Labcorp Holdings - Earnings Call - Q2 2012

Transcript

Operator (participant)

Ladies and gentlemen, and welcome to the Q2 2012 Labcorp Holdings earnings conference call. My name is Reggie, and I'll be your conference operator for today's call. At this time, all participants are in a listen-only mode. After the speaker's remarks, you will be invited to participate in a question-and-answer session. If at any time during the call you require assistance, please press star zero, and an operator will be happy to assist you. I would now like to hand the call over to the host for today's call, Mr. David King, Chairman and CEO. Please proceed.

David King (Chairman and CEO)

Thank you. Good morning and welcome to Labcorp's second quarter 2012 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, Adam Feinstein, Senior Vice President, Corporate Development and Strategy, and Steve Anderson, Vice President, Investor Relations. This morning, we will discuss our second quarter 2012 financial results, update our 2012 guidance, highlight our progress on our five-pillar strategy, 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.

Steve Anderson (VP of Investor Relations)

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 8K that included additional information on our business and operations. This information is also available on our website. Analysts and investors are directed to this 8K 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. These non-GAAP measures include adjusted EPS, adjusted EPS excluding amortization, free cash flow, and adjusted operating income. I would also like to point out that we are making forward-looking statements during this conference call. These forward-looking statements include, among other statements, about our expected financial results, the implementation of our business strategy, and the ongoing benefits from the Genzyme Genetics and other acquisitions.

These statements are based upon current expectations and are subject to change, based upon various factors that could affect the company's financial results. Some of these factors are set forth in detail in our 2011 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.

Brad Hayes (EVP and CFO)

Thank you, Steve. On today's call, I will review four key measures of our financial performance: cash flow, revenue growth, margin, and liquidity. I'll also review our updated 2012 guidance. First, cash flow. Our cash flow remains strong. Free cash flow for the trailing 12 months into June 30, 2012, was $749.5 million, excluding the Hunter Labs settlement. We remain pleased with our cash collections. DSO was 47 days at the end of June, a decrease of one day sequentially, and an increase of one day year-over-year. During the quarter, we maintained our bad debt rate of 4.4%. Second, revenue growth. Revenue increased 1.4% year-over-year in the second quarter. During the quarter, revenue per requisition increased 1.5% year-over-year. Total company volume was essentially flat year-over-year during the second quarter. Esoteric volume increased approximately 1.3% in the quarter. Third, margin.

For the second quarter, our adjusted operating income margin was 19.7%, compared to 19.9% in the second quarter of 2011. The decline in adjusted operating income margin is due to a 30 basis point drag from recent acquisitions that we've not fully integrated. Fourth, liquidity. We remain well capitalized. At the end of June, we had cash of $124.4 million and $510 million available under our credit facility. During the second quarter, we repurchased $130.3 million of stock, representing 1.5 million shares. Year to date, we've repurchased 2.9 million shares for $252.6 million. At the end of June, $332 million of repurchase authorization remained under our share repurchase program. This morning, we updated our 2012 financial guidance. We expect revenue growth of 2%-3%, adjusted EPS excluding amortization in the range of $6.80-$7, excluding the impact of any share repurchase activity after June 30, 2012.

Operating cash flow of approximately $950 million and capital expenditures of approximately $155 million. I'll now turn the call over to Dave.

David King (Chairman and CEO)

Thank you, Brad. We are pleased with our performance given that we continue to face a very difficult environment for volume growth. During the quarter, we grew earnings per share by nearly 8% year-over-year. We continued to integrate our recent acquisitions and focus on expense control, lowering our selling, general, and administrative expenses as a percentage of revenue by 90 basis points year-over-year, adjusted for the Hunter Labs settlement and Orchid legal expenses in 2011. We extended our contract with WellPoint on a multi-year basis with stable pricing and continued exclusivity in our key markets. We continue to make significant progress on each aspect of our five-pillar strategy. The first pillar of our strategy is that we deploy our cash to enhance our footprint and test menu through acquisitions and to repurchase shares.

