Labcorp Holdings Inc. (LH) Q2 2010 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2010 Laboratory Corporation of America Earnings Conference Call. My name is Crystal and I will be your operator for today. [Operator Instructions] I would now like to turn the conference over to your host for today, Mr. David P. King, Chairman and CEO of LabCorp. Please proceed.

Thank you. Good morning, and welcome to LabCorp's 2010 Second Quarter 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 Steve Anderson, Vice President, Investor Relations. This morning, we will discuss our second quarter 2010 results, highlight a few of our strategic initiatives and provide answers to several frequently asked questions. I'd now like to turn the call over to Steve Anderson, who has a few comments before we begin.

Before we get started, I would like to point out that there will be a replay of this conference call available via the telephone and Internet. Please refer to today's press release for replay information. This morning, the company filed a Form 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 we are making forward-looking statements during this conference call, and these statements are based upon current expectations and are subject to change, including based upon various important factors that could affect the company's financial results. Some of these factors are set forth in detail in our 2009 10-K and subsequent filings. The company has no obligation to provide any updates to these forward-looking statements, even if our expectations change. Now, Brad Hayes will review our financial results.

Thank you, Steve. By now, you should've had a chance to review our second quarter 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 remain excellent. Free cash flow for the trailing 12 months ended June 30, 2010 increased 19.6% to $800 million compared to $668.8 million in 2009, in each case, net of transition payments to UnitedHealthcare. We were extremely pleased with our cash collections. DSO improved five days year-over-year to 45 days at the end of June. As a result of our continued success in cash collections, we reduced our bad debt rate by 25 basis points to 4.8%. We're very proud of the LabCorp employees who have made this success possible through their diligent focus on getting paid for the services we provide. Second, revenue growth. Revenue increased 4.2% year-over-year in the second quarter. During the quarter, we achieved strong growth in revenue per requisition, which increased 6.3% of year-over-year. The growth in revenue per requisition is attributable to mix shift, increases in test per requisition and rate increases. The revenue growth per requisition was also impacted by the Canadian exchange rate, Monogram and the lost government contracts, which together, improved revenue per requisition by 3.3%. Total company volume decreased 2% year-over-year. Excluding Canada, volume decreased 2.1% year-over-year. The termination of two large government contracts at the end of the second quarter of 2009 reduced volume by 2.4%. Excluding the lost contracts, volume increased by approximately 0.3% in the quarter. Esoteric volume increased 4.9% in the quarter. Third, margin. For the second quarter, our operating income margin was 21.8%. This margin increased 40 basis points year-over-year due to reductions in bad debt expense and operational improvements. Margin expansion was hindered by costs associated with recent transactions and acquired assets that are not yet integrated. Fourth, liquidity. We remain well-capitalized. At the end of June, we had cash of $103.8 million and approximately $430 million available under our revolving line of credit. At the end of June, total debt was $1.3 billion, including $30 million drawn down on our revolving credit facility. During the quarter, we repurchased $116 million of stock, representing approximately 1.5 million shares. At the end of June, approximately $100.1 million of repurchase authorization remained under our previously approved share repurchase program. This morning, we updated our 2010 financial guidance. We expect revenue growth of 4.5% to 5.5% compared to previous guidance of 2.5% to 4.5%, adjusted EPS in the range of $5.40 to $5.55 compared to prior guidance of $5.35 to $5.55, excluding the impact of any share repurchase activity after June 30, 2010, operating cash flow of approximately $870 million, excluding any transition payments made to UnitedHealthcare and capital expenditures of approximately $135 million. Finally, while we do not provide quarterly guidance, we want to remind you that the fourth quarter is always our softest quarter from a top line and earnings perspective due to the impact of the holiday season on volumes. I'll now turn the call over to Dave.

