Labcorp Holdings Inc (LH) 2005 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Laboratory Corp. of America 2005 third 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, please press the one followed by the four on your telephone. As a reminder, this conference is being recorded Thursday, October 20, 2005. I would now like to turn the conference over to Tom MacMahon, Chairman and CEO of Laboratory Corp. of America. Please go ahead sir.

Thank you. Good morning and welcome to LabCorp's third quarter conference call. Joining me today from LabCorp are Brad Smith, Executive Vice President, Corporate Affairs, Brad Hayes, Executive Vice President, Chief Financial Officer, Ed Dodson, Senior Vice President and Chief Accounting Officer, and Scott Fleming, Vice President, Investor Relations. As you know, many thousands of people in Mississippi, Louisiana and East Texas, including many LabCorp employees, have been severely impacted by Hurricanes Katrina and Rita. Unfortunately, LabCorp employees, about 1,000 in the region, have also been affected. Even with their own personal crisis, our employees continue to provide the highest level of service possible to our clients under the most difficult circumstances imaginable. Efforts like these are what make it possible for LabCorp to achieve strong results. I will have more to say about the impact of the hurricanes later in this call.

Brad Hayes will provide a review of our third quarter and year-to-date financial results. I will then update you on achievements in key strategic areas during the quarter and Brad Smith will cover a few anticipated questions. I would now like to introduce Brad Smith who has a few comments before we begin. Brad?

Before we begin, I would 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 October 20 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 website. Analysts and investors are directed to this 8-K on our website to review this supplemental information. Additionally, we refer you to our press release dated October 20, 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 factor are set forth in detail in our 2004 10-K and subsequent filings.

Additionally, I would like to announce that LabCorp will be hosting a meeting for analysts and institutional investors on December 8 at the Washington Duke in Durham, North Carolina. Please note that we have changed the date for this meeting to accommodate requests for many of our analysts and investors and we feel that this date will be more convenient for more of our analysts and institutional investors to attend. Interested analysts and institutional investors should contact Scott Fleming in Investor Relations at (336) 436-4879 if they have any questions or would like to attend. Now I would like to introduce Brad Hayes who will review our financial results.

Thank you, Brad. Our third quarter results are as follows. Revenues increased 9.1% to $852.9 million. Price increased 7% and volume increased 2.1% compared to the third quarter of 2004. We estimate that hurricanes during the quarter decreased revenues by approximately $7 million and negatively impacted volume by approximately 1%. During the third quarter, the Company recorded pretaxed, restructuring and other special charges of $10 million in connection with the integration of U.S. labs and Esoterix as well as losses realized as a result of Hurricane Katrina. Before the charges, earnings per diluted share increased 11.1% to $0.70 for the third quarter, compared to $0.63 in the third quarter of 2004. The charges negatively impacted EPS by approximately $0.04. A reduction in revenue related to hurricanes negatively impacted EPS by approximately $0.02.

EBITDA was $213.6 million, or 25% of revenues. Operating cash flow for the quarter was $172 million, an increase of 25.4%. During the quarter, the Company repaid $57 million in borrowings under its revolving line of credit. As a result, we had a zero balance on the revolver at the end of the quarter. Also during the quarter, the Company repurchased $78.7 million of stock representing 1.6 million shares. The SO for the quarter was 55 days.

Our nine months results are as follows. Revenues increased 8.1% to $2.5 billion. Price increased 6.9%, and volume increased 1.2% compared to the first nine months of 2004. Before the third quarter charges and the second quarter non-recurring investment loss, earnings per diluted share increased 14.4% to $2.14 for the first nine months compared to $1.87 in the first nine months of 2004. EBITDA was $646.3 million, or 25.8% of revenues. During the first nine months of the year, the Company generated operating cash flow of $413 million. During the same period, the Company completed the acquisitions of U.S. Labs and Esoterix, repurchased $200.7 million of stock, representing 4.1 million shares, repaid $135 million in borrowings under its revolving line of credit and made capital expenditures of $71.4 million. At the end of the third quarter, the Company had a cash balance of $52.5 million.

In summary, we are very pleased with our results for the quarter given the challenges we faced due to severe weather. We believe that our performance is due to sound planning and the execution of a focused strategy. Now I will turn the call back over to Tom who will provide an update in connection with the progress the Company is making towards achievement of our key strategic initiatives.