In June, we announced our intended acquisition of MedTox Scientific, a premier forensic and clinical laboratory with a diverse test menu and a reputation for exceptional quality, dependability, and customer service. This acquisition gives us a great foundation for growth in our specialized toxicology testing as we build and expand our toxicology center of excellence. The transaction has received FTC clearance, and we expect to close as soon as customary closing conditions are met, including the approval of MedTox's shareholders. The integrations of Integrated Genetics and Integrated Oncology and Orchid Cellmark continue to go well and are in line with our expectations. We continue to realize synergies on schedule and to offer new services in genetics and oncology. Finally, we have repurchased 2.9 million shares at a cost of $252.6 million year to date.

The second pillar of our strategy is to enhance our IT capabilities to improve the physician and patient experience. We continue to see strong growth in the adoption of our Beacon platform, which is now deployed to more than 14,500 sites and has more than 66,000 users. We added a number of features to Beacon in the second quarter, and we will add more analytical ordering and reporting capabilities specifically for physicians and hospitals later this year. We successfully completed the pilot of our Beacon Patient Portal and received positive customer feedback. The portal is a secure and easy-to-use online solution that enables patients to receive and share lab results, make appointments, pay bills, set up automatic alerts and notifications, and manage health information for the entire family.

We continue to see rapid adoption with more than 2,000 new patient registrations each week, and we remain on track to launch the portal nationwide later this year. We continue to improve our electronic medical record connectivity. We have added over 3,500 new client EMR interfaces year to date and are on pace to exceed 7,500 in 2012. We continue to pursue our open platform strategy, allowing our customers to connect seamlessly to Labcorp directly or via the EMR of choice. We continue to expand the capabilities of our Beacon platform to deliver data aggregation and advanced analytic services, including Labcorp data sets alongside diagnostic guidelines, prescription data, and hospital information to aid physicians and healthcare administrators in treatment and population management. These new data sources are industry-leading services that should assist our customers in multiple ways as they seek to improve patient outcomes and reduce the cost of care.

The third pillar of our strategy is to continue to improve efficiency to offer the most compelling value in laboratory services. We are pleased to report that the Labcorp Touch accessioning and workflow tool is now installed in over 1,500 locations, and deployment is nearing completion. Labcorp Touch, including AccuDraw, automates key aspects of our specimen collection, improving quality by reducing secondary collections by 50% and significantly reducing accessioning labor. Additionally, Touch and our enhanced logistics capabilities allow us to move specimens more rapidly through our supply chain, widening our lab testing windows and improving turnaround times. We have expanded our patient self-service offerings through two key enhancements. First, our online appointment scheduling system now allows patients to enter demographic and insurance information, reducing their registration time at our PSCs and enhancing our efficiency and their experience.

Second, in select markets, we have introduced a telephonic voice recognition system to schedule appointments in our patient service centers. We began the rollout of the Vantage Positive ID system in our histology testing division. The system will improve quality, standardize workflow, and enhance throughput across all of our histology operations. We anticipate the rollout of the Vantage system to last approximately 18 months. We are preparing to pilot our splitting and sorting robotic system, which we call Propel, over the next several months. We are excited about this opportunity to enhance efficiency and quality. The fourth pillar of our strategy is to continue scientific innovation at reasonable and appropriate pricing. We introduce new tests and collaborate with leading companies and academic institutions to provide our physicians and patients with the most scientifically advanced testing in our industry.

We recently launched an age-based guideline initiative for cervical cancer and STD screening. This innovative age-based test protocol aids physicians in ordering cervical cancer and sexually transmitted disease screening tests. Clinicians can now select a test number that will individualize cervical cancer and STD testing based on the patient's age and corresponding test protocol, as published in the American Congress of Obstetricians and Gynecologists Guidelines. We continue to enhance offerings in the NuSwab family of tests. NuSwab allows us to perform multiple women's health tests selected by the ordering physician from a single collection swab. We are the only laboratory that has validated each test we offer on the precise collection device used for NuSwab testing, meaning that doctors and patients can be assured of the highest quality results to guide diagnosis and treatment.