Thank you, Brad. We were very pleased with our second quarter results. Despite continued challenging economic conditions, we grew revenue by 4.2% in the quarter. We also grew Esoteric revenue by approximately 5%. Revenue per requisition remains strong, increasing 6.3%. Taking into account the previously lost contracts, volume increased by approximately 0.3%. And we generated operating margin expansion of 40 basis points due to our continued improvement in bad debt expense and our focus on automating and optimizing our labs and patient service centers. Margins would have been higher, but for the factors Brad Hayes mentioned. I would like to mention the performance of the many LabCorp employees working in our billing operations and patient service centers. Beginning in the third quarter of 2008, over 6,000 people have maintained a disciplined focus on getting paid for the valuable services we provide. They have performed exceptionally during a very tough economic environment, and our declining DSO and bad debt expense reflected this. We are very proud and appreciative of their efforts. I would now like to update you on a few of our strategic initiatives. First, we continue to take advantage of attractive acquisition opportunities. On June 14, we acquired the assets of DCL, a full-service clinical laboratory located in Indianapolis, with a strong specialized women's health offering. This acquisition furthers our strategy of growing in large metropolitan markets and enhancing our disease state-focused offerings. On June 16, LabCorp acquired certain assets of Westcliff Medical Laboratories, a clinical lab in California pursuant to the Asset Purchase Agreement and an order of the Bankruptcy Court administering the bankruptcy Of Westcliff. This acquisition furthers our strategy of growing in the California market, where we have historically been underrepresented. LabCorp was notified by the Federal Trade Commission that it intended to review the acquisition. And on June 24, we entered into an agreement with the FTC to hold the Westcliff business as an independent laboratory separate from LabCorp, while the FTC conducts its review of the transaction. LabCorp is working with the agency to complete the review as quickly as possible. We are unable to provide further color on the impact of the transaction until the conclusion of the FTC's review. Second, effective August 1, 2010, Empire Blue Cross Blue Shield, New York's largest insurer by medical membership is expanding its reference laboratory network to include LabCorp in all of its markets and products. This expansion provides broader choice for Empire's members and physicians, reduces member costs associated with out of network laboratories and creates a more competitive environment among labs. We were excited about the opportunity to work closely with Empire and its members and to provide them with greater choice and exceptional lab service. Third, we recently launched our new online gateway for client lab connectivity called LabCorp Beacon, accessible anywhere and at any time, LabCorp Beacon is an end-to-end solution that allows physicians to view, share, manage and analyze lab results. Beacon was developed with significant customer research and input and offers a user-friendly interface and sophisticated tools that will help our customers streamline office workflow and information sharing. LabCorp Beacon will enhance our connectivity portfolio as the solution of choice for direct client connectivity. We will continue to offer physicians a choice of tailored solutions, including robust integration with EMRs, EHRs and PHR applications. These options allow our customers to choose the right solution based on their needs for decision support, interoperability and their meaningful use objectives. LabCorp Beacon represents our ongoing commitment to innovate and invest strategically in our IT capabilities while maintaining our open platform approach. We have rolled out Beacon to a select group of our customers and they have received it enthusiastically. We will continue to roll out Beacon throughout the year. Fourth, we continue to execute on our 2010 initiatives that have now driven year-over-year gross margin improvement for three consecutive quarters. These initiatives are even more important in light of the passage of the healthcare reform legislation, which we believe will drive business in all sectors of healthcare to the most efficient and lowest cost providers. Our Protedyne subsidiary continues to provide innovative solutions for automating and streamlining our operations. We are rolling out next-generation appointment scheduling and we continue to optimize the workflow at our patient service centers to improve the customer experience, as well as the overall efficiency of our business. As a result of our agreement with Sysmex America, Inc., we have fully automated hematology operations in our regional core laboratories throughout the United States. The Sysmex partnership allows us to increase throughput with less labor and to improve turnaround time for our customers. It is one of the largest laboratory automation projects ever undertaken. This is just a sampling of the many initiatives we have underway to increase efficiency and improve service. They will remain an important strategic focus for us in the months and years ahead. In summary, we are pleased with our second quarter performance and remain very excited about our future growth opportunities and the strategic initiatives that will help us capitalize on them. Now, Steve Anderson 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 second quarter, approximately 36% of our revenue was in the 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 2010? 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 programs. 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. Since the beginning of 2006, the company has repurchased approximately $2 billion worth of its stock. Can you remind us of how drugs of abuse volume trended during the year? In the quarter, our drugs of abuse volume increased 15.4% year-over-year. That compares to a year-over-year increase of 6.8% in Q1 of 2010 and year-over-year decreases of 6.5% in Q4 of 2009, 15% in Q3 of 2009 and 19% in Q2 of 2009. What is the status of your transition payments to UnitedHealthcare? In the quarter, the company was billed $1.1 million in transition payments and paid $2.1 million in transition payments. As a reminder, our obligation to reimburse UnitedHealthcare for transition payments ended on December 31, 2009. We have received the final invoices for these payments and the final amount is approximately $120 million. What impact would the proposed 2011 Medicare physician fee schedule rule have on your business? Assuming the Congress acts to prevent the conversion factor reduction within the proposed Medicare physician fee schedule rule, we would expect to receive a modest increase to our revenue tied to the physician fee schedule. As a reminder, approximately 2% of our revenue is tied to the physician fee schedule. Now, I'd like to turn the call back over to Dave.

Thank you, Steve. In summary, we are pleased with our performance in this quarter and are optimistic about our business in 2010 and beyond. Thank you very much for listening. We are now ready to take your questions.

[Operator Instructions] And your first question today comes from the line of Robert Willoughby with Bank of America Merrill Lynch.

Dave, what realistically can you accomplish on the acquisition front? It looks like the pace has really picked up here. Can you bang out three or four more of these type tuck-in deals? Or operationally or logistically, it that just tough to accomplish and does a Genzyme opportunity potentially freeze you here?

The tuck-in deals are generally organized, managed and integrated through the divisions, Bob. So we have a good deal of capacity to continue to do them. Obviously, the bigger they are, the more complex they become. But the smaller fold-in deals really are divisionally driven, and we have quite a bit of bandwidth there. Obviously, a deal like the Genzyme Genetics deal would be a large deal. It's a much more national deal in scope because of the breadth of their business, so it will require a good deal more of listening. But it certainly doesn't freeze us or prevent us from doing the fold-in deals concurrently.

So a reasonably full pipeline, maybe we should we expect to see more announcements over the course of the year?

Yes, again, we want to remain disciplined and be focused on valuation metrics, accretion dilution profile, but I think it's reasonable to expect that we're going to continue to make acquisitions as long as the opportunities are attractive.

And anything from an early read on healthcare reform as yet? Is that resulting in more dialogs for you with better quality assets? Or any change you can glean from that effort as here?

I think there's more interest from lab owners who potentially see healthcare reform in the next 24 to 36 months having an impact on their, particularly, on their revenue structure and also on their expense structure. So labs that are getting a substantial amount of their revenue from Medicare are facing five years of payment cuts, pretty much regardless of what the CPI does. And there certainly is pricing pressure from other fronts as well. And the inflationary side of the cost factor with wage inflation and other things doesn't go away. So I think we're having good discussions with a number of owners of quality assets. And again, it's going to come down to how do we feel about valuation? Is it accretive or dilutive? How does it fit with our strategy? As I mentioned, both DCL and Westcliff, with important strategic initiatives, greater size in major metropolitan areas, greater strength and disease-state focused and particularly, we've been so small in California for so long that the opportunity to make a modest acquisition there was very attractive to us.

