Labcorp Holdings Inc (LH) 2004 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Laboratory Corporation of America, 2004, fourth quarter results conference call. During the presentation, all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. At that time if you have a question, press the one followed by the four on your telephone. As a reminder this conference is being recorded Tuesday February 15, 2005. Now I'd like to turn the conference over to Tom MacMahon, Chairman and Chief Executive Officer of Laboratory Corporation of America. Please go ahead, sir.

Thank you, Craig. Good morning and welcome to LabCorp's fourth quarter conference call. Joining me today from LabCorp are Brad Smith, Executive Vice President Corporate Affairs, Wes Elingburg, Executive Vice President, Chief Financial Officer, Ed Dodson, Senior Vice President and Controller, and Brad Hayes, Senior Vice President Investor Relations.

We'll start by having Brad Hayes review our financial results. I will then review our accomplishments for the year and update you on key strategic initiatives. Then we will go over anticipated questions about the company and provide our guidance for 2005.

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

Before we begin, I'd like to point out that there will be a replay of this conference call available via the telephone and Internet. Please refer to our press release dated February 15th for replay information.

This morning the company filed an 8-K that included additional information on its business and operations. This information is also available on our Web site. Analysts and investors are directed to this 8-K and our Web site to review this supplemental information.

Additionally, we refer you to our press release dated February 15th for a reconciliation of EBITDA, which is non-GAAP financial information discussed during this call. I would also like to point out that 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 2003 10-K and subsequent filings and will be available in our 2004 10-K when filed.

Now I would like to introduce Brad Hayes, who will review our financial results.

Thank you, Brad.

Our fourth quarter results are as follows: Earnings per diluted share increased 13 percent to $0.61before the required change in accounting related to our zero coupon subordinated notes. After the required change in accounting, EPS was $0.58 as compared to $0.52 for the fourth quarter of 2003.

EBITDA was $185 million or 24.1 percent of revenues, compared to 23.8 percent during the fourth quarter of 2003. Cash flow from operations was $106.6 million. Revenues increased 4.8 percent to $766.5 million.

Volume increased 2 percent, and price increased 2.8 percent. DSO for the quarter was 52 days.

During the quarter, we repurchased approximately $128 million of LabCorp stock representing approximately 2.6 million shares. We are also pleased to have announced a definitive agreement to purchase US Labs which closed on February 3rd.

Now for our 12 month results.

Earnings per diluted share increased 16.2 percent to $2.58 before the required change in accounting related to our zero coupon subordinated notes. After the required change in accounting, EPS increased 16.1 percent to $2.45 for 2004, as compared to $2.11 for 2003. EBITDA was $787.8 million or 25.5 percent of revenues, compared to 24.2 percent during 2003.

Cash flow from operations continued to be very strong at $538.1 million. Revenues increased 4.9 percent to $3.08 billion. Volume increased by 3.6 percent, and price increased by 1.3 percent.

During 2004, we repurchased approximately $378 million of LabCorp stock representing approximately 8.8 million shares. And at year-end, our balance of cash and short-term investments was $206.8 million.

We're pleased to continue to lead the industry with an EBITDA margin of 25.5 percent of revenues. Our revenue growth, combined with our efficiency, allowed us to grow diluted EPS by 16 percent for the year.

We continue to believe that the free cash flow generated by this performance is best used to grow our company and complete our authorized share repurchase.

Now, Tom will review our accomplishments for 2004 and provide an update on our key initiatives for 2005.

Thank you, Brad.

As Brad discussed, we have again delivered solid financial performance growing revenues and margins and using our free cash flow to return value to our shareholders by repurchasing shares, and most recently, our acquisition of US Labs.

I would like to review several of our major accomplishments during '04.

In March, we signed a ten-year agreement with Swedish Medical Center, one of the largest and most comprehensive not for profit healthcare providers in the Pacific Northwest to provide lab services to all of their facilities. Also in March, we began to exclusively offer HCV FibroSure, a non-invasive blood test for assessing liver status in hepatitis-C patients.

In July, we signed a national strategic partnership with WellPoint. As a result of this partnership, we were pleased to report that in December, WellPoint awarded LabCorp an exclusive contract for the HMO in Georgia.

In October, we entered into a multi-year agreement with Cytech for their Thin-Prep Imaging System. Also in October, we were added to the S&P 500.

In November, we entered into an expanded relationship with Allscripts Healthcare Solutions. This relationship makes available to our customers an innovative new chart-based laboratory order entry and results delivery system. In December, we entered into a definitive agreement to purchase US Labs.

During 2004, we Dianonized four major LabCorp locations.