In May, we announced our collaborative relationship with Ariosa Diagnostics, through which we offer an innovative non-invasive test for detection of common fetal trisomies using DNA in maternal blood. The test is performed using a maternal blood draw taken at a doctor's office or patient service center and provides accuracy approaching that of invasive testing for common fetal trisomies. The fifth pillar of our strategy is to develop alternative delivery models. We continue to discuss alternative models with managed care partners, health systems, and physician groups, and our Beacon Lab Benefit Solution product will be operationally available next quarter to better meet their needs. Our goal in this initiative is to provide payers, health systems, and physicians with a variety of options to improve laboratory quality, reduce treatment costs, and improve patient outcomes.

In summary, we are pleased with the quarter and the progress we have achieved on our five-pillar strategy. Now, Steve Anderson will review anticipated questions and our specific answers to those questions.

Steve Anderson (VP of Investor Relations)

Thank you, Dave. Can you describe the impact of the Medicare reimbursement cuts you will face in 2013?. Absent any additional congressional action through the end of the year, we would anticipate an approximate 5% reduction to the clinical lab fee schedule beginning January 1, 2013. The Affordable Care Act baseline for the 2013 update to the clinical lab fee schedule will be a negative 0.95% based on the recently published CPIU and productivity adjustment figures. As part of the sustainable growth rate fix, the clinical lab fee schedule will be rebaselined an additional 2% lower, effective January 1, 2013. Further, absent any congressional activity, mandatory sequestration will impose an additional 2% reduction in the clinical lab fee schedule, effective January 1, 2013. Together, these cuts sum to an approximate 5% cut to the clinical lab fee schedule, which represents approximately 12% of our total revenue.

In addition to the reduction in the clinical lab fee schedule, mandatory sequestration will impose a 2% reduction in the physician fee schedule, effective January 1, 2013. The physician fee schedule represents approximately 2% of our total revenue. Can you update us on the status of the inquiry you received from the Senate Finance Committee?. Labcorp continues to work closely with the staff of the Senate Finance Committee to respond to their request for information. We were the first company to meet with the committee staff shortly after receiving their letter asking us to provide a responsive overview of how our contracts with managed care organizations work. We continue to work closely with the staff to respond to their inquiry. Can you update us on the mix of your business coming from esoteric testing?.

For the year, approximately 40% of our revenues were in the genomic, esoteric, and anatomic pathology categories. As we reiterated last quarter, our goal is to increase our esoteric test mix to approximately 45% of our revenue within the. Now, I'd like to turn the call back over to Dave.

David King (Chairman and CEO)

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

Operator (participant)

Ladies and gentlemen, if you wish to ask a question, please press star one on your phone. If your question has been answered or you wish to withdraw your question, please press star two. Your first question comes from the line of Gary Lieberman with Wells Fargo. Please proceed.

Gary Lieberman (Managing Director)

Thanks for taking the question. This is a little disorienting with Adam not getting the first question.

David King (Chairman and CEO)

Thanks. He's had plenty of questions.

Gary Lieberman (Managing Director)

Okay. I will not throw this one at him. I asked this question on the earlier call, but there is a lot of discussion continuing around pricing pressure. For a very long time, there was pricing stability, and I do not know exactly when, but it seems like five or six years ago, we started to see pressure on price. Maybe could you comment about, is there a path back towards pricing stability, and what are the challenges of getting there?.

David King (Chairman and CEO)

Yeah, Gary, I guess it's Dave. I guess I would characterize it a little differently, which is there was, I think, as everybody remembers, in 2007 and 2008, a fairly sizable pricing reset. My view is that since that time, pricing has been quite stable and that on both a unit cost and a mixed basis, pricing has generally been positive. I look at other industries, probably aside from pharmaceuticals, in healthcare services, and I see a trend where unit pricing—I mean, you look at imaging, look at hospital services, look at physician services—I see a trend where unit pricing has been fairly steadily going down, whereas for us, unit pricing has been relatively flat. In a couple of years, unit pricing has been positive.

Our pricing in this quarter was positive, and we're happy about that, and we continue to make every effort to be disciplined on pricing given the surrounding environment.