Thank you, Brad. Yes, we are pleased with our results for the quarter and for the first nine months of this year. We feel that in 2005 we continue to build on the strengths that will allow us to continue our growth and profitability in 2006 and beyond. We did, however, face significant weather challenges in the third quarter. As you are aware, the Gulf Coast region has experienced a very severe hurricane season. It sounds based on information that I'm hearing today that it isn't over yet. Hurricane Katrina was particularly devastating for the eastern portions of Louisiana and all of southern Mississippi. Just days later, Hurricane Rita caused the evacuation of areas including Galveston and Houston and caused substantial damage in eastern Texas and western Louisiana. I have personally visited some of these impacted areas and have seen first hand the devastation. These are all areas of significant businesses for LabCorp. When weather of this nature occurs, our primary concern are for the safety and well-being of our employees and their families and the ability to report results on any testing in progress. We are pleased to report that our employees are safe and that we are able to reroute most testing to other LabCorp facilities for near normal turn-around time. While our more significant testing facilities were not damaged by either storm, a number of smaller facilities, including several patient service centers, continue to be inoperable. We anticipate that certain facilities, mainly in southern Mississippi and New Orleans, will remain closed for the remainder of 2005.

Specimen volume is also negatively impacted due to patients' inability to visit doctors' offices, the source of the majority of our testing volume. We typically see a significant drop in specimen volumes during the event, returning to normal several days after the event has passed and service are restored. Due to the significant impact of these storms on southern Mississippi and New Orleans, we expect the impact will last longer than normal. We will have more to say about this lingering impact later in the call.

Moving a way from hurricanes, I would now like to review several important accomplishments in the third quarter that as part of our overall strategy will lead us into 2006 and beyond. First, business integration activities. As I discussed during our second quarter conference call, our acquisitions of US Labs, Esoterix, and previously DIANON, position LabCorp as the leading provider of cancer and specialty testing in the United States. At the end of September, approximately 35% of our revenues are now in the genomic, esoteric and anatomical pathology categories. In addition to greater revenue and earnings potential, these acquisitions provide Lab Corp the opportunity to reassess the cost structure of our entire organization to eliminate any redundant functions and costs where they may exist. Our third quarter restructuring marks the beginning of the implementation of these integration efforts. In connection with these acquisitions, we believe that the LabCorp enterprise will be able to achieve cost reductions of approximately $30 million on a pretax basis.

Next, cytech thin prep imaging system. The acceptance of the cytech thin prep imaging system continues to accelerate as more physicians become aware of this service and the benefits it provides to them to them and to their patients. As I've mentioned previously, this new service offers both enhanced quality to our clients and their patients as well as enhanced efficiencies to our labs. We are very pleased with the adoption rate so far and view this as one of our key growth drivers for the remainder of 2005 and for 2006. By the end of the third quarter, the thin prep imaging system was being requested for approximately 24% of all liquid based Pap smears ordered, up from approximately 12% at the end of the second quarter, and approximately 5% at the end of the first quarter. On an annual run rate basis, this means that we are now performing approximately 1.9 million image guided Pap tests. The significant adoption rate clearly indicates that physicians recognize the benefits of this Pap screening technology advancement.

Beyond our major new testing offering this year, image guided Pap, we are excited about other opportunities that we see including the recent FDA approval of cytech's testing method for chlymidia and gonorrhea or CTNG, as we call it. This methodology allows CTNG testing in a thin prep pack to be performed using a single patient specimen. Previously, the molecular testing for CTNG had to be performed from a separate patient specimen, adding inconvenient, additional steps for the patient, the physician and for LabCorp.

We remain focused on identifying and commercializing novel testing technologies where we see a diagnostic need. We also continue to assist our existing partners in their efforts to gain regulatory approval and clinical acceptance for their products. This process, however, provides unique and challenging business, scientific and regulatory hurdles, and can take longer than we would like. We recognize this and continue to deal with these issues. As difficult as this process has been in the short term, we remain optimistic about the long-term prospects for the introduction of new testing technologies to address existing gaps in diagnostic capabilities.

Managed care. LabCorp is fueled not only by the introduction of new testing capabilities but also by expanding and strengthening our relationships with our managed care partners. A major driver of volume growth this year is a result of managed care relationships. And it starts with Wellpoint. As I mentioned during our second quarter conference call, we were awarded the exclusive national provider contract for Wellpoint's PPO in the entire state of Georgia effective October 1. We have been officially servicing this fee for service plan for approximately three weeks now and we are pleased with the additional volume that we see flowing through this region.

