Laboratory Corporation of America Holdings Q4 2008 Earnings Call Transcript

Feb.12.09 | About: Laboratory Corporation (LH)

Laboratory Corporation of America Holdings (NYSE:LH)

Q4 2008 Earnings Call

February 12, 2009 09:00 AM ET

Executives

David P. King - President and Chief Executive Officer

Bill Bonello - Investor Relations

William B. Hayes - Executive Vice President, Chief Financial Officer and Treasurer

Analysts

David Claire - Piper Jaffray

Bob Willoughby - Banc of America Securities, LLC

Ralph Giccobbe - Credit-Suisse

Adam Feinstein - Barclays Capital

Arthur Henderson - Jefferies & Co., Inc.

Amanda Murphy - William Blair & Co.

Ricky Goldwasser - UBS Securities, LLC

Shelley Gnall - Goldman Sachs

David MacDonald - SunTrust Robinson Humphrey Capital Markets

Darren Lehrich - Deutsche Bank

Operator

Good day ladies and gentlemen. And 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 this conference. (Operator Instructions).

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

David P. King

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 growth drivers and provide the answers to several frequently ask questions.

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

Bill Bonello

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. Analyst and investors are directed to this 8-K and our website to review this supplemental information.

Additional we refer you 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 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 2007 10-K and subsequent fillings.

Now, Brad Hayes will review our financial results.

William B. Hayes

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'll discuss four key measures of our financial performance; Cash flow, revenue growth, margin and liquidity.

First, cash flow: Our cash flow trends remain excellent. Free cash flow for the year increased 10.1% to $624.2 million, net of $42.3 million in transition payments to UnitedHealthcare, compared to $567.1 in 2007.

We're 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 2 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 payments 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 its defined benefit retirement plan during 2009, based upon the underlying value of planned 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 discuses excludes the impact from consolidation of our Ontario, Canada joint venture and the 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 U.S. volume growth by a 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 through 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 payers 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're 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 its 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.

David P. King

Thank you, Brad. I would like to highlight some of the initiatives that 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 will remain focused on growing our esoteric testing platform, expanding our outcome improvement programs and developing and commercializing companion diagnostics.

We are also optimistic about our ability to reduce fixed cost through facility rationalization and introducing robotics to automate front-end solutions.

Let me discus 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 physicians as referral patterns maybe 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 testament to the success of this strategy.

On the pricing front, we are receiving rate increases from both Medicare and large commercial payers. 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 additional supply cost savings. We are also keeping a tight lid on discretionary costs such as consulting and travel. All of these efforts will be 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 you us towards 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's worth reiterating 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 medical needs. We will also continue our important collaborations with academic institutions such as Duke University and Yale University to help us in identifying and commercializing new and innovative tests.

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

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, payers, 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 are 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 access 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 use by physicians to identify whether a drug is safe and effective for a specific individual.

On the margin front, overtime we believe there is an opportunity to reduce our fixed cost base through automation and capacity rationalization. We are beginning to rollout 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 it.

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

Bill Bonello

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 remain committed to returning value to our shareholders; 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 own shares. During 2008, the company repurchased $330.4 million worth of stock representing approximately 4.6 million shares. Approximately $95.4 million of repurchase 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'd like to turn the call back over to Dave.

David P. King

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 not ready to take your questions.

Question-and-Answer Session

Operator

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

David Claire - Piper Jaffray

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

David King

Thank you.

David Claire - Piper Jaffray

I was just hoping you could give us some color on pricing in Canada. Looks like we saw another sequential decline there.

William Hayes

That is a... this is Brad Hayes Dave. That's 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's not a negotiated price decrease if you will.

David Claire - Piper Jaffray

Okay. Great and given the...

William Hayes

Dave, one other thing. Also the exchange rate in the fourth quarter is going to have a negative impact on that metric as well.

David Claire - Piper Jaffray

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

David King

It's Dave, Dave. I would just comment that, we use the Dia-Stron (ph) method for vitamin D which is the FDA cleared and approved method. And I think overtime, our decision to continue to use that method will pay us benefits in terms of the appropriateness and validity of our testing results. And beyond that I really don't think it's appropriate to comment.

David Claire - Piper Jaffray

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

William Hayes

David, 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, little bit of positives impact going forward, but certainly not to the extent that you saw in the fourth quarter.

David Claire - Piper Jaffray

Okay, great. Thanks a lot guys.

Operator

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

Bob Willoughby - Banc of America Securities, LLC

Thanks. First, I think I'd say that I didn't think that Bill Bonello could speak anymore on a conference call. But I think you proved me wrong. But, welcome aboard, Bill.