Gary Lieberman (Managing Director)

Okay. Maybe just a follow-up to that would be, with the assuming the Accountable Care Act is implemented, what kind of impact do you see on your overall unit pricing from the implementation of healthcare reform?.

David King (Chairman and CEO)

I just think it's too early to hypothesize about what's going to happen to price. There are too many variables that are in play. For example, it's been widely discussed that employers may decide not to continue to extend coverage and pay the penalty instead. If that happened and employees go to the exchanges, I mean, that has one potential pricing impact. You have potentially more patients in Medicaid, which has unit pricing implications if they're uninsured now or if they're outside the system. I just think it's too early to tell what implications the ACA would have for price because there are too many moving pieces.

Gary Lieberman (Managing Director)

Okay. Great. Thanks for taking the question.

Operator (participant)

Your next question comes from the line of Amanda Murphy of William Blair.

Amanda Murphy (Stratigic Advisor and Advisory Board Member)

Hi. Thanks, Steve. To follow up to some comments, Dave, that you made about the alternative delivery models, I'm curious, what are you seeing these days in terms of managed care's efforts to manage lab spend?. How willing are they to adopt those types of models?. Specifically, how do we think about those models impacting the P&L relative to current models?.

David King (Chairman and CEO)

I think that there is increasing focus in managed care on lab trend, not so much on lab spend because, as we have always said, the spend is 3% of total healthcare expenditure, although we provide a heck of a lot more than 3% of the value. I think there is increasing focus on trend, and the trend is utilization, and it's also what tests are being selected. I think in an appropriate way, managed care—and it's not only managed care, by the way, it's integrated delivery networks, it's health systems—are focused on what tests are being ordered and why are the tests being ordered, and are they being ordered from the right provider. I think there's more willingness to approach these issues.

Like everything, there's an implementation period, there's a learning curve, and we're still in the early stages of what I would describe as managed care and hospitals and delivery networks and health systems and even physician groups implementing a more focused approach to how tests are ordered.

Amanda Murphy (Stratigic Advisor and Advisory Board Member)

Just thinking over the next couple of years, how do we think about the offsetting factors of—I think there's been a lot of discussion about hospitals purchasing physician practices and how those test volumes or, I guess, the referral source changes the direction of the test volume. You think about hospitals selling their outreach businesses and some of the things you've talked about. I mean, how do you rationalize all of those and think about the impact to volumes over the next couple of years?. Does one seem like it's standing out more than the other?.

David King (Chairman and CEO)

Obviously, we've talked about it, and it's been widely discussed that health systems—I would describe them as big health systems—are purchasing physician practices as well as a significant number of other types of services as well, which has the potential to redirect the flow of lab specimens. On the other hand, it also has the potential to significantly increase the cost of the lab expense to the payers and even the internal costs of the laboratory services that the health systems are now providing to the physicians. To me, the increasing focus on reducing the overall cost of care and on directing not only lab work but all services to the highest quality and most efficient provider benefits us because I think we're the highest quality and most efficient provider.

Amanda Murphy (Stratigic Advisor and Advisory Board Member)

Okay. And then just last one. If you think about volumes over the past few years, they've been—it's been a challenging environment just given the macro situation. I mean, how do you think about—if you put reform aside for a second—how do you think about just general utilization of patients? Is this something that you think is a fundamental shift in how people are using healthcare, or is this something that you think, as the macro environment theoretically improves, we could see better utilization levels?

David King (Chairman and CEO)

I've always maintained that as the macro environment improves, we will see improved utilization levels. I continue to hold that view. It certainly is the case that we're in a period of low volume growth. That's the environment. It requires us to manage the business very well to be able to continue to be successful. We're also in a very, very tough macro environment with a lot of overhang of high unemployment and the economy not picking up steam the way that economists and everybody else thought that it would. I do think that has the effect of muting the use of healthcare services generally and lab services specifically.

Amanda Murphy (Stratigic Advisor and Advisory Board Member)

Okay. Thanks very much.

Operator (participant)

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

Darren Lehrich (Managing Director)

Thanks. Good morning, everybody. Just a couple of questions here. The first is just on organic growth. Could you comment a little bit on what you think your underlying organic growth was in the quarter if you X out some of the smaller acquisitions that you made over the last 12 months?.

