Labcorp Holdings Inc (LH) 2008 Q4 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the fourth quarter and year end 2008 Laboratory Corporation of America earnings conference call. My name is Becky, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question and answer session towards the end of the conference. (Operator Instructions).

I will turn the presentation over to your host for today's call, Mr. David King, Chief Executive Officer. Please proceed.

Thank you Becky. Good morning and welcome to LabCorp's 2008 fourth quarter and year end conference call. Joining me today from LabCorp are Brad Hayes, Executive Vice President and Chief Financial Officer, Ed Dodson, Senior Vice President and Chief Accounting Officer, and Bill Bonello, Senior Vice President, Investor Relations. This morning we will discuss our fourth quarter and year end 2008 results, highlight our strategic priorities, and provide answers to several frequently asked questions.

I would like to turn the call to Bill Bonello who has a few comments before we begin.

Before we begin, I would like to point out that there will be a replay of this conference call available via telephone and internet. Please refer to today's press release for replay information. This morning the Company filed an 8-K, that included additional information on our business and operations. This information is also available on our website. Analysts and Investors are directed to this 8-K and our website, to review this supplemental information.

Additionally we refer you to today's press release, which is available on our website for a reconciliation of non-GAAP financial measures discussed during today's call to GAAP. I would also like to point out that any forward-looking statements made during this conference call are based on 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 2007 10-K and subsequent filings.

Now Brad Hayes will review our financial results.

Thank you, Bill. By now you should have had a chance to review our fourth quarter and year end financial results. On today's call, I will discuss four key measures of our financial performance, cash flow, revenue growth, margin and liquidity. First, cash flow. Our cash flow trends remained excellent. Free cash flow for the year increased 10.1% to $624.2 million, net of $42.3 million in transition payments to the UnitedHealthcare, compared to $567.1 million in 2007.

We were also pleased with our collection efforts in the second half of the year. Cash collections were strong in the quarter, as evidenced by an improvement in DSO. DSO at the end of December was 51 days, an improvement of two days from the end of September. Our bad debt rate was stable at 5.3%. For 2009, we expect operating cash flow excluding any transition payment made to UnitedHealthcare to be approximately $800 million. We expect capital expenditures to be approximately $130 million.

The Company estimates that it will contribute approximately $56 million to it's defined benefit retirement plan during 2009, based upon the underlying value of plan assets at December 31, 2008. This contribution is greater than our previous estimate of $22 million as of the end of the third quarter of 2008, which was based on the underlying value of the plan assets as of September 30, 2008.

Second revenue growth. During the quarter we achieved strong volume growth and continued mix shift to higher value tests. The revenue volume and price growth that we will discuss excludes the impact from consolidation of our Ontario, Canada, joint venture, and a special charge which is described in our press release. Revenue increased 6.2% year-over-year in the fourth quarter. Volume increased 3% year-over-year, despite a substantial decline in our drugs of abuse testing business. Volume growth remains strong in our Esoteric segment where volume increased 13.5% year-over-year.

Drugs of abuse testing volume declined by 15.9% year-over-year in the fourth quarter of 2008, with a significant deterioration in the months of November and December. This decline reduced total US volume growth by 140 basis points. Revenue per accession increased 3.2% year-over-year. The growth in revenue per accession increased sequentially, due to mix shift and to rate increases realized during the quarter.

Our 2009 guidance is for revenue growth of 2 to 4%. We expect that 2009 could be a challenging year for volume growth, given the economic environment. On the other hand, our pricing outlook is positive. We are pleased to have price increases from both Medicare and several large managed care payors in 2009.

Third margin, for the fourth quarter our adjusted EBITDA margin was 23.6%. The consolidation of our Canadian joint venture effective January 1, 2008, had the effect of reducing our adjusted EBITDA margin by 130 basis points year-over-year. Excluding the impact of that consolidation, our adjusted EBITDA margin was 24.9%, and declined approximately 80 basis points year-over-year, primarily due to an increase in bad debt expense.

Nevertheless, we continue to lead the industry in EBITDA margin. We expect that 2009 could be a difficult year for margin expansion, given our expectations for relatively low volume growth, increased pension expense, and the impact of the Canadian exchange rate. Looking beyond 2009, we are focused on increasing automation and efficiency in our labs, which should enable greater margin expansion in the years to come.

Fourth, liquidity. We remain well capitalized. At the end of December the Company had cash of $219.7 million, and approximately $300 million available under it's revolving line of credit. At the end of December, total debt was $1.7 billion, including $70 million drawn on our revolving credit facility. Net debt to trailing EBITDA was 1.3 times.