David King

Now you say, Bob. It's Dave, Bob. Now he is already waiting again (ph) to speak first every time.

Bob Willoughby - Banc of America Securities, LLC

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

David King

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

But the drugs-of-abuse testing, obviously from what we have told you declined pretty dramatically in the fourth quarter and we're certainly not forecasting that we're going to see any improvement in that for the balance for the year. So, in terms of what we've done to improve overall forecasting, and we're continually working to improve our overall forecasting capabilities.

I will say that the pace of the 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 healthcare is something that we haven't seen before. So we're 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've set out.

Bob Willoughby - Banc of America Securities, LLC

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

David King

No, I think we have very good access to real time information about our business. I think what we don't have is same thing that no body else has which is the ability to see what is going to happen in the overall environment. So, last summer gas prices were $4 now they are $1.80. And we don't have any ability to see where they are going to go between now and end of the year. And that 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 or they not going 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. So there is... we have very good access to real-time information about what's going in 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's going to mean to the consumer.

Bob Willoughby - Banc of America Securities, LLC

Okay. Thank you.

Operator

And your next question comes from the line of Ralph Giccobbe of Credit-Suisse. Please proceed.

Ralph Giccobbe - Credit-Suisse

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

William Hayes

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 have been more on a small basis and not something that we needed to callout. So they are definitely a contributor as they have been in the past. And it's just not something that we breakout.

Ralph Giccobbe - Credit-Suisse

Okay. But we shouldn't think of it as significant to that 6.2 we should think that 6.2 is roughly organic, is that the way you will consider that number?

William Hayes

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

Ralph Giccobbe - Credit-Suisse

Okay, that's fine. And then again just going back, just so I understand, I guess I'm still a little confused around sort of the disconnect between 4Q where we surely saw a considerable deceleration from your comments in November, December, your ability to still post 6% top-line number. And the disconnect between the sort of 2 to 4% revenue guidance for next year, does that... I mean is it fair to say that it assumes a much further weakening from where you saw trends in November and December? And is it something you're seeing in January that's worsening even from the November, December time frame?

David King

Ralph, it's Dave. We're not going to talk about January. What it assumes is that there will be... 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. So there is a greater likelihood that people are going to the physician and the lab when they are through their deductibles.

In my view it 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 annualized in the impact of the lost of the Aetna contract...

Ralph Giccobbe - Credit-Suisse

Right.

David King

That gave us... third quarter and fourth quarter look better by year-over-year comparison because in 2007 the Aetna contract had... we had lost the Aetna contract in the third quarter and fourth quarter. So we were starting off a lower volume base. So if we look at the whole year, trying to be realistic about where we think the expectation is for volume growth.

Ralph Giccobbe - Credit-Suisse

Okay. And then just sort of shift to LabCorp 2010 cost initiatives, I think in the past you said that you accepted savings of at least, $100 million net as we exited 2010. I guess, first is that still the long-term goal. And then second, I think you've also estimated that first year savings in kind of $30 million range and is that still the case for this year?

David King

I think the long-term goal is still a 100 million in annualized cost savings. It does assume that we will be able to get some bad-debt improvement in 2010. And that if we don't get the bad-debt improvement than the numbers is going to be less than 100 million. But our goal is still the 100 million in savings.

In terms of the 2009 expectations, I think its going to be less than what we originally guided to which was 35 million. And couple of reasons; one is, we're not going to get a bad debt... we're not forecasting that we're going to get a bad-debt reduction in 2009 as we originally thought we would. And some of it is just timing of the execution of the some these initiatives.

But our goal remains exiting 2010 with a 100 million in annualized cost savings through facility rationalization, greater automation in the laboratories, improvements in IT and technology and some reduction in bad debt.

Ralph Giccobbe - Credit-Suisse

Okay. Great. Thank you.

David King

Thank you.

Operator

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

Adam Feinstein - Barclays Capital

Hey, thank you. Good morning everyone. Just maybe, you'd mentioned, Bill you mentioned something about the WellPoint contract. We're just curios if you could just provide some more details? So you said you extended that to 2013. As I recall, you had several different markets where you had contracts with them. So, is this for the entire booked business or only certain pieces of it? Could you just give us a little bit more clarity there?

Bill Bonello

Yes. The contract was originally was to expire in mid 2010. So, we've now agreed on an extension to the middle of 2013. We're 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's in the best interest of us and our shareholders and of our managed care customers that we now talk about details of the contract.