Another question, just -- one of your competitors here, obviously, your large competitor indicated pricing seemed now part of their strategy to grow. Is this -- have you noticed any change in the basis of competition for managed care or other contracts?

Well, I think the -- first of all, pricing has always been very competitive and very tough in our industry and we shouldn't suggest otherwise. And everybody who does business with healthcare providers of any kind, whether it's labs, doctors, hospitals, always wants more services for less money. That's inevitable. So I don't think the pricing environment has changed particularly in the last 12 to 18 months. We said last year that we had gone out and made some important contractor renewals with WellPoint, with CIGNA, with some of our regional plans. And we also have pointed out that with UnitedHealthcare, we have a ten-year contract and they have been a terrific partner and we continue to grow that business. So our strategy is not to lead with price. Our strategy is to be disciplined on pricing. Our strategy is to compliment organic volume growth with acquisitions, and our strategy is to continue with innovations like our LabCorp Beacon platform and other IT innovations that are coming is to continue to differentiate ourselves by making it easier for the doctors and their patients to do business with us. So I know that was a long answer, but the short answer to the question is there will be pricing pressure, there will be impacts on price. For the reasons Brad mentioned, you will not see the kind of pricing the rest of the year that you're seeing this quarter simply because we're going to annualize Monogram. We're going to annualize the lost contracts as drugs of abuse testing grows. That has a downward pull on price. But we feel good about where we are on pricing and we feel good about the contractual relationships that underpin our pricing.

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

Dave, maybe there's a starting point and since you were just talking about the pricing, managed care, why don't we just start there? Obviously, a lot of interest after yesterday. And I guess I just wanted to get your feedback, you had said there's always competition, there's always issues with managed care, but feeling of the last 24 months is that things were very stable on the managed care side. So just want to get some clarity whether you think that is still the case and even though we've seen some bigger contracts and some news, and you mentioned Empire as an opportunity earlier, but just certainly just wanted to just get clarity in terms of, would you characterize this as a more stable environment for managed care than it was a couple of years ago?

I think it's about the same, Adam. I don't think it's gotten measurably better and I don't think it's gotten measurably worse. I think since the repricing in 2007, pricing, generally, has been pretty stable. Again, everybody always wants more service for less price, but I don't think we've seen any major change in the managed care dynamic from a pricing perspective.

Maybe just on the Empire opportunity, could you talk a little bit about that, just how are you guys thinking about that? Is there anything included in guidance for that, such as -- and if you can't give any point on numbers, I totally understand. But I just wanted to just get a general sense, in terms of, are you guys assuming any benefit from Empire?

The opportunity starts on August 1 and so, given the transitional nature of it for this year, I don't think the benefit will be huge. It is incorporated into the guidance. I don't think you're going to see meaningful change in the numbers based on Empire. Now that's this year. I do think as we -- one of the obstacles that we have had in the New York market, in terms of fully capitalizing on the great benefits we got from the United and Oxford relationship is that physicians have not been able to send us their Empire work. And so I think over the long term, WellPoint's decision to broaden the provider network, to include us, is going to have a significant benefit for us, but it's not -- I don't expect it to be anything big that you'll see in the numbers this year. And it is part of the guidance that we've given.

Just thinking more about the core business, your pricing growth has been very strong. You talked about some of the drivers there in terms of just mix and such, and said that we shouldn't anticipate the same rate of volume growth, but how should we think about normalized growth in terms of other core business, so in terms of what you guys report as all-in pricing? How should we think about it in terms of a more normalized number?

Just from a pricing perspective?

Yes, so I guess in the other quarter, there's 7.2%. And once again, I guess that includes mix also. So I guess it's just revenue per session.

Adam, this is Brad. I think that has a lot of things going on. The loss contracts were of the core nature. So a number of things that we mentioned that are having a positive lift on price. I think we'll obviously come down over time. What I would expect to see there is a very low single-digit number in a normal environment. There is some, what I would call mix within mix that can happen in that line, where some tests that are greater or lower than the average price might be growing or shrinking faster than others. But I think there's a lot of lift in that number right now due to some of the factors that we've mentioned.

Yes Adam, it's Dave. I think what we have always said -- and I don't really think it's any different is real price that is unit pricing, year-over-year, is going to be zero to maybe 50 basis points. Mix-based pricing is going to be 1% to maybe 1.5%, which obviously isn't the core, that includes higher esoteric mix. So that's how we get to a sense of we expect pricing growth in a normalized environment to be 2% over time, but again, real unit price growth is going to be relatively flat to maybe 50 basis points.

And your next question comes from the line of Amanda Murphy with William Blair. Amanda Murphy - William Blair & Company L.L.C.: Just a couple of more questions on the managed care situation, if I may. I guess first, Dave, would you ever consider any kind of early renewal process? And if so, what would be the advantages in your mind at that type of program?

We've already done our early renewals. We did them in 2009. And the advantage of early renewals is greater visibility on price and volume in a -- as you look out a couple of years ahead, so it helps you plan the business. I think the reality is with these, particularly with the larger payers, we're always in discussions about the contracts and we're always in discussions about how we can enhance the opportunities. So WellPoint is a good example with Empire. We've been in those discussions for a long time about our desire to help them by offering more choice for patients and physicians in the New York market. So we're always talking to managed care about contracts and when the opportunity arises to renew contracts prior to the termination date on favorable terms -- and when I say favorable terms, I mean favorable for both parties. Obviously, they want to get something out of it too, and part of what they get is some certainty about their provider network and coverage and how may patient service centers are going to be close to their patients. We would certainly do that. Amanda Murphy - William Blair & Company L.L.C.: I think when we went through this repricing effort a couple of years ago, a few years ago, that there were some effort to, sort of, strengthen the language around the ability to terminate those contracts, which I think is what was in Part D, facilitator of the industry-wide event. So am I remembering that right or not?