For the year, we repurchased approximately $378 million of LabCorp stock representing about 8.8 million shares. Since we began repurchasing shares in '03, we have repurchased approximately 14.4 million shares for approximately $528 million.

And in addition to the progress with WellPoint in the fourth quarter, we have signed renewals with all of our major managed care customers that were set for renewal last year.

Now I would like to update you on the three priorities that form the foundation of our LabCorp strategic plan: Scientific leadership, customer retention, and managed care. We believe these are key to LabCorp's future growth opportunities.

First scientific leadership. As a pioneer in genomic testing and the commercialization of new diagnostic technologies, LabCorp is dedicated to maintaining and enhancing our position of scientific leadership in the industry.

We believe this strategy implemented eight years ago not only has been enormously successful to LabCorp, but has also changed the industry. The entire industry has recognized this strategy as a way to change laboratory testing in a positive way.

The strategy, combined with our two-year-old anatomical pathology strategy continues to have a profound impact on the clinical testing market.

During 2004, the rate of revenue growth for all genomic and esoteric tests as a group was slightly more than double the rate of growth of routine testing. Genomic and esoteric testing represents 31 percent of LabCorp's total revenues, but are an even greater contributor to profit margin.

We will continue to focus our resources on the identification and introduction of novel testing technologies that will offer better treatment options to physicians and their patients. Continued expansion of our capabilities through licensing agreements, acquisitions, and key scientific partnerships, will help us to continue to be the leader in bringing important new tests to market.

I would now like to update you on several of our key initiatives related to this important area of our strategic plan.

Dianonization, our program of expanding the DIANON anatomical pathology model throughout LabCorp continues to progress. To date, four major LabCorp sites have been Dianonized. All conversations went very well.

Over the next two years, we plan to aggressively continue Dianonizing LabCorp sites. With six sites planned for '05, the first one to be completed by the end of [audio problems] '06, we expect nearly 80 percent of all of our anatomical pathology work Dianonized.

Dianonization continues to redefine our approach to anatomical pathology and helps position us as the clear and preferred provider in the field of cancer testing.

PreGen-Plus.

During our third quarter conference call, we stressed the importance of PreGen-Plus' multi-center study being published in a respected journal. To gain widespread usage, it is important to have this test included in standard of care guidelines. We now have a platform to help convince payers to reimburse for this test.

It is important, however, to note that we launched PreGen-Plus with a better method for DNA capture than the method used in the multi-center study. We believe that subsequent studies will show an even greater sensitivity than that shown in the multi-center study.

OvaCheck.

We remain committed and excited about the medical value of this test, which will be offered for the more than 8 million women in the United States at high-risk for ovarian cancer. We are continuing to work with Correlogic as they work with the FDA to bring this important test to patients as soon as possible. LabCorp is ready to offer this test as soon as that process has been successfully completed.

FibroSure.

This past March through our exclusive relationship with BioPredictive, we began offering their non-invasive blood test for liver fibrosis, under LabCorp's brand name of HCV FibroSure. HCV FibroSure further extends our extensive menu of tests for HCV.

Since its introduction, the demand for FibroSure has increased every month. Additionally, we are participating in clinical trials with prestigious academic facilities using this test.

Cytech Thin-Prep Imaging System.

We are pleased to be the first national laboratory to offer Cytech's Thin-Prep Imaging System to our clients and their patients. We expect to complete our national rollout during the first half of 2005. Early results indicate that clients recognize the benefits of this method and are switching from the non-automated to the automated system in fairly significant numbers.

US Labs.

We completed our acquisition of US Labs on February 3, 2005, for approximately $155 million in cash. US Labs is a well respected provider of anatomic pathology and oncology testing located in Irvine, California.

This is an important acquisition in that it furthers our capabilities in the cancer testing market and gives us additional lab capacity on the West Coast. During 2005, we plan to add certain genomic and esoteric testing capabilities to that facility and provide improved turnaround time to our customers located in the western part of the United States.

We also plan for US Labs to operate essentially as it was before the acquisition and are happy to have retained this existing management team. Our guidance for 2005, which I will detail later in this call, includes USL.

Customer retention.

Our industry has historically experienced customer churn, due to a variety of factors, including service issues, problem resolution, price, and requirements by managed care payers. The amount of churn is higher than we would like it to be. That is why customer retention is one of our growth strategies.

Metrics to measure reduction of lost business are in place and improvement in this area has been tied to our bonus system. Specifically, we were in the process of implementing solutions to enhance our capabilities in the following ways.

Call center consolidation.