Additionally, we were awarded the exclusive National Lab provider contract for the Wellpoint HMO and PPO for service plans in Nevada, effective October 15. While it is too early to the assess the impact from Nevada, from the Nevada arrangement, initial volumes are in line with our expectations. You should expect to hear more about additional arrangements like these during our future quarterly conference calls.

As I'm sure you are also aware, United Healthcare recently requested proposals from a number of lab providers to help them reduce their overall spending on lab services. We have responded to their proposal with a number of ideas that we feel would help them achieve their objectives. We believe we have the ability to satisfy their needs and are excited about the opportunity to expand our relationship with United.

During the quarter, we continued to strengthen our relationships with all of our managed care partners through three major initiatives. First, by helping managed care companies understand how we can reduce their overall laboratory spending while still allowing us to be fairly paid for the services we provide. Control of leakage. The amount of work performed and billed by non-contracted providers remains a major area of cost reduction opportunity for managed care companies. Second, by providing managed care companies with unique scientific capabilities, both in traditional clinical and anatomical pathology services, and in breakthrough areas such as wellness. Third, by bringing unique connectivity and information aggregation and analysis solutions to our managed care partners. These capabilities demonstrate how we can differentiate the value that LabCorp offers to all of our managed care partners by meeting what they have told us are their key objectives: reduced leakage, accessing greater scientific capabilities, and increasing access to clinical data.

Web-based solutions. In mid-September we announced the launch of eLabCorp, our web-based connectivity solution for our physician clients. eLabCorp is a key building block in our connectivity strategy and further enhances the options available to doctors to more easily order tests for their patients and access the test results. eLabCorp provides a web-based connectivity solution that integrates easily with a wide variety of existing electronic medical records and practice management systems, allowing doctors to access the web for testing services without changing the computer system they use for the rest of their practice needs. We are very pleased with the performance of eLabCorp and with how it has been received by our clients.

LabCorp remains on track with a simple and consistent business philosophy: select the most important areas of focus that we believe are critical to the future success of our Company, develop plans, metrics and goals for each area and then monitor progress for achievement of these goals. We believe that by applying this simple philosophy to our three strategic focus areas, scientific leadership, customer retention and managed care, we will 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, can you provide some insight into your margins? Due to the investment in our sales force and call center consolidation, we knew that for a period of time, our margins would be impacted. You also know that US Labs and Esoterix both had lower margins than ours. At the same time, we do, however, continue to have industry leading margins and we will continue to so. Our guidance for the year was clear that we expected margins to be flat due to the investments we were making in the business but that we expected these investments to provide the opportunity for enhanced margins in the future.

What are your plans for the use of excess cash? Our policy with respect to the use of excess cash and free cash flow has not changed. Our first priority will be to use free cash to help grow the Company by pursuing our strategic objectives, including acquisition and licensing opportunities. And second we plan to continue to repurchase our shares under our board approved share repurchase program.

Can you provide any details regarding your response to the United Healthcare RFP? As Tom mentioned in his remarks, we are excited about this opportunity and have responded to the RFP with several ideas that we feel would help them achieve their objectives. However, for competitive reasons, we will not discuss the details of our response.

Is there anything new on the reimbursement front? We continue to monitor developments of both the federal and state levels and to our knowledge there is nothing specific to report. As healthcare costs continue to rise, we know that we need to remain on guard for reimbursement as well as regulatory change that could impact us negatively. As you know, CMS has announced a proposal for a significant restoration of the 2004 fee cuts related to flow cytometry tests. Assuming this proposal is implemented, along with a 1.5% increase in the conversion factor for the physician fee schedule, we estimate that revenue would be positively impacted by approximately $12 million in 2006.

What are your thoughts regarding the market for acquisitions? Do any attractive candidates remain? The clinical lab industry remains highly fragmented and consolidation will continue. We remain focused on identifying acquisition candidates that further our strategy of strengthening our scientific leadership and enhancing our national core infrastructure. Our acquisitions over the past several years have further differentiated LabCorp from others in the clinical lab industry by significantly enhancing our capabilities in the high-value, high margin, esoteric testing arena.