I'm not sure I follow, I'm sorry, Amanda. Amanda Murphy - William Blair & Company L.L.C.: I guess I recall that there was some effort to remove -- I guess there was language in the contract that allowed a plan to terminate a contract with notice and that, kind of, drove the whole industry-wide event in 2007. And there was an effort to, maybe have it be more -- that a health plan just couldn't come and do that, that it was more collaborative, maybe I'm not remembering that right.

Yes. Amanda Murphy - William Blair & Company L.L.C.: Switching to the volume side of things, if you look at the core business, the numbers were a little bit better than last quarter's. So I'm curious if there's, is that just an easier comp sort of situation or have you seen anything improving sequentially? And then just also it seems generally that you're doing better than maybe IMS data would suggest though? would you even go as far as to say that you're gaining share in some segments?

Amanda, this is Brad. I agree on your observation on the core improvement. I'd just like to remind you there was weather in the first quarter and no weather in the second quarter. I think that's the biggest driver. As we look at the business second quarter compared to first quarter, and consider a number of factors, many of which we've mentioned in terms of the loss contracts and the like, we think the business performed in the second quarter very similar to the way it performed in the first quarter. And as we look at IMS data, those are obviously down more than the volume that we're experiencing. So I'd like to say that, that is a tribute to our strategy and the fact that potentially, we are taking share. But it's very hard to draw direct conclusions from that information. I think it is directional and we certainly pay attention to it, but like to see us performing better than that directional piece of information.

And your next question comes from the line of Gary Lieberman with Wells Fargo.

Maybe talk about some of the insourcing trends that you're seeing, maybe specifically on the anatomic pathology side and what you guys have been able to do to compete there?

Obviously, we're pretty transparent in the disclosures on our 8-K about this, so you can see that we did continue to have a downward trend in the anatomic pathology volumes. However, the rate of decline has slowed and so as I mentioned on the call last quarter, Gary, I think we've seen the big impact from this in the end of last year and the beginning of this year. The major areas where we're seeing insourcing are in the urology. And I guess particularly in the urology and now in the dermatopathology, where physicians are setting up their own internal laboratories and are making arrangements with pathologists to do their reads. And from a competitive perspective, what we've done is focused on the fact that when you send your specimens to LabCorp, you get specialized pathologists. You don't get general pathologists reading these specimens, so that's very important for patient care that you have a uropathologist or a dermatopathologist reading these specimens, not just a general pathologist. We focus on the full menu of services that are available from LabCorp, special stains and other more sophisticated techniques that are not necessarily available at an internalized physician labs. And we focused on the IT solutions and capabilities that we can offer that are not available in the internalized labs and the ability to perform other tests on the specimens. We also have continued to point out to regulators that there is a high potential for abuse in physician insourcing, that the number of, for example, the number of biopsies on a prostate, typically increase and increase fairly significantly after physicians insource, and that adds expense to our healthcare system in a time when we're trying to make healthcare expenses go the other way. There are also concerns about physicians' self-interest and conflict of interest and there are concerns about the quality of patient care, so we continue to point those things out to the regulatory authorities. And we have had support in that from our own trade association, from the College of American Pathologists and from other influential trade associations that have interest in the lab industry. So I said in the first quarter and I continue to say in the second quarter, we need to pick up the level of competition. We need to pick up our game here, but at the same time, I'm pleased to see that the trend has ebbed a little bit in terms of the pathology volumes going down.

Maybe one quick follow-up on price. I guess you said that most of your contracts were awarded in 2009, you started to term out some of the contracts. Be interested to know if, because of any incremental price competition, any of those contracts have come back or and tried to renegotiate, based on maybe better prices that they're getting elsewhere?

I think pricing discussions between us and our large customers are really something that we should not spend a lot of time talking about publicly. We're very, very happy with our relationships with United, who as I mentioned, has been a terrific partner, with WellPoint, which has been our national sole strategic partner with CIGNA, with Humana. And these contract extension processes have been -- and I don't mean to overlook anybody else, with Horizon, with the Texas Blue plan, with all of the plans that we do business with, these contract negotiations are always -- there's always discussion about pricing. But I think it's, suffice it to say that we have contracts. Our managed care partners have shown no indication that they plan not to honor the contracts or that they want to rediscuss the contracts and -- I just think we need to look at this as -- I don't see anything that has changed from where we were last year, from where we were in 2008, which is the payers always want to pay less for more. And we always want to get paid more for the value that we provide. And that's the way the dynamic is going to be probably as long as I'm around here.

Your next question comes from the line of Tom Gallucci with Lazard Capital Markets.

Just a couple of quick follow-ups on something that have already been discussed. I guess in the revenue guidance raise there, you've obviously done some acquisitions. Are there any other moving parts that we should be aware of that drove that?

Tom, it's Dave. I think the increase in the revenue guidance is largely to incorporate the impacts of the acquisitions plus the potential Empire opportunity.

You obviously said before, when you talked about acquisitions remaining disciplined and things looking for the sort of right opportunities accretion/dilution wise, could you characterize the pricing expectations out there on behalf of sellers compared to where we were maybe a year ago? Or the competitive landscape versus other potential buyers and what that's doing to pricing?