I will now turn the call over to Dave.

Thank you, Brad. I would like to highlight some of the initiatives we are pursuing to drive growth in 2009 and beyond. As Brad noted, we expect 2009 to be a challenging year in terms of volume growth. Therefore our most important priorities for this year are to gain new customers, maintain pricing and control costs.

Furthermore we see opportunities to accelerate revenue growth, through continued leadership in personalized medicine, so we remain focused on growing our Esoteric testing platform, expanding our outcome improvement programs, and developing and commercializing companion diagnostics. We are optimistic about our ability to reduce fixed costs through facility rationalization, and introducing robotics to automate front end solutions.

Let me discuss what we are doing to gain new customers, maintain pricing, and control costs. On the volume front we are continuing our efforts to target specialty positions, whose referral patterns may be less sensitive to the economy. Our ability to grow volume by 3.0% in the fourth quarter, despite steep declines in drugs of abuse testing, is a testament to the test of this strategy. On the pricing front, we are receiving rate increases from both Medicare and large commercial payors. We are also rigorously reviewing our pricing structure, to ensure that we are being appropriately paid for more complex and higher value tests.

On the cost front, we are working aggressively to reduce expenses without compromising quality or growth. For instance, we are revisiting all of our leases in an attempt to renegotiate better pricing, given the commercial real estate environment. Similarly, we are undertaking a vigorous supply chain review to identify the additional supply cost savings. We are also keeping a tight lid on discretionary costs, such as consulting and travel. All of these efforts are balanced against the spending that is necessary to accommodate our continued volume growth.

I would also like to spend a few minutes discussing some of the initiatives that we are pursuing to lay the foundation for future revenue growth and margin expansion. On the revenue front, our objective is to continue to be the leading provider of personalized diagnostic medicine. We have three strategies that will move us toward that goal. Continued growth in Esoteric testing, expansion of outcome improvement programs, and development and commercialization of companion diagnostics.

With regard to growth in Esoteric testing, it is worth re-iterating that we saw 13.5% year-over-year volume growth in the quarter. Our goal is to increase Esoteric testing to 40% of our revenue in the next three to five years. We will continue to introduce new Esoteric tests to respond to scientific discoveries, to improve patient care and outcomes, and to satisfy unmet and medical needs. We will also continue our important collaborations with academic institutions, such as Duke University and Yale University, to help us in the identifying and commercializing new and innovative tests.

We continue to expand our outcome improvement programs. Our Litholink programs for kidney stone management has been well received, and we are seeing double-digit revenue growth, widespread acceptance from payors, and premium reimbursement. We have introduced in selected markets our unique outcome improvement program for chronic kidney disease, CKD.

The deterioration in kidney function generally takes place over a number of years. However, with proper treatment, disease progression and the significant morbidity, mortality and expense associated with CKD can be greatly reduced. We have received an enthusiastic response to the program from physicians, payors and employers. Looking forward, we believe that the CKD program will be the gateway to other outcome improvement programs, which we are already developing.

We were also focused on developing and commercializing companion diagnostics. To this end, we continue to invest in our growing clinical trials division. Tandem Labs, which focuses on preclinical analytic work for pharmaceutical companies, and is a leader in biomarker discovery has grown rapidly, as pharmaceutical companies seek markers to assess drug safety and efficacy, during the preclinical stage of drug development. We are also seeing strong growth from the rest of our clinical trials business, as we work with pharmaceutical companies, to develop diagnostic tests that will be used by physicians to identify whether a drug is safe and effective for a specific individual.

On the margin front over time we believe there is an opportunity to reduce our fixed cost base through automation and capacity rationalization. We are beginning to roll out robotics to automate the front end processing for HPV testing. We are also in the process of developing robotics to automate other pre-analytical processes. In summary we remain very excited about the growth opportunities that lie ahead, and continue to believe that we are well-positioned to capitalize on them.

Now Bill Bonello will review anticipated questions, and our specific answers to those questions.

Thank you, Dave.

Can you update us on the mix of your business coming from Esoteric testing? In the fourth quarter and year-to-date approximately 35% of our revenues were in genomic, Esoteric, and anatomic pathology categories. Our goal over the next three to five years is to increase our Esoteric test mix to approximately 40% of revenue.

What are your plans for uses of free cash flow during 2009? We will remain committed to returning value to our share holders. First, by using our free cash flow to grow our business through strategic acquisitions and licensing agreements, and second, through continuing our approved share repurchase program. However, given the economic environment, we may choose to retain a higher than normal cash balance throughout the year.