Adam Feinstein - Barclays Capital

Sure. Okay, all right, understood, All right. And then, just maybe... just, when I talk about the esoteric testing side of the business. Clearly, that's where most of the volume growth is coming from. Just, I wanted to get some more thoughts in terms of what's your feedback you are hearing. These tests obviously cost more. So with all the concern about the economy, I guess, I've just been a little bit surprise, how strong the esoteric testing has been. I just want to get any comments as you think about that?

David King

I think part of it is that the esoteric testing tends to be less discretionary, so there is anatomic pathology, there is our high-end endocrinology testing that we do through Endocrine Sciences, that's for patients with chronic disease or who are being treated by endocrinologist; rheumatology, specialized testing with rheumatology for people who are being treated by... in that specialty area.

So, yes there tends to be more expense associated with esoteric testing. But there also tends to be I think a less discretionary component. And that... we are going to 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 priced test. And so there is a lot of growth in the esoteric line that is not add but is not far above our average company PPA.

Adam Feinstein - Barclays Capital

Okay great. And just one more question here. I appreciate the details. Just then, on the bad debt side I just wanted to get an update there and you had made some comments there earlier, Dave above may be expectations, or you won't get the same improvement in 2009, that you guys were thinking several months ago. But just, my question just deals with that you guys took the charge back after the second quarter. Just curious as you have revisited process around that debt, you've talked about lot of initiatives back then, just wondered again in terms of how some of those initiatives are going and in any anecdotes that you can may be give us is terms of managing through that the bad debt issue?

William Hayes

Hey Adam this is Brad.

Adam Feinstein - Barclays Capital

Hey, Brad.

William Hayes

I will give you an update on the initiatives. I mean we continue work then very diligently and we are pleased with our success through the first half... or the second half of the year I should say of 2008 but we need to keep going there. I mean we're fully rolled out for the tools in our patient service centers.

So we are monitoring how we're doing towards goals there and there is still improvement that we can make, both in collecting cash from the uninsured as well as collecting cash from those patients who we've seen before, who show up in our patient service centers with an outstanding balance from the past transaction.

We've 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've 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 the tools are there inside of our patient service centers. Again we monitor their 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 also paying them (ph) incentive on the collection activities.

The next phase is our employees who are senior physician officers, we call them in-office provider or IOPs. In a very early stages of roll out there. And one of the things that's going to 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 to 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. So again, 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 are ordering accounts that send us work that ends up becoming patient bad debt specifically.

And work through options to improve the outcomes there, through either directing those patients to our patients' service centers, switching those accounts to physician bill or doctor office bill and having then collect from the patient where they charge in the client, while 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. So those are the three big things that we continue to work towards. And again just given the overall economic environment and the situation in bad debt I'm pleased with our second half, but we need to press on because there is opportunity to do better.

Adam Feinstein - Barclays Capital

Okay thank you very much.

Operator

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

Arthur Henderson - Jefferies & Co., Inc.

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

William Hayes

Art, we really just give total revenue guidance and we don't typically provide the volume and price components of that guidance.

Arthur Henderson - Jefferies & Co., Inc.

Okay.

William Hayes

But I do believe that we'll be more mix and revenue per acquisition will obviously for the points that you raised be significant contributors.

Arthur Henderson - Jefferies & Co., Inc.

Okay, okay, that's fair. And then Dave or Brad I'll just toss this up to you, either one of you. I know that Bill was commenting the uses of your free cash flow and you talked about growth opportunities. With the growth that you are experiencing in the esoteric side, I mean is that an area that you are looking for more acquisitions or bigger acquisitions or what is your focus now just in terms of what you want to do from an acquisition perspective?

David King

Art, it's Dave.

Arthur Henderson - Jefferies & Co., Inc.

Hi, Dave.

David King

How you doing?

Arthur Henderson - Jefferies & Co., Inc.

Good.

David King

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

Than the second thing that 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're pleased with what we've accomplished in the esoteric testing area and that would be the first thing we would look for as we allocate dollars towards acquisitions this year.

Arthur Henderson - Jefferies & Co., Inc.

And, does the economic environment and your sort of 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.

David King

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. And so, I think we're going to be strategic about the deals that we decide to do and about... and we're going to be responsible about what we pay for them. But I don't think that the desire to potentially have a little bigger cash position is going to prevent us from doing things that we want to do.

Arthur Henderson - Jefferies & Co., Inc.

Okay. That's fair. One last question and I'll jump back in the queue. Obviously, you did get some better reimbursement from Medicare and some of you payers, but as you look down the road, 2010 and beyond, given the economic environment and pressures on different sorts of payers, what's your outlook, given all that's kind of happened in terms of reimbursement, a little bit longer term than this year?