We currently have over 50 locations where customer call centers are received, where customer calls are received. In order to provide a higher level of service by leveraging standard processes, training, and technology, such as customer relation management or CRM system, we plan to consolidate most of these facilities to two centers by the end of 2007. We believe the end result will greatly enhance the customer experience with LabCorp when calling with any questions.

Customer connectivity.

In order to continue to support our customers and encourage them to remain or become long-term customers, we must continue to be easy to do business with. Providing our customers with a solution that best fits their needs and workflow is a key priority at LabCorp.

We have multiple initiatives related to improving our EDI capabilities and improving our internally developed ordering and resulting platforms, we're working with a variety of third party technology and EMR companies, that is Electronic Medical Record companies, such as Allscripts and Medicity, so that we were able to offer physicians a choice in how they connect with us. We have specific goals and monitor progress towards these regularly.

End-to-end specimen tracking.

Many of our currently tracking mechanisms are manual and don't easily allow us to track the journey of a sample through its entire life cycle, especially for those samples that don't originate in one of our facilities. We are working on initiative to automate and enhance these tracking systems that will allow us to know exactly where a sample is in the process in real time.

This new capability will allow us to provide better monitoring of turnaround time performance and to better answer customer's questions about the status of a sample. There are several major phases to this effort, with deliverable schedule to occur in each of the next three years.

Finally, in order to enhance our service to all clients, we will be significantly expanding our sales force, with approximately one-half of our expansion planned for this year and the remainder in 2006. I will continue to update you on this important part of our strategic plan as it progresses.

Third, managed care.

Strong managed care partnerships are key distribution channels for new and existing products and services and are critical to the long-term evolution of our scientific leadership priorities. Additionally, LabCorp is focused on securing appropriate reimbursement while working closely with managed care organizations to communicate the health benefits of laboratory testing.

During the second half of last year we were very active in the managed care arena. As you are aware, we lost decapitated portion of our contract with Blue Cross Blue Shield of Florida, effective August 1, 2004.

For the first eight months of 2005, this loss will negatively impact volume comparisons by between 1 and 1.5 percent, but it positively impacts price as demonstrated by our fourth quarter results.

Also, we entered into new multi-year agreements with Aetna, CIGNA, and United during the fourth quarter. These contracts will have a positive impact on our pricing.

In July we announced a national agreement with WellPoint to be their sole national strategic partner. As a result of this new relationship, WellPoint selected LabCorp as the exclusive laboratory provider for their HMO product in the Georgia market effective December 20th of last year. LabCorp has historically had very little business in this area of the country.

During the quarter, we made significant investments to expand our operations in this area and are pleased with our progress to date. These activities clearly represent early success with our strategic focus on managed care.

We will continue to work closely with our existing and potential managed care customers on solutions that provide value to them and ultimately patients and ordering physicians.

Our LabCorp business philosophy is simple and consistent. Select the major areas of focus that we believe are critical to the future success of the company, develop plans, metrics and goals for each area, then monitor progress towards achievement of these goals.

We believe that by applying this simple philosophy to these three focus areas, scientific leadership, customer retention, and managed care, we can continue to deliver outstanding results.

Now, Brad Smith will review anticipated questions and our specific answers to those questions. Brad.

Thank you, Tom.

The first question is, what is your assessment of revenue in the quarter and for the year?

For the quarter, revenue increased by 4.8 percent as a result of a 2 percent increase in volume and a 2.8 percent increase in price. For the year, revenue increased 4.9 percent as a result of a 3.6 percent increase in volume and a 1.3 increase in price.

Over the course of the year, we did experience a change in the volume price dynamic. This can be attributed to several things. Our focus on pricing discipline, a continued shift in our test mix to more genomic and esoteric testing, and the loss in August of Health Options in Florida, which worked against volume but helped price, most notably in the area of histology.

Two, why was free cash flow in the fourth quarter lower than expected?

Given our cash position after considering requirements for our share buyback program and for the US Labs acquisition, we consciously accelerated certain activities during the fourth quarter. For example, we funded capital projects during the fourth quarter related to a major lab consolidation project in the Pacific Northwest, and the implementation of our new financial system. Additionally, we made discretionary contributions to our defined benefit pension plan.

How do you plan to use your free cash flow in the future?

We continue to believe our cash is best utilized for a combination of acquisitions and internal investments. Additionally, we plan to use remaining cash to repurchase shares and as always, remain flexible in the pursuit of these goals.

Do you still think there are appropriate acquisition opportunities available to augment your growth?

Yes. If you look at the estimated size of the industry, less the known players, there are many remaining opportunities. Our policy in connection with the use of cash provides us with the flexibility to take advantage of good opportunities when they present themselves.