When will you provide guidance regarding the impact of the adoption of FAS 123 R related to the expensing the value of stock based compensation? We will incorporate the impact of this pronouncement on 2006 EPS and other financial performance measures when we issue in-depth guidance for 2006 on our fourth quarter conference call. Now Tom will review our updated guidance for 2005 and preliminary guidance for 2006.

Thank you, Brad. Guidance for the remainder of 2005, including the continuing impact of third quarter hurricanes on the fourth quarter, is as follows: compared to 2004, LabCorp expects 2005 revenue growth of approximately 7.5 to 8%, EBITDA margins of approximately 25.5% of revenues, diluted earnings per share in the range of $2.73 to $2.77, excluding the third quarter restructuring and other special charges, capital expenditures of approximately 90 to $100 million, free cash flow, net of cap expenditures, of approximately 440 to $465 million. We also expect net interest expense of approximately $32 million, and a bad debt rate of approximately 5.3% of sales for the remainder of the year.

We expect that the fourth quarter will be impacted by the continuing effects of third quarter hurricanes. This does not include any hurricanes that may occur in the fourth quarter. We estimate that revenues will be negatively impacted by approximately $7.5 million. Volume will be negatively impacted by approximately 1% and EPS will be negatively impacted by approximately $0.02. These impacts are reflected in our guidance for the remainder of 2005. As a reminder, there is one less revenue day in the fourth quarter of 2005 versus the fourth quarter of 2004. Note that this guidance does not include any potential restructuring charges at Lab Corp associated with the continued integration of US Labs and Esoterix into LabCorp or future share repurchases beyond quarter three.

Now for 2006. Our preliminary guidance is as follows. Compared to 2005, LabCorp expects 2006 revenue growth of approximately 6.5 to 7.5%, including the full year impact of acquisitions, and diluted earnings per share growth in the range of 12 to 14% compared to our 2005 EPS guidance. We expect to achieve this EPA growth through the following initiatives: increasing revenues and further shifts in our test mix, particularly in our esoteric and genomic businesses which generate higher profits than the core business, achieving the $30 million in annual synergies that I mentioned earlier, contributions from small acquisitions. We expect to provide more definitive guidance for 2006 after we complete our internal budgeting process for next year.

We are very pleased with our results through the first nine months of this year. Investments made and relationships built during 2005 position us well for significant growth in 2006 and beyond. We remain fully committed to our strategy of leveraging our core national infrastructure to deliver industry leading scientific expertise and excellence in patient care to physicians and their patients. Thank you very much. We are now ready to answer any questions you may have.

[OPERATOR INSTRUCTIONS]. Our first question comes from the line of Tom Gallucci, Merrill Lynch. Please proceed with the question.

Good morning everyone. Thanks for the color. I just had one or two follow-ups here. First, you seem to identify the $0.02 from the hurricanes from the revenue impact and then you've got the $0.04 of costs and the $10 million, that's a combination of the charges from the integrations as well as some costs from the hurricane. Can you further clarify kind of how that $0.04 breaks down?

Yes, Tom, this is Brad. The $0.04 from the restructuring charge is about 85% made up of the severance and other items related to the restructuring activities, and about 15% related to the hurricane impact. 95% of the hurricane impact amount is related to receivables in the affected areas.

Okay. Great. And then as we think about the volume and the price, something people are always focused on is trying to get down to more of an organic type number so with some of the acquisitions in there. Maybe if you kind of account for the acquisitions and you account for the hurricane and you adjust for those things, do you guys have an estimate of what you think organic volume and pricing was?

Tom, this is Brad again. Last quarter, we talked about that number without all of the noise being in the 6% range which I think was low threes in volume and high twos in price.

Right.

I think we still think that's about the same.

Okay. And then just a final question on Wellpoint. I know you addressed it a little bit in the formal remarks but I guess last quarter you had talked about maybe we will learn a little bit more about what you mean by the nature of this broader strategic type relationship with them in the coming months and I haven't really heard a lot of incremental information on that. I was wondering if there was anything else to offer or are you still expecting further details on that to come?

I think what I can say is this, Tom. We continue to have much interaction with Wellpoint expanding in service areas throughout the United States. That's one. Two, now we have entered into discussions with Wellpoint on the exchange of certain scientific technology that resides inside the LabCorp and they are interested in utilizing some of this technology in their wellness efforts that they have talked much about around the country. So as we get more on that, we will let you know about it.

Okay. And just on a follow-up to that, to the extent you can, is that something you can create another business out of or is that more to enhance the relationship with a customer?

