank you.

But Billy, just to make sure that you're clear, and I want -- I've said it before -- is that the northern California will not have a lot of impact this year because it will be rolled out over a, Brad, a six-month period. So we wouldn't -- if the deal were to close by March 1st, and again, I don't know the status of Quest negotiations with the FTC, but if it were to close by March 1st, we would not even begin implementing those contracts until the May period. And they would roll out over the remainder of the year 2003, so I don't think there's much upside potential in the numbers if one thinks that northern California is gonna bring significant upside this year. That's just not the case.

Okay, thank you.

Thank you.

Our next question comes from the line of Kemp Dolliver with SG Cowen Securities. Please go ahead.

HI. Thanks and good morning.

Good morning.

Couple questions. With regard to the physician fee schedule, Tom, any read on what kind of increase you would expect relative to the 1.6% average increase.

I'm gonna ask Brad to answer that question.

We haven't -- you know, Kemp, the individual codes -- I mean, you look at the 1.6, you think it would be directly applicable, but we haven't. It's so new, that we haven't gone back to reanalyzed our views or the reversal of the 4.4% conversion factor. You would think the 1.6% would apply straight across the board, but the document itself that included the 1.6% is like 3,000 pages. And I actually tried to pull it off the internet and it's a challenge to sort through all the different sections, so it's really too early for us to definitely say that it's gonna be 1.6%, but that's what we expect it to be.

Okay, second question: Given your experience in North Carolina, are there other markets where you've decided to-- you've looked at patient service centers and said it's time to spend money to be essentially preemptive. Before a problem shows up -- or do you feel pretty good across the other markets.

As I've mentioned before, and sometimes you have to learn in life the hard way -- but as I've said before, in North Carolina, what was unique? We don't see another market that this kind of problem could develop, but we have re-looked as part of our budget process, back in the November period. We have looked at all of our coverage, and when you think coverage, it's really important -- although we don't share the details of this -- it's really important that you understand that in some markets, collection centers are more predominant than in other markets because of the amount of physicians that either draw samples or don't draw samples. So there's no guideline that one can use in understanding exactly the number of patient service centers on a per-state level or per-physician level that we need to look at.

We need to look at how many are drawn in the doctor's office versus how many aren't drawn in the doctor's office and come up with ratios that way. And I can say this, we have looked carefully at our coverage throughout the country in terms of account management and in terms of patient service centers, and in certain markets we have expanded, and that's all built into our guidance.

Super. Last question: And that is with regard to the share count and the share re-purchase, give a reasonable ballpark of what kind of increase you would have in the share count, just from new stock option issuance of the like, just to have a handle on the potential accretion estimates we can come up with on the share re-purchase.

I really don't think we're gonna share that information in that much detail, because I think then you'll figure out exactly what price we're gonna buy it at.

You're giving me more credit than I deserve, but thanks. [ LAUGHTER ]

All right, our next question comes from the line of Andrew Bhak with Goldman Sachs. Please go ahead.

Good morning. Thank you. Two questions. The guidance on bad debt for 2003, I'm just wondering what the financial assumptions are underlying that? Is there an element of conservative, if you were to do better than that operationally, what factor you would likely attribute that to.

And then secondly, as you look at the types of physicians that represent the large categories of referrals -- excuse me, of sort of sending test samples to -- has that changed at all over the last three years? And would you anticipate any changes going forward given some of the interesting agreements and some of your efforts into the genomic testing area? Thank you.

Okay, I'll answer the second and then I'll ask Wes to answer the first. I think you bring up a very interesting question, not that everybody doesn't, but a very interesting question on the physician focus. The physician focus at LabCorp is generally OB/GYN's, internists, family practice, and to a degree, urology of course with PSA. So, internists, urology, OB/GYN's, family practice, and in a highly focused way, infectious disease. Obviously if we went back to 1998 or 1999, we would not see as part of the American healthcare system as many infectious disease physicians as we see today. So, we have had to broaden our coverage of internists that really specialize in infectious disease.