I think it depends on which sellers. I mean, there are some sellers who still have high expectations on valuation. There are others who I think have more realistic expectations. So I think expectations, if you sort of think of it as in a global, what do people think they should get for selling their asset, I think expectations have trended down from where they were in 2008 and 2009. So that's part of the reason that we have become more active is because the assets are available at valuations that are increasingly attractive.

Last thing. I'm sorry if you commented on it, I missed it. But obviously, there's been some talk out of the FDA about increasingly sort of regulating testing. So just curious what your thoughts were there?

Sure. As I think you know there was a two-day meeting earlier this week regarding FDA regulation of laboratory developed tests and also the FDA's regulation of direct-to-consumer genetic testing. And there's also a hearing this morning, the Energy and Commerce committee is having a hearing on direct-to-consumer genetic testing. I think this is an area in which there's increasing regulatory focus. And I think that in various discussions with the FDA, their view is there is a need for some greater oversight of laboratory developed testing. Their view is also that they do not want to do anything abrupt or without thorough deliberation. So my sense is that there is going to be greater oversight in some form or another of lab developed testing. I think there'll probably be greater oversight in some form or another of direct-to-consumer testing, particularly direct-to-consumer genetic testing. And our goal is to work collaboratively with FDA to make sure that whatever regulatory activity they undertake takes into account the importance of laboratory developed testing, the importance of the laboratory's ability to innovate and bring tests to market rapidly that people need without having to go through the whole process of a kit or of a lengthy regulatory review. So I think this is an evolutionary process and we're very much committed. Both LabCorp and the American Clinical Laboratory Association are very much committed to working collaboratively with the FDA to coming out with the right answer.

And your next question comes from the line of Kevin Ellich with RBC Capital Markets.

Just a couple of questions. Just following up on the guidance. Is Westcliff included in the guidance? I'm just trying to get clarity on that.

Yes, Westcliff is included in the guidance. Now to be clear, because of this situation with the FTC, we are not able to integrate Westcliff into our Western operations while their review is pending. So Westcliff is included in the guidance and it is a positive to revenue, but it actually is a negative to EPS because of their expense structure, which we can't change until the FTC finishes its review of the transaction.

Dave, one thing you've talked about in the past is Canada and you've been pretty positive on that. It sounds like there is more consolidation, especially in the province of Alberta, on the pathology testing or cervical cancer testing. Just wondering, is that a good opportunity for you or is that a positive for LabCorp?

Kevin, this is Brad. I do think it's a positive. As a reminder, that business is -- our business in Alberta is not consolidated, so you see the earnings from that down below the operating income line. But it's still a business that we are very much interested in and stay in touch with, and I think it is a good signal in Canada and it really applies to our market as well that getting testing into the best provider in terms of cost and quality is good for the system.

Just wondering about the margins. Obviously, we've seen a very nice improvement on DSO and also bad debt. I'm just wondering how much lower can bad debt really go? I mean, we've seen a pretty big improvement here.

Right. And we still see opportunity. Obviously, as we look at our initiatives, we're still making progress but we're not 100% successful yet. So I think the opportunity is there to potentially decrease in the future. As we've said in the past, we would like to lead the industry in most categories of metrics, and that's one that we keep an eye on as well.

Kevin, it's Dave. Just a further comment on that because I think it's important that we'd be clear about this. When we set our bad debt rate, we set it based on a 12-month going forward projection of what we think bad debt is going to be. So if we adjusted bad debt to the inverse of the collection rate every quarter, you would see a much broader fluctuation and it would go up and down depending on what top line revenue in the quarter was and the collection experience. I think from the standpoint of the predictability of earnings and the predictability of our business model, the way that we do it is more desirable, which is we try to figure out what we think bad debt will be for the next four quarters, if not beyond, and that's where we set it. So when we started the year, we thought that bad debt would continue in that 5% range. And as a result of collection experience and as a result of the initiatives that we have had in place, now we think that for the next four quarters, it's going to be sustainable at the 50 basis points lower.

Thinking about the big picture changes in the U.S. healthcare landscape, just wondering which areas you're still focused on? Is it infectious disease? Any sub-testing category? And then maybe more broad thoughts on international expansion. Is that still in the works at some point? And there was some chatter about Sonic. Just wanted to see if you had any opinion about that?

Well, I think Sonic is a terrific company and a very good competitor, and they have businesses in a lot of places that we don't know anything about. Do we have international aspirations? Obviously, we have. The Canadian business, and as Brad has mentioned, that's an attractive business and it's a business we'd like to continue to grow. We've said for a considerable period of time, there are clinical trials business which is doing very well this year after a tough year last year, when the whole CRO industry was under a lot of pressure. We've said that we have broader international aspirations for our clinical trials business and being able to provide services, clinical, central lab services, central lab services I should emphasize, in some countries where we don't have a presence now or where our presence is through some collaborative arrangement. Beyond that, in terms of broad international aspirations, I'll reiterate what we've said for a long time, which is that we think there is a great opportunity in the U.S. and that's where we're going to continue to focus. In terms of overall thoughts on healthcare reform, with my thoughts on healthcare reform, in a couple of bucks, you can buy a cup of coffee. But my thoughts on healthcare reform are, there's going to be a great deal of pressure to bring down costs. And there's going to be a great deal of pressure on providers to become more and more efficient. And the good news from LabCorp's perspective is the 2010 initiatives, the IT investments, which will be extremely important to physicians. I read over the Meaningful Use Regulation that came out, there are I think 20 criteria that physicians have to meet for meaningful use and then there's a menu of another 15, and I think they get to pick five of those. So the automation and efficiency, the IT investments, the continued innovation in improving customer service, are all going to be to our benefit. And I think, if you saw the newspaper this past weekend on Sunday, there was a front page article about how insurers are offering narrower networks as a way of reducing or holding down or not increasing premium costs to employers. And those narrower networks are going to be focused on the lower cost providers and we are the lowest cost provider in our industry. So as long as we continue to remain -- as long as we continue to improve efficiency and we continue to improve our overall interoperability, IT capability, service levels, efficiency of our business, I think we're going to be in good shape.