The acquisition market remains attractive with a number of opportunities to strengthen our scientific capabilities, grow our Esoteric testing franchise, and increase our presence in key geographic areas. Historically we have been a consistent buyer of our own shares. During 2008, the Company repurchased $330.4 million worth of stock, representing approximately 4.6 million shares. Approximately $95.4 million of repurchased authorization remained under our approved share repurchase plan at the end of the quarter.

Can you remind us of how drugs of abuse volume trended during the year? In the quarter, our drugs of abuse volume declined 15.9% year-over-year. This compares to a decline of 10.3% in the third quarter, 7.9% in the second quarter, and 4.4% in the first quarter.

What is the status of your transition payments to UnitedHealthcare? In the quarter, the Company was billed $5.3 million in transition payments, and paid $12.5 million in transition payments.

Can you give us an update on the status of your other managed care contracts? We have no national contracts up for renewal in 2009. In addition, we are pleased to announce that we have extended our contract with WellPoint through mid-2013.

Now I would like to turn the call back over to Dave.

Thank you, Bill. In summary, we are pleased with our robust top line growth in this challenging environment. We will work aggressively to gain new customers, maintain price, and manage costs. Looking forward, we see great opportunities to accelerate revenue growth through continued leadership in personalized medicine.

Thank you very much for listening. We are now ready to take your questions.

(Operator Instructions). And your first question comes from the line of David Clair of Piper Jaffray. Please proceed.

Hey, guys, Dave Clair here for Bill. Congratulations.

Thank you.

I was hoping you could give me some color on pricing in Canada? It looks like we saw another sequential decline there.

This is Brad Hayes, Dave. That is a contract with the government. So it is basically like a capitated arrangement, so to speak, and volumes have increased a little there, in terms of utilization. So that has some downward pressure on the price. It is not a negotiated price decrease, if you will.

Okay, great.

Dave, one other thing, also the exchange rate in the fourth quarter will have a negative impact on that metric as well.

Okay. Thank you. And then given the vitamin D testing issues experienced by your primary competitor, I was hoping you could give us some color how that business is going for LabCorp? Do you think you are gaining some share as a result of that?

It is Dave. I would just comment that we use the Diasorin method for vitamin D, which is the FDA cleared and approved method. I think over time our decision to continue that method will pay us benefits, in terms of the appropriateness and validity of our testing results. Beyond that, I really don't think it is appropriate to comment.

Okay. And then just a quick question on the tax treaty benefit. Is that something we can expect to continue in 2009?

Again, this is Brad. It has a little impact on 2009. But most of the positive benefit that we recorded in the fourth quarter is for prior years. So a little bit of positive impact going forward. Certainly not to the extent that you saw in the fourth quarter.

Okay. Great. Thanks a lot guys.

And your next question comes from the line of Robert Willoughby of Banc of America. Please proceed.

Thanks. First I think I would say that I didn't think that Bill Bonello could speak any more on a conference call, but I think you proved me wrong. Welcome aboard, Bill.

Hey, Bob. This is Dave. He gets to speak first every time.

(laughter). I am always last in the queue. What have you modeled for substance abuse going forward, and maybe as part of that question, Dave, can you speak to what tangible changes you have made to ensure that the forecasting here is more spot on?

The guidance we give is intended to incorporate what we perceive as the most likely range of foreseeable outcomes. So it is hard to break apart each of the individual components. So if you ask us how are you modeling drugs of abuse, or how are you modeling unemployment, or how are you modeling various aspects of the economy. What I would say is we look at the sum of the parts to come up with the guidance, as opposed to trying to slice and dice each part individually.

The drugs of abuse testing obviously from what we have told you declined pretty dramatically in the fourth quarter, and we are certainly not forecasting that we will see any improvement in that for the balance of the year. In terms of what we have done to improve overall forecasting, we are continually working to improve our overall forecasting capabilities. I will say the pace of economic change between the beginning of November of 2008, and even up until yesterday, is something that I don't think anybody has ever seen before.

And the volatility in markets, and the volatility generally in health care, is something that we haven't seen before. So we were continuing to refine our forecasting capabilities, and also to as I made reference to, manage the business very closely on a day to day basis, particularly in terms of seeking new customers, in terms of controlling our expenses, so that we end up delivering results within the range that we have set out.

Dave, do you think you have challenges in terms of your ability to access information on a timely basis? I agree with you the obvious economy issues are really an issue for all of us. Is there something at LabCorp that structurally prohibits you from getting the information as soon as you need?