Now, as we move towards these new contracts, obviously with DIANON, we have now picked up the oncologist. The oncologist is more heavily involved now than I think five years ago. Not only in treating cancer, because they've always been involved in treating cancer, but assisting in the diagnosis of cancer. So, the diagnosis of cancer is something that's very important to our business, so we are seeing and calling on more oncologists than we have historically. DIANON helps us rather significantly with both the urology market and oncology market.

So, now, moving forward, I think it's fair to say that family practitioners and internists, to a large degree, associated with OB/GYN's, and urologists, will be treating chronic diseases going forward, including cancer. So our strategy, as it relates to particularly all the licensing agreements, is to sell and promote and educate physicians in the specialties we are most familiar with, with these new kinds of tests. For example, the exact science test market will not only be the gastroenterologists, but will be other internists, will be family practitioners and will be OB/GYN's. So our feeling is that cancer, an area of tremendous focus for us, will be managed by more than the oncologists, and that the diagnosis of cancer will be done by the specialties that we call on. Clearly, clearly we've broadened our scope in the last three years to include heavily infectious disease physicians and now oncologists.

Wes, do you want to deal --

As to the bad debt rate, as we have always done, we evaluate that every quarter. Although our guidance for the year is 8.4%, you know, our goal internally has always been, and as we have always communicated with everyone, is to bring down the bad debt expense percentage by 1% per yar. We'll evaluate it every quarter, and if we feel like it's justified, we will let you know at the end of the quarter and have revised guidance. I think the things that - the initiatives that we continue to work on to further give us the ability to reduce bad debt expense is our challenges to always come up with new initiatives. We have done that. We have some big initiatives in place for this year, but I think on of the big keys this year is gonna be our continued process of converting to our centralized system. We have an opportunity this year with a lot of the Dynacare locations to, as part of the integration process to convert them into our centralized billing system, and we think that in itself will give us up side on our ability to lower bad debt expense. But for now, we stick with 8.4% until we see history quarter by quarter.

Okay. Just as a follow-up to your comments, Wes, is it the case that integration of acquisitions, as always, pose some challenge on the bad debt front, but pose no greater challenge than that which you faced in the past in terms of conversion?

That is correct. I mean, you know, it is always a challenge, but I guess what I'm saying is I think we have some upside opportunities based on some of the locations within Dynacare that we're going to convert, and knowing some of the DSO's that those locations have.

Great, understood. Thanks very much.

Our next question comes from the line of Abe Bronstein with Glenview Capital. Please go ahead.

Good morning, folks, can you hear me? Hello?

Hello. Good morning, Abe.

Hi, Tom, your free cash flow estimate for 2003, without reducing share count, works out to about $2.58 to $2.72 a share, in that general ballpark?

That's a cash yield -- that's adjusted for taxes, seems to be better than any acquisition you have been able to make recently, even allowing for the synergy's, which suggests that even with the stock up $2, and that's using the current price of the stock by the way, up $2 and change, that would suggest that you should be very aggressive, even in current stock prices and buying back, compared to the acquisition opportunities that you've been able to come up with while there were more pickings than there are left now.

Is that analysis reasonably on target with respect to your views on stock buy-back price?

That's too complicated for me, Abe. I'm gonna defer that to Wes.

Yeah, sure, Tom, I believe that. I had mentioned before, and it is the case, is our goal will be to aggressively pursue the share buy-back and get that done as quickly as possible.

You approved this buy-back when the stock was just under $22. It's a little bit higher. Is there a reason you wouldn't be willing to complete the entire buy-back at current prices right now if you could?

Not gonna get into details on the pricing, Abe.