Just to follow-up on that point though. If you guys are the lowest cost providers and assuming that your biggest competitor is also, what's the logic or rationale behind renegotiating the managed care contracts early and taking lower price now, when you guys have the size and scale and are already the lowest cost provider? Any thoughts behind that?

I think that was a question for yesterday's call. When we negotiate these contracts, obviously, we are very sensitive to the needs of our managed care partners, but we're also very sensitive to the pricing dynamic. And I think our performance shows that.

Your next question comes from the line of Kemp Dolliver with Avondale Partners.

Question relates to your progress with integrating Monogram. Just strikes me based on the sequential improvement in earnings that you have made substantial progress in reducing the dilution there.

Kemp, it's Dave. Yes, we made substantial progress in reducing the dilution there, and Monogram continues to be a very important strategic initiative for us. As a result of our infrastructure and logistics, we've been able to broaden the reach of their testing services, which has been positive to revenue and to reduce their expenses. The science there is terrific. The technology is terrific. We've established Monogram as a Center of Excellence for our Virology business. They've already integrated very nicely into our Clinical Trials business, with helping with the development of companion diagnostics. We're looking to expand their capabilities, particularly into Hepatitis C. And the revenue, the utilization uptake on HERmark, now that physicians can order it without having to send their specimens to two different places, has been a positive. And we've had a number of significant inquiries from clinical trials partners about the use of the Virotech assays to develop targeted oncology therapy. So Monogram has been exactly what we thought it would be in terms of a very important strategic acquisition for us, and we've done a good job in reducing the cost structure there.

In Q4, you had said that dilution was $0.08. You didn't quantify Q1, but suggested you had made progress. I'm going to take another shot and ask what the EPS effect in Q2?

Kemp, this is Brad. We're not going to break it out, but I would characterize it as follows. The improvements that you're seeing are much greater driven by LabCorp excluding Monogram, than the impact of Monogram.

Your next question comes from the line of Gary Taylor with Citigroup.

What would you say your average revenue multiple in acquisitions is for what you've acquired in the last 12 months?

Well, I don't think there's a way to quantify that, Gary. Because it just varies so widely and I'm not sure it's helpful to quantify either because I think it probably has an impact in the marketplace. So we look at multiple of revenue as one of many factors, again including accretion/dilution, multiple of EBITDA, pre and post EBITDA, synergy opportunities, discounted cash flow. And the revenue multiple alone is not determinative.

When you look at your 4.2% year-over-year revenue growth, how much of acquisitions contribute to that year-over-year number?

It's relatively small other than Monogram. And Monogram, because it was August of last year, there is certainly a -- we know that Monogram is 1% positive on price all by itself. So that's a contributor. The rest of the acquisitions, the sizable acquisitions, as we mentioned in the talking points, were done in June of this year. So they're pretty small. Two weeks of Westcliff or two weeks of DCL is not going to have a major impact given the size of our organization.

And Gary, I'll just back that up with, between Monogram and the two that Dave just mentioned, there's been nothing sizable to speak of other than what I would consider to be the normal kind of small tuck-ins that are incorporated and the way we think about the business on a go-forward basis.

Yes, I mean, we see those a little bit in the 4Q, a little bit in the 1Q and they'll really hit the threshold to get called out. I know, but I'm just trying to think about the overall contribution. On the Indianapolis lab DCL, can you give us of any sense of the size of that or if the revenue is there or not?

I believe it was the largest independent lab in the Indianapolis market and also had some business in St. Louis and some Patient Service Centers. So we think of it as a nice-sized acquisition, but again, not going to talk specifically about its revenue or its volumes.

Just going to the commercial pay question. Again, that was raised yesterday and we've talked a little bit about today. If I'm not mistaken, I thought when you guys talked about WellPoint last year, that was renewed through mid '13, if I'm not mistaken. Is that right?

Correct.

Can you just talk about -- can you ballpark, when we look at '10, '11 and '12 for you, what percent of the managed care book has scheduled expirations? Even if we can use adjectives instead of numbers.

Yes, I mean, I think the problem is that we have, if I'm not mistaken, we have something on the order of 2,000 managed care plans that we deal with. And it may even be more than that. Many of these plans have contracts that are just evergreen contracts, if nothing happens, they roll over from year to year without any major changes. The major contracts that we have are basically extended. WellPoint, as you mentioned out to 2013, CIGNA's out in '13. We have a couple of contracts in '11 that are not -- they're not small, but again, we're already talking to our managed care partners about those relationships. And we really don't have anything that's sizable in 2010 that has not been addressed. So I think the landscape looks pretty clear until you get out toward the end of 2012 and into 2013.

The gross margin improvement, I know you touched on that a little bit earlier. Can you, in a little more detail, can you refresh us a little bit on what's driving that year-over-year improvement? I didn't think mix would really be a big driver there but maybe I'm wrong on that?