Can you give some financial details for US Labs historically and for 2005?

US Labs sales were approximately 70 million in 2004. The acquisition of US Labs is included in our updated guidance which we will go over in a moment.

I'd like to point out that US Labs is a strategic acquisition in that it provides us with additional anatomic pathology business and West Coast genomic and esoteric testing capacity. This is not a full [inaudible] synergy deal and we intend to retain the management of US Labs and allow them to operate essentially as is.

What is the impact of recent changes in the Medicare fee schedule for 2005?

The majority of our Medicare revenues are covered by the clinical lab fee schedule, which was frozen through 2008 as part of the MMA last year. We also received payments based on the physician fee schedule, which is subject to change each year.

For 2005, there were increases and decreases in reimbursement for tests that we performed, which resulted in an insignificant change compared to 2004. Within those increases and decreases, there was a reduction in Medicare reimbursement for new CPT codes related to flow cytometry.

While flow cytometry procedures are used in other types of testing, the changes impacted oncology flow, which represents less than 1 percent of revenues at LabCorp. We were aware of these fee schedule changes when negotiating with US Labs.

What is the status of the Florida Medicaid lab proposal?

Florida's Agency for Healthcare Administration, or AHCA, issued an invitation to negotiate, or ITN, on December 13, 2004. The ITN is a bidding process to award a three-year contract to one laboratory to perform all non-hospital Medicaid laboratory testing in the state.

LabCorp and others are protesting the ITN for a number of reasons and the process is now suspended until those protests are resolved. In general, we believe the ITN would not achieve its stated objectives and that quality care to patients would be diminished.

Is there any update on the pod lab concept?

On December 17, 2004, the OIG released a new advisory opinion that addresses anatomic pathology, condominium laboratory arrangements. This advisory opinion is strongly worded on the key issues and there is no lack of clarity on the essential points.

Our interpretation of the opinion is that there's clear anti-kickback, star claw, and false claims risks for many physicians involved with pods. We think this development should result in a slow down in new arrangements being created as well as serious reflection by doctors involved in arrangements already in effect. These pod activities negatively impacted our anatomic pathology revenues during 2004.

Are you seeing any impacts from migration to consumer directed health plans?

We are monitoring the development of this type of coverage and its potential impact on us as a provider of healthcare services. However, estimates we have seen indicate that enrollment for the 2005 planned year is still fairly low and to date we haven't noticed any impact.

Some estimates predict that enrollment in these plans will accelerate in 2006. We will continue to monitor this development, especially when working with our managed care partners who are offering these products.

What has your experience been so far with the Cytech Imager?

In the location where we first offered this choice, early indications are that physicians recognized the benefits of this improved method and are ordering the tests for their patients. We performed approximately 9 million pap smears in 2004 with approximately 5.8 million of those submitted as Cytech Thin-Preps.

Therefore, conversation to the Imager could occur for some portion of this testing over time. We will keep you updated periodically as we gain more experience.

What impact will the expensing of stock options have on LabCorp?

We will continue to disclose the potential impact in the notes to our financial statements. However, our updated guidance for 2005 does not include this impact and we anticipate updating guidance during 2005 when the new accounting is implemented. We are not prepared to discuss any impact on your approach to stock-based compensation at this time.

Now, Tom will review our guidance for 2005.

Thank you, Brad.

For 2005, our guidance, which includes the affect of US Labs is as follows. Compared to 2004, LabCorp expects 2005 revenue growth of approximately 7 to 8 percent, including in year revenues of 25 to $35 million from small acquisitions and our new contracts. EBITDA margins in the range of 25.5 to 26 percent of revenues.

Before the required change in accounting for shares related to our zero coupon subordinated notes, diluted earnings per share in the range of $2.87 to $2.92, an increase of between 11 and 13 percent. This is an increase to our preliminary EPS guidance for '05, which was growth of between 8 and 10 percent.

After the required change in accounting, reported diluted earnings per share in the range of $2.72 to $2.77, also an increase of between 11 and 13 percent. Please refer to Page 19 of the 8-K we filed this morning for a table that summarizes our EPS amounts before and after the required change in accounting.

Capital expenditures in '05 of approximately 110 to $125 million. Free cash flow, net of Cap Ex, of approximately 440 to $465 million.

We also expect net interest expense of approximately $32 million, a tax rate of approximately 41 percent, and a bad debt rate of approximately 5.5 percent of sales for the year.

Note that this guidance does not include share repurchases made after December 31, 2004, major acquisitions other than US Labs, possible significant contributions from new tests, and the impact of new accounting for stock-based compensation.