Second question. In the S-4, related to the note offering by the original buyers, there's an interesting section on your relationships with hospital outreach programs, which I don't think you've ever spoken about. It talks a great deal about your partnerships with a number of these programs. Up next the last two weeks, it's been all about you know, who's cutting who's throat. This sounded considerably more cooperative and positive. Could you elaborate a little bit on that?

Sure, I won't give the exact numbers, but our revenues from hospitals probably are in the range of $250 million, give or take $10 million or $20 million either way. So about 10% of the revenues of LabCorp come from hospitals. And they usually take the form of one or three approaches, one is we do reference work for hospitals. Two is on hospitals outsource their business to LabCorp. Or three, we actually manage the hospitals for hospital administration. And this is not unique to LabCorp, it's consistent, from what I understand, with many labs throughout the United States. But probably in terms of generating hospital business, LabCorp's probably the second-largest lab in the United States in terms of revenues coming from hospitals.

And I think as I've said previously, Abe, is that hospitals really are betwixed and between. Some hospitals are not interested in the lab business, they want to outsource it and they recognize the economic impact of outsourcing. While other hospitals, where there are very strong pathologists, in particular, want to maintain their position in the community, and that's an example of what's gone on in the North Carolina market, a hospital network that rather than outsourcing has decided to do it itself. But hospitals continue to be an area of, I would say moderate concentration at LabCorp, where we continue to seek ways to associate ourselves with hospitals and grow our business. And it's certainly a viable business strategy.

Thanks.

Thank you.

Our next question comes from the line of Colin Moran with Chiefton Capital. Please go ahead.

Hi, yes, just three quick questions. Can you clarify that the bad debt expense of your guidance for 2003 is 8.4%, which would be a 20 basis point improvement versus last year of 8.6?

8.4%.

Okay. And then can you walk us through your DNA and working capital assumptions to get you to the free cash flow guidance you gave us for the year of 2003?

No, we have not disclosed the depreciation and amortization numbers for 2003.

Okay. Can you just talk a little bit about working capital though?

Have not disclosed that either.

What about the EBITDA from the UniLab, whatever that is fully baked in, what kind of EBITDA contribution would you expect?

I'm sorry, the EBITDA from UniLab?

From the California assets you acquired.

I'm sorry, Colin, okay, well, we're not disclosing that, and as I've said, what we're getting is approximately $27 million -- that's what Quest reports. ,Our EBITDA in the western part of the United States -- okay in the western part of the United States -- because of the amount of capitated business out there is generally a slight bit lower than the rest of the country.

Now, on the other side though, we have never done very well at LabCorp in the esoteric business in California. In the great opportunity out of getting a position in northern California is accessing the San Francisco market as it relates to certain genomic tests, and if we are able to do that, which we think we are, with the coverage we now have of 65 centers, that we will -- it will be a very good transaction. But we don't normally break down small acquisitions and disclose EBITDA margins for that.

Okay. Then just finally -- what are you assuming in the way of interest savings within that 225 from the debt pay-down?

Well, the only guidance we've given for 2003 is the net interest expense of $35 to $38 million.

Okay.

Our next question comes from the line of Mark Miller with Banc of America Securities. Please go ahead.

Good morning.

Good morning, Mark.

My understanding of DIANON's accounting is that bad debt expense was taken as a pre-revenue number, opposed to an operating expense. Is that how you'll be accounting for it?

Yes, that is the way that we will be accounting for it, and that is built into the guidance that we have given.

Okay, thanks. Second, following up on your comments earlier about no large acquisitions over the next maybe 18 months but maybe small ones -- can you quantify the upper end of small is say on a revenue basis?

Probably $50 million.

Great, thanks.

Okay, Mark.

Our next question comes from the line of Tom Gallucci with Merrill Lynch. Please go ahead.

Thank you. Good morning, everyone.

Good morning, Tom.

Just a few follow-ups. First, in terms of capacity and esoteric capacity and a stronger presence in California, do you have any needs or any plans to increase your capacity, particularly in the esoteric area in the future?