Yes, a couple of things have an impact on gross margin. First of all, obviously, price growth has a positive impact on gross margin, because if you're doing the same volumes at a higher price, with the same number of people, that helps your gross margin. So we shouldn't overlook that. However, in my mind, the big drivers of gross margin are in the 2010 initiatives. So the automation, which is fully completed now of our HPV preparation in our major laboratories, the hematology automation which is a very substantial project but is going to lead to very substantial savings and improved turnaround times for our customers, the improvement in Patient Service Center workflow through appointment scheduling, the improvement in Patient Service Center workflow through the IT improvements that basically allow the phlebotomist to accession the specimens in Patient Service Centers, which means that they don't have to be re-accessioned when they get to the laboratories. So these are all major contributors to the gross margin improvement, and the gross margin improvement is three consecutive quarters year-over-year. So obviously, it's not all from pricing. It's considerably contributed to by the efficiency initiatives that we've undertaken. And I would also comment on that, in undertaking these efficiency initiatives, one of our major areas of focus has been to move our personnel out of the "back office" and into customer facing position. So we've been able to increase the number of phlebotomists, increase the number of couriers, increase the number of service personnel without -- and still have gross margin improvement. And then the last thing I should mention is just, very aggressive optimization of the supply chain in terms of vendor relationships, inventory management. I mean, all of those things have been material as well.

In the hematology automation, where are you in that process?

All of the major core laboratories are done. So that's fully into the run rate.

And your next question comes from the line of Ralph Giacobbe with Credit Suisse. Ralph Giacobbe - Crédit Suisse AG: Can you maybe talk about the drugs of abuse testing a little bit? Just if possible, maybe quantify the positive contribution to volume and maybe the drag to pricing?

Ralph, it's Brad. I think Steve said it was up 15% and it's about 5% of our volume. So that's going to imply 0.7 or 0.8, I think, impact on the total. And then on the price side, it's going to be a hindrance to price of just a few basis points less than that. So not a tremendous impact on total revenue, but certainly driving some volume growth, but detracting from the price component a little bit. I want to get back to something I said earlier and that would be one of the considerations. Again, when we look at the business first quarter to second and look at a number of moving parts that we mentioned today, even taking that component out of the analysis for both the first and second quarters, we think the business performed very much in the second quarter like it did in the first quarter. Ralph Giacobbe - Crédit Suisse AG: Just to be clear, you said 5% of volumes drugs of abuse?

Yes, approximately. Ralph Giacobbe - Crédit Suisse AG: I thought you said that margins where impacted in the quarter by acquisition transition costs. I guess, how material is that? I mean, any color there?

Yes, I mean, we've got, obviously, some acquisitions that we haven't fully integrated yet. And also, the deal costs associated with those that are now, as of last year, I guess hit the P&L as opposed to get considered in the deal cost. And I would just say that's a pretty meaningful impact in the quarter of something between 50 and 100 basis points negative impact on the margin. Now some of that will not be erased immediately, especially as we consider back to some of Dave's comments about the Westcliff integration. That's certainly a drag in the quarter. Even though it's two weeks, it's certainly impacting a little bit on the quarter and will continue to impact going forward. Ralph Giacobbe - Crédit Suisse AG: Maybe, I guess, where are you with LabCorp 2010 initiatives? Obviously, we're seeing it show up in the numbers. Just wondering kind of how much more in terms of that specific program.

Well, Ralph, it's Dave. I mean, we're never going to be done with it. And I think that's probably the best thing that we've learned, is that every time that we make one of these major improvements, we find other opportunities. So in terms of quantifying -- have we reduced the run rate gross by the $100 million number that we said we were going to, I think with this second bad debt reduction number which I attribute to the 2010 initiatives, I think we're pretty close to having accomplished what we said. But the learning has been that as we've really focused on lab operations, focused on PSC operations, focused on the supply chain, that there's still more room there.

Your next question comes from the line of Bill Quirk with Piper Jaffray.

I just want to follow-up on a couple of earlier questions. Dave, can you talk a little about how office visits trended throughout the quarter? And then, did we see any changes here as we got toward the end of 2Q? Or you've been taking a look at the first couple of weeks of 3Q?

I think the IMS data suggest that office visits year-over-year were down about 5% in May and 5% in June, if I'm thinking about the numbers right. Maybe it was April and May. But we saw physician office visits declines of about 5%. And as Brad said earlier, that's directional, it's not perfect. But the big declines, and this is not a surprise to anybody, OB/GYN, primary care and my thesis is you're seeing a lot of people who are not getting their annual physical. They're not going in for their annual checkups. They're deferring or postponing non-acute visits. And I'm not going to talk about -- I don't know what the answer is for the first two weeks of 3Q. I wouldn't tell you if I did know because we don't talk about our quarters while we're in them. But I don't see anything that's changing materially. I don't see anything that's changed significantly in the office visit environments since the beginning of this year and even the 4Q of last year.

And so just taking a look forward here, Dave. Presumably then, as you think about the guidance for the back half of the year, you're not assuming any meaningful improvement to that environment?

Correct.

Top test for the quarter. I don't think you mentioned it. If you did, I apologize. But could you give a little color there?

I don't think we usually do mention it. So I don't think we've broken with any President by not mentioning it. I mean, it shouldn't be any surprise that, and I'm not going to say any particular top test is, but we continue to see strong growth in Vitamin D. We continue to see strong growth in HPV and some of the Esoteric testing. The Anatomic Pathology, as previously mentioned, was down a little bit, although the trend was better. We're actually seeing positive trends in some of the core testing like hemoglobin A1C, lipid testing, thyroid testing. So there's a good mix of areas where we're seeing volumes improve on a test-by-test basis.

Your next question comes from the line of the Darren Lehrich with Deutsche Bank.