That we can create a business or that they can create a business?

You by giving them information, scientific information. Is that more of a relationship builder or do you actually get paid explicitly for that?

There will be an opportunity for both sides to get revenues and royalties or things like that from that kind of a relationship.

Our next question comes from the line of Ricky Goldwasser, UBS. Please proceed with the question.

Good morning. Just some clarification regarding '05 guidance. You talked about an impact of $0.02 in the third quarter from the hurricane but then you also said that the impact is going to be about $0.02 for the year. The low end of the guidance is $0.02 and the high end is $0.03 so the question here is, what are you assuming the impact of hurricanes is going to be in the fourth quarter? And then are you seeing better than expected trends in other areas of kind of offsetting the weakness that you are expecting because, due to the hurricane? And then my other question is regarding the '06 guidance. I apologize if you mention it. Does the '06 guidance include the impact of the increased reimbursement for flow cytometry?

Ricky, either I didn't say it properly or maybe you didn't hear it properly. I want to make sure that I'm clear on this. We expect the hurricane had a $0.02 impact on the third quarter and will have an additional $0.02 impact on the fourth quarter. So the revenue impact was in the range of 7 to $8 million in the third quarter. It will be another 7 to $8 million in the fourth quarter from those areas that we know are not open. So we look at that every day. So the impact of the hurricane on the results is $0.04, not $0.02. Okay? Now, in terms of the guidance for next year, we really have not completed our budget for LabCorp. Based on what I know today, we are saying that the EPS will increase in the range of 12 or 14% and that's based on the information I have today. We have to go through a rigorous budget process at LabCorp. But we do know that the reimbursement will have a positive impact if it ends up, as it is being proposed, and if they change the physician fees, as many people expect they will. So all in all, the 12 to 14% EPS growth would include, would include the reimbursement based on what we know today.

Okay. And then just back on for the '05, you are saying the hurricane in the second half of the year will have an impact of $0.04.

Correct.

But you lowered guidance by $0.02 to $0.03. So then are you seeing any strength in other areas? What's offsetting the negative impact from the hurricanes?

Ricky, our share repurchases that we've completed through the end of the third quarter will have some fourth quarter impact. And then we do also, would expect to not just have the hurricanes lower it across the board because we will try to do better.

Okay. Thanks.

Our next question comes from the line of Adam Feinstein, Lehman Brothers. Please proceed with the question.

Great, thank you. Good morning everyone. Several questions here. First, just on WellPoint, it sounds like you guys are really ramping up there. My question is they just recently announced they're buying Wellchoice here in the New York area. I was just curious, do you currently service the Wellchoice business and is that a future opportunity?

We don't currently service the Wellchoice business and I don't know if it will be a future opportunity. Obviously we hope it's a future opportunity but we really couldn't comment at this point in time.

Okay, great. And then I guess secondly, in the 2006 guidance and I'm sorry to belabor the point, I just want to make sure I have all of the details here. If we were going to think about, I guess the question is, are you assuming any residual hurricane impact in 2006 from your point earlier that this is a more severe hurricane season than previously? I guess does the 12 to 14% growth assume any impact from the hurricanes?

No, it doesn't. We were hopeful that we will be back in business by January 1 in those areas. Now if that's not the case, we will update you in February when we have our final or actual final guidance for the year. It's always tough, a challenge to give guidance in mid-October when we really still have 2.5 months left and we are not heavily into the budget process. We have a sense of what we are going to do next year and while I know everyone wants us to split it up in great detail, it's very difficult to do at this time.

I totally understand. Just on the UNH business and I understand you can't talk too much because you are still in the RFP process but was just curious. Is it your understanding that they are going to go to just a handful of lab companies? Are they looking for one partner? I guess do you have any clarity there in terms of how many partners they would eventually have?

Good try, Adam. We are not going there. We've given you everything we are giving you on United which is probably more than most people would give you.

Okay. No, absolutely. My final question, just curious if had you any updates in Washington, at the med-pack meeting last week, they spoke about the clinical lab sector, an area they haven't focused on previously in the past. Just curious whether you have any thoughts there? I don't know if you guys are working with any lobbyists but would be curious to get your sense in terms of Medicare reimbursement for clinical labs in the future. Thank you.