Brad Hayes (EVP and CFO)

Darren, this is Brad. If we go back in and look at the schedule we prepared to look at the organic growth, and I'm going to speak to the volume metric, that volume in the second quarter was down 50 basis points on a year-over-year basis.

Darren Lehrich (Managing Director)

If you could just maybe comment a little bit more about the drivers of the organic growth trends, are you seeing anything that are worth pointing out in either bucket, any test categories, anything that would help put this deceleration into perspective?.

Brad Hayes (EVP and CFO)

Sure. Two things come to mind that are drivers. One is vitamin D. And the vitamin D test, as you know, grew quickly for several years, and it has since flattened out. I think that is challenging to the growth rate of overall volume. The other is in our histology area. We see continued weakness from a volume perspective in the histology category of our business. I think there some of the trends that we've talked about in the past are still with us and impacting our experience there.

Darren Lehrich (Managing Director)

Just specific to histology, is there a deterioration versus what we've heard about in the past?. Is it still kind of a single-digit decline?.

David King (Chairman and CEO)

Darren, it's Dave. I think it's just a continuation of the trend.

Darren Lehrich (Managing Director)

Okay. I guess the other question I had is just stepping back. Dave, I know you've made comments to investors and analysts over time just about the decelerating growth and the overall environment. As you think about that more and look at the company's capital structure, if this trend persists, how seriously would you consider dividend on top of share repurchase?. It seems like we're looking at much more GDP-like growth, and that may be deserving of a dividend for your shareholders.

David King (Chairman and CEO)

Yeah. Darren, I mean, we've talked about this frequently in the last 18 months and have said that our goal is to make a decision on this issue of whether to initiate a dividend by the end of this year. I think one of the confounding factors in terms of the idea of introducing a dividend is if what I'm reading in the press is accurate and nothing changes in the tax structure next year, the potential marginal tax rate on dividends could be 45%. That, in my view, really takes away from the attractiveness of a dividend. Some of it is going to depend on what is Congress and the executive branch going to do, and are they going to be able to come to any agreement about the tax structure?. The second is, what do we see in the environment?.

Darren Lehrich (Managing Director)

Okay. And then last thing here, just maybe a comment on strategy. It seems like one of the bigger market share opportunities for the big labs still remains to be hospital business. I know you've commented a little bit on this, but maybe can you just update us maybe more specifically on how you're approaching that market?. What types of things you're working on there that might allow you to capture share in that realm?.

David King (Chairman and CEO)

Yeah. I think when we think about the system, the system is certainly becoming, the healthcare system is becoming more health system-centric. I think hospitals are becoming more than hospitals. Hospitals own physician practices. They own urgent cares. They own acute care facilities. They own imaging facilities. Hospitals are transforming themselves into integrated delivery networks, broader health systems. I continue to believe that we have all the tools in place. We have all the right strategies to demonstrate to hospitals and health systems that we can improve the quality of the laboratory services and ultimately of the patient care that is delivered, and we can help them reduce their costs. I think some of it is that the health systems also need to increase their awareness of the savings and quality improvement opportunities. Managed care payers need to increase their awareness of the savings and quality improvement opportunities.

We need to continue to refine the message and refine the financial analytics that demonstrate that. I think there are opportunities on all sides of the equation, but I continue to believe that we are extremely well-positioned to benefit from what we are all going to see, which is in the next several years, there is going to be pressure to reduce costs. The higher costs, less efficient providers are going to be disadvantaged, and the more efficient providers, particularly the high-quality, more efficient providers like Labcorp, are going to be in a strong position.

Darren Lehrich (Managing Director)

Thanks very much.

Operator (participant)

Your next question comes from the line of Ricky Goldwasser with Morgan Stanley. Please proceed.

Ricky Goldwasser (Managing Director)

Good morning.

David King (Chairman and CEO)

Good morning.

Ricky Goldwasser (Managing Director)

A couple of questions. First, the first one is more focused on the near term. If you can just detail for us what would be the impact of the MedTox acquisition on pricing metric in the second half of the year?.