No. I think we have very good access to real time information about our business. I think what we don't have is the same thing that nobody else has, which is the ability to see what is going to happen in the overall environment. So last summer gas prices were $4.00, now they are $1.80. And we don't have any ability to see where they are going to go between now and the end of the year. And gas prices affect consumer confidence. They affect consumer spending. They affect the amount of discretionary income that consumers have.

We also don't have the ability to see, are people going to go to the doctor? Are they not going to go to the doctor? We know that hospitals are reporting that discretionary and elective procedures are down. We don't know how that affects the physician office. We have very good access to real time information about what is going on in our business. What we don't have is any better than anybody else, information about how the economy is going to perform, or what it is going to mean to the consumer.

Okay. Thank you.

And your next question comes from the line of Ralph Giacobbe of Credit Suisse, please proceed.

Great, thanks. I guess there are any acquisitions in that 6.2% top line number? If so, what was the contribution?

Ralph, this is Brad. There are acquisitions that have impacted our growth rate all year. We don't break that out separately because the nature of the acquisitions we have done were on a small basis, and not something that we needed to call out. They are a contributor as they have been in the past. It is just not something that we break out.

Okay. We shouldn't think of it it as significant to that 6.2? We should think of that 6.2 as roughly organic. Is that the way you would consider that number?

No. I think it obviously has some impact of acquisitions.

Okay. That is fine. Again, going back just so I understand that, I guess I am a little confused around the disconnect around 4Q, where we saw considerable deceleration from your comments in November and December, yet your ability to still post a 6% top line number, and the disconnect between the 2 to 4% revenue guidance for next year, is it fair to say that it assumes a much further weakening from where you saw trends in November and December? Is it something that you are seeing in January that is worsening even from the November/December timeframe?

Ralph, it is Dave. We are not going to talk about January. What it assumes is, that there will be continuing impact on volume from economic conditions. Remember, in the first quarter deductibles reset for consumers, most of which were used up by the fourth quarter. There is a greater likelihood that people will go to the physician and the lab through their deductibles in my view, than there is when the new year starts, and their deductibles fully reset.

And also I would observe that if you remember last year in the first half volume growth was relatively slow. We were annualizing the impact of the loss of the Aetna contract. That gave us third quarter and fourth quarter looked better by year-over-year comparison, because in 2007 the Aetna contract, we had lost the contract in the third and fourth quarter, so we were starting off a lower volume base. As we look at the whole year trying to be realistic about what we think the expectation is for volume growth.

Okay. So just shifting to LabCorp 2010 cost initiatives, I think in the past you said you expected savings of at least 100 million net as we exited 2010, I guess first is that still the long-term goal? Second, I think you have also estimated that first year savings in kind of the $30 million range, and is that still the case for this year?

I think the long-term goal is still 100 million in annualized cost savings. It does assume that we will be able to get some get bad debt improvement in 2010. And if we don't get the bad debt improvement then number will be less than 100 million. But our goal is still $100 million in savings. In terms of the 2009 expectations, I think it will be less than what we originally guided to which was 35 million.

And a couple of reasons. One is, we aren't forecasting that we will get a bad debt reduction in 2009 as we originally thought we would, and some of it it is just timing of the execution of some of these initiatives. Our goal remains exiting 2010 with 100 million in annualized cost savings through facility rationalization, greater automation in the laboratories, improvement in IT and technology, and some reduction in bad debt.

Okay. Great. Thank you.

And your next question comes from the line of Adam Feinstein of Barclays Capital. Please proceed.

Thank you. Good morning, everyone. Maybe you mentioned, Bill had mentioned something about the WellPoint contract. I was curious if you could provide some more details, so you said you extended that through 2013? As I recall you had several different markets where you had contracts with them. Is this for the entire book of business? Only certain pieces of it? Could you give us more clarity there?

Yes. The contract originally was to expire in mid-2010. So we have now agreed on an extension through the middle of 2013. We are very pleased about the terms of the renewal, and without going into a lot of detail, it renews our status as WellPoint's sole national strategic partner, and it also extends our status as the sole national provider in all states where we are currently the sole national provider. Beyond that, I think it is in the best interest of us and our shareholders and of our managed care customers, that we not talk about details of the contract.

Sure. Okay. Understood. Then just maybe just I want to talk about the Esoteric testing side of the business. Clearly that is where most of the volume growth is coming from.

Wanted to get more thoughts in terms of what sort of feedback you are hearing? These tests obviously cost more. So with all of the concern about the economy, I guess I have been a little bit surprised in how strong the Esoteric testing has been. Just wanted to get any comments as you think about that?