I think that, when you look at the 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 healthcare system. I continue to think that we are a tremendous bargain for the healthcare system. We're 3% of the spend, we influence 80% of the decisions that are made in healthcare, the average encounter... our average encounter cost is somewhere in the range of between 40 and $50.

It's for me to see how anybody could get more value out of an encounter with the healthcare system than patients get and payers get out of laboratory testing.

So, our view is, we'll be firm on pricing. We're not looking to gauge anybody, but we are going to be firm on pricing, we don't think we should be taking price reductions. And we're going to try in collaboration with the Federal government and with our manage care payers, and with our clients to maintain price integrity.

Arthur Henderson - Jefferies & Co., Inc.

Okay. That's very helpful. Thank you very much.

David King

Thank you.

Operator

And your next question comes from line of Amanda Murphy of William Blair. Please proceed.

Amanda Murphy - William Blair & Co.

Hi, good morning. I just wanted to dig into esoteric testing a little further. It was like sequentially there was a nice uptake in growth. Is there something in the fourth quarter that specifically drove that?

And then, I know you are not giving guidance and throughput volumes, but how should we think about that in this year?

David King

I think... I don't think there was anything in particular in the fourth quarter that drove with other than the continuation and maybe continuing to come to fruition of the strategy that we talked about, that we started back in February, 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 test, as I mentioned, vitamin D, HPV, K-ras some others that we're starting to see some momentum with. In terms of... and I think Amanda that, if I'm 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're 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; remember the core business is a little bit... it's a little bit under represented because the decline in drugs-of-abuse testing which pulls down the core actors in the course, it pull downs the core volumes. But our goal is and our expectation is in 2009 that we're going to continue to see this growth in esoteric testing and fruition of our targeted marketing and sales effort toward physicians who are ordering less discretionary testing.

Amanda Murphy - William Blair & Co.

Okay. And then also on the core business, it looks like pricing was up as well. Is that primarily the United contract escalators or is there something out there that drove that?

William Hayes

Amanda, this is Brad. I think that is a definitely a driver. Another driver, as Dave mentioned is the volume in the drugs-of-abuse testing is down. So...

Amanda Murphy - William Blair & Co.

Right.

William Hayes

That's going to also raise that core price from the loss of that lower priced business.

Amanda Murphy - William Blair & Co.

Okay, one last question on the Medicare revenue adjustment. Could you just provide some background on that, and maybe which segment it was in and is that a fourth quarter event or is something that's going to be continuing?

David King

Amanda, it's Dave. Just because of the nature of it, we are not 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 itself, and it's 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 over paid over that five year time span.

Amanda Murphy - William Blair & Co.

Okay. Thank you.

Operator

And your next question come the line of Ricky Goldwasser of UBS. Please proceed.

Ricky Goldwasser - UBS Securities, LLC

Good morning.

David King

Good morning.

Ricky Goldwasser - UBS Securities, LLC

Can you talk a little bit about, now obviously, historically you had extend... exposure to regions with direct physician billing. And, if you can give us a little bit more color on what you are seeing with your interaction direct with the physicians, are you seeing more pushback and if physicians are looking for more discount? At a time that volumes are actually slowing down which could have an impact on your margins.

And then also that historically you used to introduce the price increase to the physicians and patients around the fourth quarter. Did you do it this year and if so, how, what was the feedback?

William Hayes

Ricky this is Brad. First of all we don't typically do a price increase to our patient line. So I think what you're referring to is the typical direct-to-physician and another client billing, where we do 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're very focused on and getting appropriate pricing is something from that payer population as well, that we're focused on. I will say the experience in '08 was no different than in '07 in terms of how that's received and applied and what ends up actually happening in that process. And again, it's always been a fairly competitive in that market, it continues to be... I don't think it's anymore or less competitive than in the past.

I hope that answers your question?

Ricky Goldwasser - UBS Securities, LLC

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

William Hayes

Yes we were... yes we were able to receive increases. And no, we haven't seen push backs any different that we've seen in the past.

Ricky Goldwasser - UBS Securities, LLC

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

David King

Well, I am not sure about the premise of the slowdown in volumes. So 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 the way that I think 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 negative 5% someplace else. We saw generally consistent behavior around the country, similarly with collections, yes, similarly with all of the metrics that we monitor.

Ricky Goldwasser - UBS Securities, LLC

So when the way... and the way you should... that we should think about your '09 guidance and if volumes did, the volume assumptions embedded into the '09 guidance. Is that also consistent across geographies or do you expect some geographies to come under more relative pressure than others?

David King

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

Operator

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

Shelley Gnall - Goldman Sachs

Great, thank you. Quick question, I am wondering if you've had a look at the impact on the industry from either of the corporate subsidy program, which was proposed by Congress or SCHIP expansion. And whether any of that upside is embedded in your guidance?