I would also like to add that while, excuse me, that while we do not provide quarterly guidance, we do ask you to consider that the Easter holiday occurs in the first quarter of 2005 as opposed to the second quarter of 2004. Also, 2005 contains one less revenue day, which occurs to LabCorp in the fourth quarter.

In closing, as we move into 2005, I think it is important to reflect on how LabCorp's strategic plan has contributed to our past results and has positioned us well for future growth. Our strategy has helped to lead a transformation of the clinical laboratory industry in a manner that will be beneficial to our clients and their patients for many years to come.

We have demonstrated this leadership as we executed our vision by being the first national clinical laboratory to focus on genomic and molecular diagnostic testing, move more heavily into the field of anatomical pathology with our acquisition of DIANON and most recently US Labs. And most recently, offered the latest in Pap smear technology with the Cytech Thin-Prep Imaging System.

Given the potential for continued advances in genetic testing, proteomics, and pharmacogenomics, we believe our strategy will place us in the best position to continue to benefit as the clinical laboratory industry continues to advance and grow. While it is difficult to predict discovery and adoption of new testing opportunities, we believe that our strategy places us in the best position to deliver those new tests to our clients and their patients.

Thank you for listening. We are now ready to answer any questions you may have. Craig?

Ladies and gentlemen, if you would like to register a question, please press the one followed by the four on your telephone. You'll 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 three. If you're using a speaker-phone, please lift your handset before entering your request. One moment please for the first question. And our first question comes from the line of Bill Bonello from Wachovia. Please go ahead, sir.

Good morning, guys. A couple of questions. Can you give us any sense of the magnitude of that WellPoint HMO contract in Georgia? And more importantly, do you think you might see additional exclusive contracts with WellPoint going forward?

Bill, I think probably I'll give you a better signal of that midyear in terms of the number of excessions we're getting from HMO exclusive capitated. That's one.

I would say to you today that the increase coming out of Georgia is less than the decrease coming out of Florida in terms of the amount of business in that capitated contract. So we really need to get more out of Georgia to offset the loss in Florida.

We are hopeful that there will be more exclusives coming out in that relationship. We are spending, me personally, a considerable amount of time of working with both the old WellPoint team and the new Anthem team. So we are trying to provide them with good reasons why they should give us more exclusive opportunities.

Okay. And then just on the cost side I know the customer call center consolidation is a revenue initiative, but will it also have a material impact on cost?

We are certainly in both the expense area and in the capital area, Bill, as you've seen our capital expenditures are up next year and our margin expansion is not as significant as other years. And that's directed related to the call center initiatives.

It's related to customer retention, call center initiatives, and the expansion of our activities in the electronic medical record area. And last but not least the expansion of the sales force. So they're the items that really are directly related to increases in expenditures next year.

Okay. So that's next year. How about longer term, so next year it will increase cost longer term post consolidation, would it result in a lower net cost, do you think?

Yes. We do think that. When you are taking 50 down to 2, there should be cost savings in the out years on that but we're not really ready to talk about that yet.

Sure. That's all. Thanks a lot.

Okay, Bill.

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

Good morning, guys.

Morning.

Brad, I want to focus on histology. Obviously some of this lab condo and issues have been kind of under your auspices. But histology trends have been slightly negative last, you know, basically the last three to four quarters. Do you think a combination of both the lab condo arrangement, that enactment coming out in December in addition to maybe competition you were seeing with US Labs on the DIANON segment and obviously that's not something you have to worry about anymore, can those two things begin to turn that histology volume number positive?

I think in terms of the volumes, David, keep in mind that we lost a very significant contract in the State of Florida. And that was a big business area and much of that was capitated in terms of anatomical. So I think if you look at the 8-K, you'll see the pricing trends have improved in the fourth quarter. So we lost a significant amount of our histology growth through the loss of that contract in Florida.

In addition to that, my best estimate is last year, in the year '04, we probably lost in the range of $10 million to pods. That's what we have calculated as lost business that has moved over to pods from either DIANON or the original LabCorp anatomic business.

Tom, you don't think that US Labs pathology initiatives specifically in prostate had any impact on DIANON last year?

I think that US Labs did have an impact, and I think that US Labs, particularly in certain pockets of the country, were very capable in terms of being a competitor.

So I think these three things that I'm talking about, the loss of the anatomical business in Florida, the pods, and competitors, which one was US Labs, all contributed to the situation that occurred in '04 as it related to anatomical.

Now as you look at '05, keep in mind that we have eight months of loss pretty much from a little over actually seven months of loss from the Florida contract of which there was capitated, anatomical down there.