The good news Tom, is that we have excess capacity for our genomic business with our Minnesota facility ViroMed. The small acquisition that we made in northern California back around mid-year, infectious disease lab, did give us some capacity as it relates to northern California. I would think, however, if the business continuous to grow, as it has been growing, that there will be a need to get capacity for the esoteric business in the 2004 period. And that would be in the capital expenditures when-- excuse me, yes, in the 2004 period next year. And that would of course be in our capital expenditures, which we would model at that point in time.

Maybe just one housekeeping question. In terms of how you calculate the weather impact. We've got a lot of questions about exactly how you know that number. Can you maybe give us a brief overview of how you figure that?

I'll give you a brief overview. What we do is look at excession counts on a daily basis. So we look at excession counts and more recently I'm asked this question than ever before. We look at the excession counts by day, by condition, and by region of the country.

So in the hierarchy for example at LabCorp, there's the national number, then we're broken down into six divisions. Then the divisions are broken down into regions. So, every day we get an excession count.

Every day of the week in this business, you know this Tom, but I'll say it anyway, the volumes are different. There's certain days of the week where the volumes are much more substantial than other days. So we don't look at volumes Monday compared to Tuesday compared to Wednesday compared to Thursday or Friday. We look at volumes on a daily basis, and we compare a Monday to a previous Monday to a previous Monday. We compare a Tuesday to a previous Tuesday to a previous Tuesday, so we see the differences. We then go to the area of the country -- and I guess for those of you in the northeast -- we go to the northeast. And we would look at Monday in the northeast and compare it to the previous ten or twenty Mondays and we see if there's a weather problem in the northeast and we make a calculation based on what's happened. Then Tuesday comes, and we look to see how much of that business we recovered. So for example, if Monday was bad in the northeast, we hope we recover some on Tuesday. So -- we expect our excession count to be higher on a Tuesday than on a previous Tuesday. We calculate it based on a statistical model. It's been very precise over time.

Great, maybe just one other one. I think it was interesting, your discussion of test per requisition possibly rising. Has it always been the case maybe that it's gone up? Is it going up faster than it was? Had it been stable and now it's rising? Maybe can you put in perspective historically there on that front?

It has been traditionally for the first three to four years, I was at LabCorp, pretty straight-forward. There had been very little fluctuations. It's only in the last year to a year and a half as some of the manufacturers of technology have created methods to get more tests out of a sample.

So we have seen a slight increase, and Brad, why don't you comment on that because you carefully follow that?

I think it is very different from the circumstance say ten years ago, when you would just add another channel on a chemistry analyzer and just add another test to an existing panel of tests being ordered.

What's happening here is rather than having multiple samples, increases in technology for medically, for tests that doctors really want, including new technologies, they're able to perform the multiple tests on single samples. So, as Tom mentioned before, whereas a year ago, you might have gotten a separate glass Pap smear slide and a swap for an HPV, which would be two separate samples and two excessions. Now you can take the monolayer liquid sample and run both tests. Or, if you look at something like cystic fibrosis where there's 25 mutations, you know, there are multiple tests on a single sample.

And I think the reason that Tom, I think it's so important, is that the manufacturer of the monolayer -- at least one of manufacturers -- is now attempting to get Chlamydia and Gonorrhea on that sample. So it is possible down the road -- and that may be this year -- a collection for a Pap smear, you can run a Pap smear, you can run a Human Papilloma Virus test, and possibly a Chlamydia and Gonorrhea test, which at LabCorp had been counted separately and are very substantial in terms of volumes. So as we go out in time, it's gonna be more difficult to look at the way we're historically looked at it, and I can tell you on our side here, we're spending a considerable amount of time and effort to work through this to figure out the best way to give you such information.

As this train continues, would we expect to see maybe a bigger impact positively on price per excession in terms from the mixed side of things?