I think part of it is that the Esoteric testing tends to be less discretionary, so there is anatomic pathology. There is our high endocrinology testing, that we do through endocrine sciences, that is for patients with chronic disease, who are being treated by endocrinologists, rhematology, specialized testing within rhematology for people who are being treated in that specialty area.

Yes, there tends to be more expense associated with Esoteric testing. But there also tends to be a less discretionary component. We will continue to focus on that strategy of sell to specialties where the testing tends to be less discretionary, as opposed to things like drugs of abuse, where we know that gaining volume is going to be extremely tough.

I also should comment that vitamin D is a significant driver of Esoteric growth. HPV is a significant driver of Esoteric growth. Those are tests that are in terms of overall pricing, we don't think of them as high price tests. So there is a lot of growth in the Esoteric line, that is not at, but is not far above our average company PPA.

Great. One more question here. I appreciate the details. On the bad debt side, I just wanted to get an update there. And you made some comments earlier, Dave, about maybe expectations you won't get the same improvement in 2009 that you guys were thinking several months ago.

My question just deals with you guys took the charge back after the second, or the second quarter, and curious as you have revisited the process around bad debt. You talked about a lot of initiatives back then. Just wanted to get an update in terms of how those initiatives are going, and any anecdotes that you can give us in terms of that bad debt issue?

Adam, this is Brad. I will give you an update on the initiatives. We will continue to work them very diligently, and we were pleased with our success through the second half of the year of 2008, but we need to keep going there. We were fully rolled out for the tools in our patient service centers, so we are monitoring how we are doing towards goals there.

And there still improvement that we can make, both in collecting cash from the uninsured, as well as collecting cash from those patients who we have seen before, who show up in our patient service centers, with an outstanding balance from a past transaction. We also rolled out credit card capture, where even for those patients who are insured, we are asking for a credit card swipe in case there is a balance due on that bill after the third party adjudicates it.

We have rolled out our patient discount program for certain tests, for patients who pay at the time of service in our patient service centers. So all of the tools are there inside of our patient service centers. Again, we monitor performance on a very frequent basis, and try to train and retrain to improve there. And again, there is room for improvement there. We are are paying the phlebotomists an incentive on the collection activities.

The next phase are our employees who sit in physician offices, we call them in-office phlebotomists, or IOPs. We are in the very early stages of rollout there, and one of the things that will enable us to pick up some steam in the first quarter on those initiatives, is the fact that we have to change one of our systems that they use, to enable them no access the tools, and that system change becomes effective in February. So that opens up an entire new population of LabCorp employees that we can use for collection efforts.

Total patients that we see through those two channels are roughly 40% of our volume. The other 60% we continue to work very hard in reviewing our ordering accounts, that send us work that ends up become patient bad debt specifically, and work through options that improve the outcomes there, through either directing those patients to our patient service centers, switching those accounts to physician bill or doctor office bill, and having them collect from the patient for that charge, and the client or doctor pays us.

And reviewing accounts for overall profitability if none of those things work and we have walked away from business as a result of those reviews. Those are the three big things that we continue to work towards. Again, just given the overall economic environment, and the situation in bad debt, pleased with our second half, but we need to press on because there is opportunity to do better.

Okay, thank you very much.

And your next question comes from the line of Arthur Henderson of Jefferies & Company. Please proceed.

Good morning. Couple of questions. On the revenue growth expectations of 2 to 4%, I know you had talked about better pricing on some of your contracts, Brad, could you break that down, just in terms of what the expectations are, and price in that number?

We really just give a total revenue guidance, and we don't typically provide the volume and price components of that guidance. But I do believe it will be more mix and revenue per requisition will obviously for the points that you raised, be significant contributors.

Okay. That is fair. Dave or Brad, I will just toss this out to either one of you. Bill was commenting about the uses of your free cash flow, and you talked about growth opportunities. With the growth that you are experiencing in the Esoteric side, is that an area that you are looking for more acquisitions or bigger acquisitions? What is your focus now, just in terms of what you want to do from an acquisition perspective?

Art, this is Dave.

Hey, Dave.

How you doing?

Good.

I think the focus will continue to be what it has been in terms of acquisitions, which is first we are always interested in expanding our Esoteric portfolio. We are interested in both laboratories, and also tests or technologies that they can help us bring more Esoteric testing to market.