We think that the pods may slow, but we have no information now that would suggest they would go away. And of course we are expanding our coverage through US Labs, DIANON, and LabCorp. So we do expect to do better in the anatomical area in the year '05.

That detail is extremely helpful, Tom. Thank you. And on the imagery front, obviously you continue to lead on technology versus some of your larger competitors. You didn't mention it was excluded from guidance so are we to assume that any revenue or profit impact from the imager is in your 2005 forecast?

Yes. The run rates are in. If it comes up at a much greater rate, we have money in the revenue budget related to what we anticipate the conversion rates will be. Hopefully we're conservative on that and that the uptake will be sooner.

But we did ask each of our divisions around the country to forecast as they convert or offer the automated system, that they forecast what they can get out of that, so that's in the guidelines, in the estimates.

Perfect. It would be safe to assume that the back half of the year if the rollup's going to happen through the mid part of the year, if there was going to be profit benefit would it be more heavily weighted in the back half versus the first?

Right. Absolutely, David. Because not on this are we doing the conversion, getting the instruments from Cytech, getting them out there, but we're also involved in significant training in the first half of the year while in the second half of the year there won't be that cost associated with that.

Okay. Tom, last question and I'll jump back in queue. In trying to phrase this correctly here, but it seems that there's a strategy that you're not talking about that actually seems to be driving a lot of profitability for LabCorp. Is there any strategy that you're kind of formulating here to really focus in on where your profit is coming from across your customer base and maybe willing to sacrifice more volume than you would have a couple of years ago to really drive home that profitability? Has your view on that strategy changed at all in the last 15 months because it seems to be at least if the financial numbers coming out more true?

Well, I think what has happened, David, I wouldn't say that we've changed our strategy, we got a little bit of an eye opener at the end of the first quarter last year when we saw that our pricing was not up. And we spent a considerable amount of time during the last three quarters of '04 carefully looking at the benefits of excession growth and the benefits of price growth and put an enormous effort behind a project here we call focus, which is pricing focus. And we're seeing the benefits of that.

Now, having said that, we didn't want to lose the Florida contract. I'd prefer if we didn't lose the Florida contract. But there are some other contracts that I think you will see in the year '05 that we did lose because we decided to walk away from it. So there's no question that this company continues to focus on price as an important contributor to profitability.

Great. Thank you very much.

Our next question comes from the line of Gene Stir from LongView Asset Management. Please go ahead.

Good morning, Tom.

Good morning, Gene.

As you mentioned a couple of minutes ago I think in response to Bill's question, 2005 is a year in which you're spending a lot of money both in Cap Ex and it looks like in the, with, above the line. In order to implement the retention strategies you talked about the sales force growth as well as the call centers. Can you talk about when in a little more detail when you think we might see some of the revenue benefits from spending, how that will sort of play out? Will we see any in 2005 at all or does it mainly hit in 2006 and '07?

I think that most of it would hit in 2006 and 2007, Gene. I'd say on the other side we do have metrics where these metrics do anticipate a reduction in lost business quarter-to-quarter this year. So I think, I'm hopeful that we'll see even in the second half of this year improving metrics in the area of customer retention. That's one.

In terms of electronic medical records and the interfaces and relationships between LabCorp and our customers, that's something we work on every day. And I do think that that will become more and more of a standard and an expectation in this industry, that all laboratories should have methods of interfacing with customers. So that's quite honestly a cost of doing business.

In the out years you will see expense reductions as a result of our implementation of our call centers. So I think these enhanced revenues will have the greatest impact in the years '06 and '07 as will quite honestly cost reductions, because we'll be able to consolidate our facilities then.

Thank you.

Our next question comes from the line of Gary Lieberman from Morgan Stanley. Please go ahead.

Thanks. Good morning.

Good morning, Gary.

Couple of questions. Seems like pricing growth was relatively strong in the quarter. Gross profit margin was down a little bit more than 100 basis points year-over-year and down sequentially as well. I think you've probably talked a little bit about it but can you maybe go into a little bit more detail what the one or two or three items in order of importance were that were putting pressure on gross profit margin? And it would seem like your guidance for '05, you expect that to moderate relatively quickly. Can you comment on that as well?

I'm going to ask Wes to do that, that Gary.

First of all, if you look at the margins for the fourth quarter, just recognize then compare it to the third quarter of '04, that the seasonality, the fourth quarter gross margins usually are historically lower than any other quarter because of the holidays.