This is Brad. We are working through the American Clinical Laboratories Association. Our comments were included with them at the med-pack meeting and we don't see, as in our general comments we said, look, we are on guard but at this point we don't see any change in our evaluation of where we stand with respect to changes in reimbursement or regulatory policy that can negatively impact us. But again we want to underscore that whenever there are pressures on healthcare spending we have to be proactive in making sure people understand the value that we provide so that the at the last minute when they look for some place to cut, they just don't take it from us.

Okay. Good point. Okay. Well, great. Well, thank you.

Our next question comes from line of David MacDonald, SunTrust Robinson Humphrey. Please proceed.

Good morning. I was wondering if you could you give some sense, with the expansion of the sales force, where we are with that. Are we 50% through hiring, 80% through hiring, just some color there? And also is it fair to assume, is it still a kind of three to six-month ramp up on these sales folks before they reach some productivity, a good number? And then I have one or two other follow-ups.

With the acquisitions of USL and Esoterix, we are about complete with our sales force expansion and we assume it's a six-month ramp up in terms of their ability to be productive and they are certainly in our guidance for next year.

Okay. And then I was wondering are there any metrics that you guys can share with us on the call centers and where we are there and is that running ahead, in line, behind, in terms of the outlook there?

I think it's probably running in line. So we are still a couple years out on that.

And I guess just final question. Can you give any sense now that the imager has been rolled out for a couple of quarters relative to the liquid based test. What are you guys seeing in terms of reimbursement? Are all your payers giving you a little better reimbursement, is that not the case, where are we on that front?

I think overall we are seeing the reimbursement as we expected which is I think we said in the past, Medicare reimbursement increased about $9. It's somewhere in that range.

Are you guys also seeing your commercial payers willing to pay you that or are they viewing it more as a lab efficiency tool and figuring that you are making your money on lower cost of goods?

The value of the technology, both in terms of enhanced quality I think is and when you look at the overall costs even with the increase in reimbursement for the Pap smear test , it's still is relatively low compared to the value that it provides. So that hasn't -- we haven't, we said early on that that's something that we'll continue to watch but at this point in the ramp up process, we haven't seen that.

Okay. Thank you very much.

Our next question comes from the line of James Star, Longview Asset Management. Please proceed with your question. Hello? Mr. Star, your line is open. Please proceed with your question. We are not hearing your question. Please check your mute button.

My question has been asked and answered. Thank you.

Thank you. Our next question comes from the line of Robert Willoughby, Banc of America Securities. Please proceed with the question.

Good morning. This is Matt Jackson in for Bob. Could you speak to how the drug testing and trial testing business performed in the quarter? And also secondarily, could you provide any comments on the Medicare position fee schedule and effects on '06 reimbursement?

Right. Let me start with the last one which is the Medicare fee schedule. And the increased, proposed increases as it relates to mainly flow cytometry. We indicated on the conference call that we think it's going to have a positive impact if the physician fee schedule is adjusted, as many people feel it will be. On an annual basis, it will have an impact of about $12 million on our revenues in '06. And that is included in our guidance. So that's question one. What was the other question?

Drugs of abuse.

Drugs of abuse testing has been a solid business for us this year. It is a growth business. It continues to grow for us and the clinical trial business is also continuing to grow for us.

The next question comes from the line of Bill Bonello, Wachovia Securities. Please proceed with the question.

Hey guys, a couple of questions. One, just a point of clarification, the volume and price growth numbers that you reported for the quarter. I assume that those are inclusive of the hurricane?

Correct.

Okay. Perfect. And then, two, and I apologize for belaboring this, but I just want to make sure I'm 100% clear. Then we should assume that if the currently slated 4.3% reduction to the conversion factor is not eliminated, your guidance is too high. Is that? --

Yes.

Okay. Thank you. And then, three, can you comment -- you talked a bit about managed care. Just coming at it a different way, can you talk at all about anything that you might be seeing managed care companies doing differently or contemplating doing differently in an effort to control leakage? In other words, are you seeing the companies put some more teeth behind their efforts to keep testing in network and if so, what are those strategies?

Well, here's what I can say, Bill, and again I don't sit inside the big managed care plants but the managed care plans have redirected their thinking to total lab spend where historically, meaning two years ago and before that, they were interested in individual laboratory purchases. They are now interested in overall laboratory spend. They have, certain managed care plans have become more clear that they are going to require or do everything they can to force physicians to utilize the in-network systems to the point, or in-network laboratories, to the point where they inform them sometimes by letter that they are prepared not to reimburse them if they go outside the system. That's about the most I can add to it. Obviously, with this proposal from United, they are seeking to reduce their overall lab spend.