Than the second thing we would look for in terms of acquisitions, is core acquisitions that would enhance our geographic positioning, that would bring us either new customer opportunities, or new infrastructure in markets where we historically have had less infrastructure. But clearly we are pleased with what we accomplished in the Esoteric testing area. That would be the first thing we would look for, as we allocate dollars toward acquisitions this year.

And does the economic environment, and your interest in maybe holding on to some more cash, I mean, does that maybe discourage you from doing what you would normally do, I guess is the best way to ask it?

I would say in terms of acquisitions, no. I am not telling you anything you don't know, and saying there are not a lot of big deals out there to be done. So I think we will be strategic about the deals that we decide to do, and we will be responsible about what we pay for them. I don't think the desire to potentially have a little bigger cash position is going to prevent us from doing anything we are going to do.

That is fair. One last question, and I will jump back in the queue. Obviously you did get some better reimbursement from Medicare and from some of your payors. As you look down the road to 2010 and beyond, given the economic environment, and pressures on different sorts of payors, what is your outlook, given all that has kind of happened in terms of reimbursement a little longer term than the share?

I think when you look at value that comes from clinical laboratory testing and you look at the average cost of an encounter with a laboratory, particularly the national laboratories, as opposed to encounters with other providers in the health care system, I continue to think that we are a tremendous bargain for the health care system.

We are 3% of the spend. We influence 80% of the decisions that are made in health care. The average encounter, our average encounter cost is somewhere in the range of between $40 and $50.

It is hard for me to see how anybody can get more value out of an encounter with the health care system, than patients get and payors get out of laboratory testing. Our view is we will be firm on pricing, we are not looking to gouge anybody. But we will be firm on pricing. We don't think we should be taking price reductions. And when we try in collaboration with the federal government, and with our managed care payors, and with our clients to maintain price integrity.

Okay. That is very helpful. Thank you very much.

Thank you.

And your next question comes from the line of Amanda Murphy of William Blair, please proceed.

Good morning. I want to dig into Esoteric testing a little further. It looks like sequentially there was a nice uptick in growth. Is there something in the fourth quarter that specifically drove that? Then I know you aren't giving guide in terms of volume. How should we think about that in terms of this year?

I don't think there was anything in particular in the fourth quarter that drove it, other than the continuation and maybe continuing to come to fruition of the strategy that we talked about in February and March of really focusing our sales effort on physicians who are ordering less discretionary testing. We did continue to have strong improvement in some Esoteric tests, as I mentioned, vitamin D, HPV, K-Ras, some others, that we are starting to see some momentum with.

In terms of, I think, Amanda, that if I am remembering the numbers right, Esoteric testing sequentially was up about 9.5% in the third quarter, about 13.5 in the fourth quarter. So we are seeing nice sequential growth as a result of our sales strategy, and as a result of continuing to bring new Esoteric testing offerings to the market. Our goal is to continue to see Esoteric testing growth be stronger than growth in the core business.

The core business is a little bit, it is a little bit underrepresented because the decline in drugs of abuse testing, which pulls down the core, that goes in the core so it pull downs the core volumes. But our goal and our expectations is in 2009 that we will continue to see this growth in Esoteric testing, and the fruition of our targeted marketing and sales efforts, toward physicians who are ordering less discretionary testing.

Also on the core business, pricing was up as well. Is that primarily the United contract escalators. Is there something else too, that drove that?

Amanda, this is Brad. I think that is definitely a driver. Another driver as Dave mentioned, is the volume in the drugs of abuse testing is down. That will also raise that core price from the loss of that lower priced business.

One last question on the Medicare revenue adjustment. Could you just provide background on that, and maybe which segment it was in, and if that is a fourth quarter event, or something that will be continuing?

Amanda, it is Dave. Just because of the nature of it, we aren't going to provide a lot of detail. It occurred over a period of about five years. It came to us from a company that we acquired, so it is not a fourth quarter event in and of itself, and it is something that as part of our periodic reviews, we identified and self-reported to Medicare, and simply recognized what we think is the amount by which we were overpaid over that five-year time span.

Okay, thank you.

And your next question comes from the line of Ricky Goldwasser of UBS, please proceed.

Good morning.

Good morning.

Can you talk a little bit about historically you had exposure to regions with direct physician billing, and if you can give us a little bit more color, with what you are seeing with your interaction direct with the physicians? Are you seeing more pushback? Are physicians looking for more discounts, at a time that the volumes are actually going down, which could have an impact on your margin. And I know also historically you used to introduce a price increase to the physicians and patients around the fourth quarter. Did you do it this year, and if so what was the feedback?