I guess I wanted to just go back to Westcliff. What is the timing of the FTC review? And can you just update us, it seems like $100 million revenue operation in a state as big as California, seems like an odd thing to be looking at. So maybe, can you just sort of update us on why that review is even going on?

Well, answer to the first question, we don't know the timing. The FTC has said they are reviewing the transaction. We are providing them the information that they want to look at. Our hope is that they will complete the review expeditiously and clear the transaction. As a reminder, the purchase price was below the Hart-Scott-Rodino threshold, so this was not a transaction that we even had to file for clearance on. In terms of why the FTC is reviewing it, I have no idea.

And I guess just going back to some of Brad's comments about Westcliff and the impact that it's having. If there's any discrete way or sort of way to frame the margin impact on a quarterly basis while you wait for the FTC, if you could just help us think about how that's sort of built in to your thought process in the second half?

Well, maybe just explain the structure of what it is. So Westcliff is being run as a separate business. There is a manager of the business who runs the business, and then there is a monitor who oversees the business to make sure that any actions that are taken do not compromise the standalone nature of the former Westcliff business. So those are where decisions are made. The only thing I think we can say from a margin perspective, Darren, is, right now, the expenses are higher than the revenues. And so that has a negative effect on margins.

And you've assumed that for the balance of the year? Is that what's in the guidance?

That's right.

And then, my last thing was really just going back to bad debt. I wanted to just clarify something and maybe dive a little bit more deeply into this. Are you saying that there's now a 50 basis point improvement versus what you originally had? And can you just clarify those comments and what is, I guess, the bad debt outlook at this point? And then Brad, obviously, a good result, David mentioned a lot of the hard work that goes into that kind of result. But is this mix-driven in any way or is this just really more about process?

First, to review the numbers, we've reduced 25 basis points in the first quarter and then an additional 25 in the second. So year-over-year, you're right, it's 50. But sequentially, it's 25 and I have to say, I think we said this on our first quarter call, that we expected the 25 in the first quarter. I think the 25 in the second is because we're doing better than we would have thought. I would say that, no, mix is not at all a driver of our improvements. The driver of our improvements are the initiatives that we first laid out back in the middle of 2008 that haven't changed in terms of what they are, but have changed in terms of how we're executing against them. We continue to make progress in all of those initiatives. I won't say that we haven't added any, but those foundational initiatives are still alive and well. And as I look at what's in front of us, I think, again, we still have opportunity to do better. There is process improvement in the area. There is performance by individuals improvement in the area and it's completely our results or a result of all that heavy lifting as opposed to anything that's fundamentally going on. We look at credit card default rates and consumer information and I don't think the environment has gotten any easier. It may have plateaued, so it's not continuing to get worse. But I just see that as sort of the fact that maybe one headwind we were fighting for a while has subsided a little bit. But still, they plateaued at very high levels compared to history. It's completely the initiatives and the heavy lifting.

Your next question comes from the line of Anthony Vendetti with Maxim Group.

A quick follow-up on two things. On the volume, that was down, and you highlighted the office visits that were down. Do you believe that, that is a bottom and it's stabilized or is it too early to be able to tell whether or not this would continue? And would you attribute that to unemployment? Or what do you think is the cause for that?

I think it's too early to tell. I mean, I don't think we're seeing big month-over-month declines. It has gotten worse from the beginning of the year when you look at the year-over-year perspective. But in my mind, there are a couple of things going on and they tie together. One is, we're not seeing job creation in the private sector. So unemployment remains high and most job creation is not coming from private sector jobs. What that translates into is that managed care enrollment, commercial managed care enrollment is down. And with commercial managed care enrollment down, that translates into people are not insured. And as a consequence, they're choosing -- it isn't that they are going to the doctor as uninsured patients, it's that they're staying home. And if you just look at our percentage of uninsured, one would have thought in the abstract that with the number of uninsured in the U.S. going up and the number of people losing their jobs, you would have thought our uninsured patient count would have gone up, it went down. And again, I think it's because people without insurance are staying home and that's why doctor visits are down, and even people with insurance who feel that they can skip that annual checkup, that wellness checkup, are staying home as well. So in my mind, the answer is, I don't know whether we're at the bottom and I don't think we're going to see a lot of change until we start to see job creation in the private sector which leads to increased managed care enrollment.

And then the follow up was on the renewals and I know you touched on this. Most of the major contracts, well, at least, WellPoint, CIGNA into 2013, nothing really sizable this year. But you said that there were some sizable ones in 2011. Did you want to name the ones in there? And if not, if you could just say what percent of your book of business those sizable contracts that are up for renewal in 2011 would account for?

I don't want to name them and they're not big enough in and of themselves to be materially impactful to our total book of business.

And your final question today comes from the line of Steven Valiquette with UBS.

Obviously, there's been a lot of questions here on the managed care pricing. I guess, if we focus just on your managed care fee-for-service line and the revenue per requisition growth data that you provide which obviously was 3% growth in this past quarter and is kind of embedded in that 3% to 4% range. Is there any reason to think that the growth numbers reported in that line going forward are going to be really any different than the trends we've seen over the past 12 to 18 months?

No reason that I can think of.

I may have missed this, but as far as the price tag on Westcliff, I think it was suggested that if you place it, it was kind of in that $57 million to $58 million range. Is that essentially the ballpark of where it was or were there some debt assumption on top of that? I'm just trying to get a read on the full price tag on that.

I think it's a public record in the bankruptcy court that it was $56.5 million all in.

And that concludes our question-and-answer session. I would now like to turn the call back to Mr. King for closing remarks.

Thank you very much, everyone for listening to the LabCorp Second Quarter 2010 Earnings Call, and we hope you have a great day.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect and have a great day.