Sure. Okay. That was actually very helpful. Then just a question on the cash flow. It looks like while your free cash flow guidance was unchanged, that your operating cash flow guidance came down by maybe 20 to 25 million along with your CapEx. I'm just wondering it looks like the hurricane is probably about 75% of that operating reduction. I just want to make sure there's nothing else going on from an operating cash flow standpoint and then why the decline in CapEx relative to what you thought it would be last quarter?

Bill, this is Brad. I think on the operating cash flow the other thing, I'm not sure I agree with your math, but the other thing that is an obstacle is the severance related to the restructuring activities so that also would come out of operating cash flow as well as the losses related to the hurricane revenues.

Okay. And on the Capex?

The Capex, I would say the biggest item there is the call center consolidation. We thought those dollars would be spent faster than they are being spent so that's probably the biggest difference from our earlier, much earlier guidance to what we seem to be running at right now.

Should we think of that as postponed spending as opposed to eliminated spending?

Yes, I think you should and I think also, Bob, we will give you guidance on CapEx, Bill, in our February, we are going to do that call center consolidation. It's just taking a little longer. You'll probably see some of those numbers in next year's Capex when we provide the guidance in February.

Just following up on that, is the incremental spend that you saw on some of those initiatives, not so much on Capex but SG&A kind of incremental spend, is that something that also carries into next year or was that kind of unique to this year and next year would be more normalized in terms of margin expansion?

I don't want to get to margin expansion yet as it relates to next year because there is an awful lot going on at LabCorp. There's the $30 million cost reduction initiatives and that's against the call center consolidation. So we expect to see lingering costs associated with that well into next year. And then when the call centers do get consolidated, we see efficiencies coming from that. So it's pretty hard at this point in time to give you any sense of the cost structure for next year.

Okay. Thank you very much.

Thanks, Bill.

Our next question comes from the line of Steve Hamill. Please proceed with the question.

I was wondering if you could talk about some of the recent headlines about direct billing. There's certainly, even without the headlines, seems to be a trend towards more states requiring direct billing and if you could talk a little bit about what impact that tends to have on you guys aside from the obvious potential for you to charge a higher price by going direct to the payer but also does it impact your share in those local markets?

Yeah, I think the core direct billing initiatives have been around for a long time. And really Medicare was the first and it was back in the early 80s, 82 or 83, where they required for the first time that physicians, if they didn't perform testing, they couldn't bill for it and only the provider could. As you know, many states, New York and others, had direct billing requirements. And then there's a variety of approaches state by state. And we have directly, and through the trade association, favored direct billing initiatives. But in fact, on a state by state basis, and on a managed care plan and managed care plan basis, it is lawful and permitted for physicians to rebill work that they didn't perform. So we've been competing in those markets and sometimes have provided commercial prices for work. But we don't think as far as the market share is concerned and our ability to compete, we think if there was a more uniform requirement across the country that we would compete favorably. But it's not, it's not something that we look at just from a perspective of being able to charge more. We think the markets will adjust just like all markets adjust, the price will adjust.

And then, the second question, if I could, is on the status of the US Labs and Esoterix acquisitions. In particular your ability to retain the customers that those laboratories had, and whether or not the attrition rates have been above, below or in the range you had expected?

For both, actually, they've been right where we expected so we are quite comfortable that we've been able to predict fairly accurately the retention and loss rates and growth opportunities with those companies.

And then just one last one as a follow on to that. It was mentioned earlier when the sales force expansion question got asked that you kind of cited that there were the additional reps that you picked up with those acquisitions. Is that a significant piece of the total expansion of your sales force is the retained sales forces of those two laboratories?

Yes. Because when we started our sales force expansion and contemplated it last November, we didn't have built into those numbers the fairly good sized sales forces of both USL and Esoterix. So as we went through the year, we had to sort out all of those additional salespeople, including our own, and have recently concluded our structure of that new organization.

So can you give us a sense at this point then how much growth your sale force has seen since last November?

I don't think we've actually ever mentioned an exact number for that but our sales force is considerably higher than it was last year and we like not to talk about that only for competitive reasons but it is increased substantially.

Okay. Thank you.

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Okay, great. If there aren't any more calls, we wish you a good day. Thank you very much, and thank you, Nelson.

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