Ricky, this is Brad. First of all, we don't typically do a price increase to our patient line. So I think what you are referring to is the typical direct to physician and other client billing, where we have an annual process, where we go in and adjust prices. And that has continued to take place, and continues to take place. As Dave mentioned in his comments earlier, pricing is something that we are very focused on, and getting appropriate pricing is something from that payor population as well that we were focused on.

I would say the experience in '08 was no different in '07, in terms of how that is received and applied, and what ends up actually happening in that process. Again, it has always been fairly competitive in that market, and it continues to be. I don't think it is any more or less competitive than in the past. I hope that answers your question.

Well, I guess when you say it is not different, I guess a direct question is, were you able to raise prices on your physician and direct clients? And then second of all, I guess it is under the same kind of line. Are you seeing more pushback from the physicians who are coming back to you and saying, our volumes are down, we need to get greater discounts from you.

Yes, we were able to receive increases, and no, we haven't seen pushback any different than we have seen in the past.

Okay. And in terms of the slowdown in volume, are you seeing it being more pronounced in one geography over the other?

Well, I am not sure about the premise of the slowdown in volume. What I would say is in terms of overall economic impact, we haven't seen any geographic differentiation. In terms of the things that we look at, so in the fourth quarter we didn't, to answer the question in a way I think that is an appropriate way to answer it, if you think about fourth quarter volume improving by about 3%, we didn't see 8% one place, and then negative 5% someplace else. We saw generally consistent behavior around the country. Similarly with collections, similarly with all of the metrics that we monitor.

And the way we should think about your '09 guidance and volumes, that the volume assumptions imbedded into the '09 guidance, is that also consistent across geographies? Or do you expect some geographies to come under more relative pressure than others?

Again, when we give guidance, our guidance is an aggregate of everything that we think is likely to happen, in attempts to encompass a broad range of outcomes. We don't, and I think it would be very difficult to model that it is going to be worse here or better here. What we do is we look at what our expectations are across the country. And those are the expectations that get rolled into the guidance .

And your next question comes from the line of Shelley Gnall of Goldman Sachs. Please proceed.

Thank you. Quick question on wondering if you had a look at the impact on the industry, from either the COBRA subsidy program we have heard proposed from Congress, or SCHIP expansion, and whether any of that upside is embedded in your guidance?

I think when we give guidance we attempt to give a broad range of outcomes. So it is very difficult to try to slice and dice the guidance by particular assumptions within a very large number of moving parts. I don't think that SCHIP expansion, which is largely children's health programs, has a major impact on us. I mean, I don't have the number off the top of my head. The pediatric component of the laboratory industry doesn't, particularly within the Medicaid population, doesn't move the needle a lot for us.

With respect to the COBRA issue, I am not sure how the expansion of COBRA would impact us. Obviously capping the number of uninsured patients, and giving them some access to health insurance, would be a positive for us. It is not clear to me how that's going to be paid for, because typically within COBRA, although the employee or the former employee pays the premium, the former employer is responsible for the actual medical costs.

And so there could be a fairly significant amount of pushback, if the former employers of people, think that they are going to have a tremendous amount of increased medical costs as a result of expansion of COBRA. I think it is too early to tell what the impact of that would be, other than clearly more patients having some sort of insurance coverage is better for our industry, than fewer patients having insurance.

Great. Thank you. Then a quick follow-up on a comment that was made earlier on fuel expense. As we look at fuel costs from here, I think the likelihood is that gas prices could probably rise rather than fall from this level. So could you update us with your views on hedging strategies, maybe what other elements of your operating costs could be hedged, and your thoughts on using hedges in this environment?

Our fuel expense, Shelly, is not big enough to merit hedging strategies. And the concern about hedging strategies if you look at the airlines, is that a lot of them lost a lot of money on the hedges that they made last summer. To us the potential downside of hedging a component of expense that is not that great for us in the total expense base, is probably greater than the upside.

Okay. Great. Thanks.

And I guess I would say in terms of other expenses, there is not anything really in our expense line, that is big enough to employ hedging strategies.

Great. Understood. Thanks.

And your next question comes from the line of David MacDonald of SunTrust. Please proceed.

Good morning, guys. Guys, just wanted to try to drill down on the drugs of abuse and touch more. It sounded like it got uglier during the quarter. When we look at the 16%, looking at the 10.3 in Q3, is it fair to think about coming into the quarter, or actually more importantly exiting the quarter closer to a down 20% year-over-year number in December? Is that pretty close to what we should think about as we head into 2009?

I think it is not really wise of us to try to break out things like volume month by month, Dave.

Is it it fair to say that December was noticeably worse than October?