As compared to the previous year in the fourth quarter it was down. The primary reason for that is some of these investments that we talked about, for example, the startup of the Georgia contract, WellPoint. We had to make some pretty significant investments in infrastructure to be up and ready for that contract. So that's the single biggest reason why the fourth quarter gross margins would be down.

Okay. And that should recover relatively quickly in the first couple of quarters of '05?

You'll see a little bit more of that in the first quarter because there's still the process of investing in that infrastructure. But I think from the second quarter forward, you should see improvement in that line.

Okay. And then Wes, I guess one follow-up question for you. It looks like investment income was relatively or comparatively high in the fourth quarter. I'm assuming you sold something. Can you tell us what that was?

We didn't sell anything, Gary.

It's just we accumulated the cash. We said our balance of cash at the end of the year was 206 million. So that was one of our higher balances as far as cash at the end of any period. So that was it more than anything else. But there was no extraordinary items in there.

Okay, great. Thanks a lot.

Our next question comes from the line of Robert Willoughby from Banc of America. Please go ahead.

Wow.

What did you do, change your name?

I just picked up coverage so you guys don't know me yet.

I'm sure we'll get to know you.

Tom, just an easy one, I guess. From a disclosure standpoint do you envision giving us maybe more formal metrics to understand the magnitude of the customer services initiative and ability to track the progress? I'm thinking like a table with call centers or something on a quarterly basis, sales reps, what have you that we can kind of model or update as warranted?

No. I think probably, Bob, I'll give some estimates of that at some point in time. But I'm concerned from a competitive perspective of how far I'm out there already in saying we've expanded the sales force, we have the strategy of call center consolidation. As we do it, I will give you updates on what we've done as opposed to have you know exactly what we're going to do in advance.

All right. Thank you.

Thanks, Bob.

Our next question comes from the line of Kenneth Yu from UBS. Please go ahead.

Hi, good morning. It's actually Ricky Goldwasser. Couple of questions. The first one is on the guidance. It seems like you raised guidance compared to what you've given us in the fourth quarter. Can you break down what's a good contribution from US Labs versus shared repurchase that you've completed in the December quarter, which I think was not included in your prior guidance, and are there any other additions?

And secondly, Tom, you talked about signing, renewing the Aetna, CIGNA and United contracts and that this will have a positive impact on pricing. So should we basically assume from that comment that the negotiations were successful and that in '05 that you'll get higher reimbursement rates from these three managed care providers?

Okay. I'm going to take, Ricky, if it's okay with you, I'm going to take the second one first. Because that is reflected in the guidance.

During the period of probably late September to all the way to December 31st, we were involved in working with those three managed care organizations, which are very important to our strategy. As I said in my call, in my prepared comments, on balance, you should see positive pricing as a result of the renewal of those contracts, which are all multi-year contracts.

So the news this year has been better than, quite honestly, in previous years in that I believe managed care organizations recognize the important value of large clinical laboratories. And I say that in a general way, that they recognize that we in the large independent clinical laboratory business bring added value to them. And they are very much concentrated not on negotiating deals now with the large laboratories, but on how to reduce their overall lab spend.

So when you listen to conference calls from the managed care organizations, please keep that in mind. When they use the words clinical laboratory testing, they're referring to their overall laboratory spend. And they are interested in reducing their overall laboratory spend.

That can come, however, by giving appropriate price increases to the large laboratories and having the large laboratories help them reduce their overall lab spend. And in all my conversations, and I personally have spent a very large amount of my time on this since September, they are very much in tune with the ideas that LabCorp has to help them reduce their overall lab spend.

In order for us to help them reduce their overall lab spend, we felt we needed appropriate price increases to do that, and in most situations, we were very successful in that area.

In terms of guidance for the year '05, we're not breaking out USL. As you saw, there was an increase in our guidance since our third quarter call. That reflects everything. It reflects the managed care contracts, it reflects share repurchase up to December 31, not beyond December 31, and it reflects the goods and bad and cost positive and negative related to US Labs.

Okay. And when will you provide us an update regarding the contingent convert because there are still kind of two sets of EPS guidance numbers here?

What we want to do, Ricky, because effective with the end of the year, that accounting pronouncement is in place. So the numbers that we need to migrate to are the numbers for guidance.

For example, we gave guidance before the change in accounting of 287 to 292. But with the change in the accounting, it's 272 to 277. And we have a chart in the 8-K that shows the before and after affects of the change in accounting. So this is our attempt this quarter to provide a bridge to everyone to show you what it was before and after.

Going forward with the first quarter phone call we'll be talking about EPS in one way, and that will be including the change in accounting. But there's a page in the 8-K that I think pretty much lays out the before and after affects.