David King

I think when we give guidance, we attempt to give a broad range of outcomes. And so it's 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 program's had a major impact on us. I mean, I don't have the number of the top of my head but the pediatric component of the laboratory industry doesn't... particularly within the Medicaid population doesn't move the needle on that a lot for us.

And with respect to the COBRA issue, I'm 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 not clear to me, how that's going to be paid for because typically within COBRA, although the employee or the former employees pays the premium, the former employer is responsible for the actual medical costs and so there could be a fairly significant amount of push back if the former employers, if people think that they are going to have a tremendous amount of increased medical costs as a result of expansion of COBRA. So I think it's 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.

Shelley Gnall - Goldman Sachs

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

David King

Our fuel expense, Shelley is not big enough to mirror (ph) 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. So 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.

Shelley Gnall - Goldman Sachs

Okay, thanks.

David King

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

Shelley Gnall - Goldman Sachs

Okay. Great, understood. Thanks.

Operator

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

David MacDonald - SunTrust Robinson Humphrey Capital Markets

Good morning guys. Hi, guys just wanted to try to drill down on the drugs-of-abuse a touch more. It sounded like it got uglier during the quarter. And so, when we look at 16% is it fair, I mean looking at 10/3 (ph) in Q3 is it fair to think about coming into the quarter or actually more importantly exiting the quarter closure 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?

David King

I think it's not really wise of us to try to breakout, things like volume month-by-month, Dave, I am not trying to be...

David MacDonald - SunTrust Robinson Humphrey Capital Markets

Dave, is it fair to say, December was noticeably worse than October?

David King

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 about 2009 that our expectation is that it's going to get better.

David MacDonald - SunTrust Robinson Humphrey Capital Markets

Perhaps, if you look at... if you just kind do the math, I mean 140 basis point drag in the 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?

David King

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. So, I think it would be unwise of us to start trying to breakdown the moving parts. Obviously, you can make assumptions in your thinking about what the drugs-of-abuse drag going to be. I 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 its going to get better in 2009.

David MacDonald - SunTrust Robinson Humphrey Capital Markets

Okay. Thanks very much.

Operator

And your next question comes from the line of Darren Lehrich of Deutsche Bank. Please proceed.

Darren Lehrich - Deutsche Bank

Thanks. Good morning everyone. I have three questions. The first one just relates to a lot of the discussion you've 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.

David King

I think the productivity measures that we would look at are things like total personal expense in the pre-analytical process compared to volume. We would think about things like supply costs per test as compared to increases in volume. 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 couple of the metrics I think that would probably 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 of... because that, within the cost of good sold is the laboratory labor and the laboratory supply expense.

Darren Lehrich - Deutsche Bank

Great. And, I know you've consolidated some locations. Can you just update us on the plan over the next couple of years with regard to lab facility consolidation? Is there any more labs there?

David King

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

Darren Lehrich - Deutsche Bank

Okay. My other question is on Medicaid and I know that, that's a relatively small portion of your mix. But obviously, lots of new dollars floating in to 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?

David King

Medicaid pays off a fees schedule like Medicare. And 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. And so I can't really comment on that.

In terms of the state of the Medicaid business, state governments are under a tremendous amount pressure. And periodically state governments announce that they're cutting Medicaid reimbursement for all players, we are not immune to that. Periodically state governments announce that they have run out of money to pay for Medicaid this year and so they're going to defer payment until next year, we're not immune to that.

I don't think we're 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.

Darren Lehrich - Deutsche Bank

All right okay. And then the last question here just as it relates to the WellPoint contract extension. How many intervals would you be able to get upgrade... updates during that time-frame, I guess it goes out to 2013 you said?

David King

Yeah, other than the comments that I made to in response to Adam's question and other than reiterating that we're very pleased with the terms of the contractual extension, we're not going to talk in any more detail about the contract terms.

Darren Lehrich - Deutsche Bank

Okay I tried. Thanks again.

David King

Thank you.

Operator

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

Bob Willoughby - Banc of America Securities, LLC

Hey Dave or Brad, are some of the fiscal difficulties the states are experiencing, you commented I think briefly on Medicaid but are there any issues in terms of reimbursement challenges for fraternity (ph), forensic, any of the other areas that the states are involved with.

David King

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

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

Bob Willoughby - Banc of America Securities, LLC

No, receivables challenge, what so ever?

David King

No.

Bob Willoughby - Banc of America Securities, LLC

Great, thank you.

Operator

And there are no further questions at this time. I would now like to turn the call back to you gentlemen for closing remarks.

David King

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

Operator

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

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