Absolutely. If - At LabCorp, where we've been consistently saying that about a third of our pricing is due to shift mix, if what I am saying becomes more accurate, then the shift mix should go greater. We -- it should clearly have an impact on pricing.

As I said in the prepared comments, this goes both ways. And you have to look at it both ways. You have to look at volume one way, it may have a negative impact on volume. Positive impact on price, and it's cleaned out in revenues.

Great, thanks for the thoughts.

Okay.

Our next question comes from Van Brady with Precideo Management. Please go ahead.

Yeah. I have a couple of questions I would like to ask them in sequence and get the answers before the next question. One, looking forward after what obviously is gonna be a very good year for you, if you make your revenue targets, you'll be between $3 billion and $3 billion 100 million -- I'd like to ask you, what do you see thereafter. You've targeted a industry growth rate of 5% to 7% organically. You'll be at the size where there really are no large acquisitions left. So, can you kind of postulate for us what additions to the 5% to 7% growth rate we might expect from small acquisitions? And then, what kind of margin improvement we might see so we can get a sense of how fast earnings can grow after this year?

Sure, I'll postulate in a general way. I'm not gonna give guidance for 2004 yet, but what I think is that, what is gonna stimulate LabCorp's growth, beyond industry norms, if we are able to do that, has to be the licensing deals.

So, it has to be the EXACT Sciences deal, which is not built into our numbers. It has to be the Correlogic deal, it has to be a test from Celera Diagnostics, like an Alzheimer's test, and those are the kinds of tests that have the potential to be as valuable as any single acquisition, because they're tests that literally have the opportunity -- and I underscore opportunity -- to change the way medicine is practiced in this country. But a lot of things have to go right before that can happen. So, I think there are the areas will stimulate.

I think the second is that there will be small acquisitions, and I think that probably in the year 2004 to 2005 and beyond, you probably should build into your models revenues coming from acquisitions in the $75 to $100 million range. That's the kind of acquisitions we've historically gotten completed in terms of revenues. And that should bring very profitable volumes through.

In terms of major acquisitions, beyond 2003, I suspect in the 2004 and 2005 area -- and I could be very wrong on this -- but I suspect there will be a series of new, mid--sized companies that emerge, and there are companies out there that we are familiar with that we think will be several hundred million dollars in size as this industry continues to consolidate into the 2004 and 2005 area. I think I've said, I've documented, over the last six months -- so this should not be new news. That those kinds of activities that give us significant incremental margins at higher value, that this company is gonna have to look very hard to find out how get these margins beyond 24% to 25%, and the only way that I see to do that in a static world, is to continue to bring down bad debt.

Okay, so you lump all that together and you could accept maybe, including acquisitions, 10% revenue growth and then --

I'm not gonna give guidance beyond 2003. I know that everybody wants it, but that's something we've never done at LabCorp in my six years here.

Okay, the other question, might involve one of the potential companies you're talking about. There's a company that just reported earnings this week called Lab One, it's in the Kansas City area. They advertise as an advantage over everybody the largest lab in the world, and their strategy is to make acquisitions of outreach hospital organizations, and go through acquisitions and improve margins dramatically because they tell us that they have the lowest cost of anybody, and also say that they, in the capitation business in their market area, which is around Kansas City and in that area of the country, they've been successful in taking managed care contracts away from both yourself and Quest on a price basis. Will you comment on all of that?

Well, I'll make general comments. I'm familiar with the company you're talking about. I'm familiar with their business strategies. The Kansas City market, I think generally for a company like LabCorp, is a good market. If they're taking away contracts from the majors, as they claim, I guess they're doing it through price, that's something that we want to remain very disciplined about. And finally, I would only question their comment that they're the lowest-cost producer, because I think that the facts are in the numbers. And you know, I again hesitate to say this, but I will anyway, the numbers are what they are and I think the numbers have shown now for four to five years that the most profitable lab in the world is LabCorp, and we think it's one of the reasons is because we're the low-cost producer. So, if that company is claiming that, which I didn't realize, I don't think it's accurate, but I'm not inside of them, so I really don't know.