Okay, great. But the way we should kind of model it going forward is really including the impact of the CoCos?

That's right. Which the guidance would be 272 to 277 that way.

Thank you. That's very helpful.

Okay.

Ladies and gentlemen, as a reminder, to register for a question, please press one four. And our next question comes from the line of Adam Feinstein from Lehman Brothers. Please go ahead.

Great. Thank you. Good morning, everyone. My question just to start here, and I appreciate your commentary for when the customer retention and the focus on that. I know you're not providing any sort of metrics but just wanted to see if you could just give us any clarity. Is it your belief that customer turnover is intensifying, or is it just that, you know, the environment is very stable but obviously you would like to always improve customer turnover. Could you just provide some clarity there?

Sure, Adam. I think that, I wouldn't say customer retention is, it's always been a major issue to us. And the lost business is something that I've been surprised by in my career here at LabCorp, because we do measure it very carefully.

I would say this, and I've been now saying it for 18 months so I hope this is not new news to people on the call is, competition is more rigorous today than it was 18 months ago, in my mind. So when you look at real opportunities for growth, and I see the metrics related to customer retention, and I look at the ways that I think we can differentiate ourselves from competitors, and I think you can do it by better customer service, that's why this has surfaced to the level it has.

Now, having said that, there's really a couple areas that I'd like to, since you brought up the question, Adam, like to talk about. One is the issue of standardization. LabCorp, we think, has an advantage because we're a fully standardized lab from a billing and lab system perspective. So that allows us now, since we've finished that project six months ago, that allows us the ability to standardize the way that people ask us, the way that we respond to people's questions.

So this really is a natural evolution to LabCorp. We've moved from a standardized billing system to a standardized lab system. We now need a standardized call center system.

And customers are asking more questions than they did five years ago. Patients are getting involved in asking questions. And quite honestly, we're a much bigger business.

Finally, which most important to me, is there is significant lost business attached to the things that LabCorp does, and I would argue the whole industry does, because we take business away from other companies. And our main goal is to reduce those losses, because that's the easiest way to enhance profitability. There are good, solid revenues, that bring good profit margins and we let them churn too much. So that's really the reason for this effort.

Okay. Great. Just one quick follow-up, if I may. I guess just in terms of the flu season, just, are you guys impacted as we think about first quarter I guess, does the timing of the flu season drive your volume growth or should we not really see that as being a key driver? Thank you.

I think, Adam, you shouldn't think of it as being a key driver and the reason is because most doctor's offices are packed anyway, and we get the benefit of a packed doctor's office. So we don't see flu having any impact on our volumes.

Okay. Thank you.

Thank you. Okay. Are there any other questions?

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

This is actually Brandon Fazio for Tom. Most of the questions have been answered already. But in terms of potential bigger new tests that could be upside for the '05 number, what are those tests that you're looking at that could provide that upside? And then secondly, the loss of the Premier contract late in '04, is that already reflected in your numbers and I guess, is there other contract wins, obviously, that have offset that at this point? What's your thoughts on those two things? Thanks.

Brandon, thank you and I'm glad you brought up Premier, because it's something I wanted to talk about. We lost the Premier contract and there's been much written about the loss of that Premier contract.

Let me make it clear that everybody understands why we lost the Premier contract. We lost the Premier contract because of price. Price and price only. There was some documents written that suggested other issues are attached to the loss of the Premier contract.

I, again, was personally involved in that and we elected not to accept the pricing proposals that were coming from Premier. Premier is a GPO. What they provide is pricing to their customers and pricing only. So we lost that contract.

Now, the numbers are guidance reflects the loss of the Premier contract. I am hopeful that that will be minimal. We do have strong relationships with many of these hospitals. So everything that we see is reflected, everything you see in the numbers assumes the Premier.

And I, oh, in terms of new tests, obviously we remain very excited about OvaCheck. I can't speak much to that, other than to say that I honestly do believe that FDA and Correlogic will come to some resolution. And I hope it will be in the first few months of this year and that maybe in some form this product will become available in the U.S. market. That's one area of significant interest to us.

In terms of the overall licensing activities at LabCorp, the opportunities couldn't be fuller. There are many, many groups of people, academic institutions, biotechnology companies that are bringing opportunities to us every day, particularly in the area of cancer. And I am hopeful that we will have a very full year in terms of new licensing deals in this company.

But I think that the one that we continue to hope to have could have an impact in '05 and just don't see it yet is OvaCheck.

Thank you.

Okay. Okay. If there aren't any other questions, let me wish you all a great day and we'll talk to you soon. Thank you very much.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.