It absolutely got worse through the quarter, and it got worse in November and December as we have said. And I don't think as we think of 2009 that our expectation is that it will get better.

If you just kind of do the math and the 140 basis point dragnet fourth quarter and if you look at the compares year-over-year, we should think about it being probably in the neighborhood of a 1% drag in 2009, is that fair?

Again, I would reiterate that the guidance that we give incorporates a broad range of outcomes, and within that guidance there are a large number of moving parts. I think it would be unwise of us to start trying to breaking down the moving parts. Obviously you can make assumptions in your thinking about what the drugs of abuse drag will be. I am going to limit myself to the comment that it did get worse in November and December. It clearly got worse sequentially throughout 2008, and we don't think it will get better in 2009.

Okay. Thanks very much.

And your next question comes from the line of Darren Lehrich of Deutsche Banc, please proceed.

Good morning, everyone. I have three questions. The first one just relates to a lot of the discussion you have made around automation, and some of the initiatives you have in the lab. And I guess my question is at a high level what productivity measures would you focus us on, as you continue to roll out some of these automation and productivity initiatives?

I think the productivity measures that we would look at are things like, total personnel expense in the pre-analytical process compared to volume. We would think about things like supply costs per test, as compared to increases in volumes. So the whole idea of automation is that we will be able to reduce the amount of labor, and that we will also be able to reduce the amount of things like short runs and supply wastes and repeated runs.

So those are a couple of the metrics that would be the things that we would think about. The things that you would see it in are improvement in, probably the most obvious place you would see it, is improvement in gross margin. And that would be the goal because within the cost of goods sold is the laboratory labor and the laboratory supply expense.

Right. And I know you consolidated some locations. Can you just update us on the plan over the next couple of years, with regard to lab facility consolidations. There is any more left there?

We are continuing to look at rationalization of facilities. We think there are still some opportunities, and as we firm up which opportunities we are going to take advantage of, and in what order, we will give you further information on that.

Okay. And my other question is on Medicaid, and I know that it is a relatively small portion of your mix. Obviously a lot of new dollars floating into Medicaid and SCHIP expansion. Could you just talk a little bit about your Medicaid economics and rate structure, and maybe just give us a sense for what the Medicaid business looks like right now?

Medicaid pays off a fee schedule like Medicare. So the rate structure is largely determined by the individual states, and what fee schedules they pay from. We don't break out the profitability of specific business within our mix. So I can't really comment on that.

In terms of the state of the Medicaid business, state governments are under a tremendous amount of pressure. Periodically state governments announce they are cutting Medicaid reimbursement for all payors. We aren't immune to that. Periodically state governments announce that they have run out of money to pay for Medicaid this year, so they will defer payment until next year. We are not immune to that.

I don't think we are any differently positioned from any other provider, in terms of where we are with Medicaid. And obviously we do our best to serve that population, and to make our services accessible to that population, just as we do for all other populations.

Okay. The last question here, as it relates to the WellPoint contract extension, how many intervals will you be able to get rate updates during that timeframe? It goes out to 2013, you said.

Other than the comments that that I made to Adam's question, and reiterated that we are very pleased with the terms of the contractual extension, we are not going to talk in any more detail about the contract terms.

Okay. I tried. Thanks again.

Thank you.

And your next question is a follow-up question from the line of Robert Willoughby of Banc of America. Please proceed.

Dave or Brad, are some of the fiscal difficulties the states are experiencing, you commented briefly on Medicaid, but are there any issue of reimbursement challenges for paternity, forensic, any of the other areas that the states are involved with?

Bob, it is Dave. Not that I am aware of. Those generally tend to be a couple of things. Particularly for the paternity and for the paternity testing, those tend to be contracted arrangements with the states. And there again my understanding there are various state and federal initiatives around the collection and payment of support, that really make it extremely important that the states maintain paternity testing so that they just don't stop it.

In terms of forensics, I think we are actually seeing states that are quite far behind on forensic testing, trying to outsource some of it. Just because the staffing challenges that they are having are making it difficult to keep up with the volume of forensic testing, and the need to move their cases through the criminal justice system. I am not aware that we have seen anything on that. And obviously it is something that we will look at, but we haven't seen anything to date that I know about.

No receivables challenge whatsoever?

No.

Great. Thank you.

There are no further questions at this time. I would now like to turn the call back to you, gentlemen, for closing remark.

Thank you very much. We appreciate your listening to our call today.

Thank you for your participation in today's conference, this concludes the presentation. You may now disconnect. Have a great day.