Okay, they're looking at $15 million acquisitions as well. Have you seen them in the market at all?

Have I seen $15 million acquisitions?

Well, have you seen them and looking at any acquisitions?

I'm not gonna comment on what we see in individual acquisitions. As I said, I'm familiar with the company and you know, we see them from a competitive perspective out there, and that's all I'll comment on.

Okay, thank you very.

Thank you.

Our next question comes from the line of John Mathy with Bear Stearns. Please go ahead.

After John's question, I'm gonna take just one more question, okay? John?

How are you doing?

Good, how are you?

One quick question. Genomic testing. Can you tell me what that was up in the quarter?

In volumes or in revenues?

In volumes.

Wes?

Let's see, for the quarter, the volumes were up about 16 1/2%.

All right. Is that prior genomic?

Well depends. Are you looking at total genomics?

I'm looking at total.

Total is 16 1/2 percent volume.

Okay. Great.

The prior genomics was 29%.

Alright. And one other -- I wanted to follow up on an earlier question that talked about your '03 guidance and refer to things that were excluded, and I think we went off, bad debt reduction, share repurchase, acquisition -- I wanted to make sure my understanding's correct. EXACT Sciences and also the UniLab acquisition, those two things are excluded also?

Yes, they are, but John, what I did say as it related to UniLab's, and I want to make sure everybody hears me because I know people go in and out of the conference calls. Is if the UniLab deal were to close for us, let's say, by March first, there's a two-month startup phase, then we will bring on the IPA sequentially over the remainder of the year. So, I do not think that anybody out there should be speculating on any incremental EBITDA coming out of that.

And then I think that the big opportunity for this company is in the year 2004, in northern California. As it relates to EXACT Sciences, our goal now -- our goal is to try and launch -- is to launch that product sometime in the mid-year area. So, we are not giving guidance on that technology or that test. And we really -- when we launch the product we will begin to understand the economic impact to LabCorp, and I'm sure EXACT Sciences also, and we will be careful to monitor that and to understand the volumes that come out of that and we will probably then give guidance as it relates to that in our 2004 guidance.

And that's really when you expect that to be a material contributor?

Yes.

Okay, good enough, thanks.

Thank you, John. This will be the last question.

Your last question comes from the line of Abe Bronstein with Glenview Capital. Please go ahead with your follow-up.

Thought you were gonna get away easy, right? [ LAUGHTER ] First of all, I'm offering you my spread sheet on the buy-back, and number two, the EBITDA, your release indicates it includes the I guess the proportionate share underlying the equity income from Dynacare investments?

That's correct.

I think the number is about $7 million net, if I read the statement correctly. How much goes up into EBITDA? What does that 7 gross up into the EBITDA number? And secondly, are any of those equity investments candidates for being monitized? Can you tell us a little bit more about them?

Abe, you said 7?

I thought I saw 7.

It's 4. -- for the quarter. [INAUDIBLE]

Yes.

That represents the -- that does represent the primarily the Canadian partnerships from the Dynacare acquisition.

Okay, but that's a net number. Then there's a footnote that the EBITDA underlying that is in your EBITDA number, I'm just wondering what is - how much is in EBITDA, because it presumably is a larger number?

Okay, the -- because of depreciation and amortization, it's about 3 million more.

What about taxes?

Excuse me - $300,000 more.

$300,000, that's all?

Right.

What about taxes?

Well, that wouldn't be a part of the EBITDA anyway.

No, no, I understand, but you're offering me $300,000 on top of 7, but the 7 was a net number --

What it is is net of a minority interest that we have in another partnership.

I know, but it's not a-- a taxed number? This is a pre-tax number I'm looking at?

Yes, it's a partnership, so no taxes.

Okay, okay, thank you very much.

Okay. Thank you all and have a nice day.