David King (Chairman and CEO)

Ricky, since we haven't closed, we haven't incorporated any of the MedTox numbers into our evaluation. Obviously, MedTox is a public company, so you can look at their revenues and their reported price and do that math, but it's not something that we're incorporating into our outlook for the rest of the year until we actually close.

Ricky Goldwasser (Managing Director)

If we just think about it, about the trends, should we think of it as a headwind or a tailwind to second half as we kind of work it through our model?.

David King (Chairman and CEO)

I actually don't know because I have not looked at their, I believe their PPA is comparable to ours. Again, it's a publicly reported number, and so the calculation should be relatively easy to do.

Ricky Goldwasser (Managing Director)

Okay. And then just kind of longer term as we think about kind of industry growth, and I think you commented earlier on your expectation for volume to go back to kind of historical rates as the economy improves. When you think about kind of top-line growth and the mix between volume and price, should we get to kind of historical 4%-5% top-line growth just from core business fundamentals improving, or are you looking to augment top-line growth with complementary acquisitions that are not necessarily kind of in core business, but just looking outside core? What would you see as complementary?.

David King (Chairman and CEO)

We've always said our foundation model was 4%-6% top-line growth. It was a combination of volume, price, and some small fold-in acquisitions. That continues to be our view of the long-term opportunity. When we think about complementary acquisitions, you can't say yes, and you can't say no hypothetically to anything without having had a chance to evaluate it. I wouldn't rule out something that would be highly complementary to what we do. Over time, we've done some of those things. They've been very small. For example, we've acquired small IT companies that provided capabilities to do things that we felt it was easier to buy than build. I wouldn't rule anything out. I think each one we would have to evaluate on a case-by-case basis. We would have to determine is it complementary to our core competencies?.

Does it give us the opportunity to advance our strategy?. Do we have the management capabilities to run it?. Those are the factors that we've obviously—what would the return be?. How would this add value to shareholders?. Those would be the things that we would evaluate in any situation where we look at a complementary acquisition.

Ricky Goldwasser (Managing Director)

Okay. Would it be fair to say that for the time being, your key focus is on the more small fold-in acquisitions?.

David King (Chairman and CEO)

Yes.

Ricky Goldwasser (Managing Director)

Okay. Great. Thank you.

Operator (participant)

Your next question comes from the line of Lisa Gill of JP Morgan. Please proceed.

Gavin Weiss (Director of Corporate Finance)

Hi. This is actually Gavin Weiss in for Lisa, and hopefully this will go a little bit more smoothly than our performance on the last call. In the press release, you noted that you expect Genzyme to be slightly accretive, which I believe is consistent with what you said previously. Can you clarify if there have been any changes in your expectations for Genzyme?. Is it more or less accretive than you previously thought?.

David King (Chairman and CEO)

I didn't listen to the last call, but obviously there's something I need to go back and listen to, I guess. No, our expectations.

Gavin Weiss (Director of Corporate Finance)

Sorry. You don't need to.

David King (Chairman and CEO)

Our expectations for Genzyme have not changed in terms of what we set out at the beginning of the year.

Gavin Weiss (Director of Corporate Finance)

Okay. That's very helpful. Thank you.

Operator (participant)

Your next question comes from the line of Isaac Ro of Goldman Sachs. Please proceed.

Isaac Ro (VP)

Hi. Good morning. Thanks for taking the question. Just a quick clarification one on vitamin D. Is there something in there beyond just sort of the comps there that you think is driving the slowdown?. Specifically, what I'm wondering is, do you see any signs of pushback from payers with regards to the amount of vitamin D testing that gets done?.

David King (Chairman and CEO)

Isaac, it's Dave. There have been some proposals by a couple of the Medicare carriers to impose diagnosis-related requirements on vitamin D. They certainly are not material to the overall utilization. I think what's happened is we have reached a plateau with vitamin D, which is that there was tremendous growth as there was widespread physician adoption. Now the test is largely adopted. The utilization is where physicians think it's appropriate. We have just seen it flatten off.

Isaac Ro (VP)

Okay. Fair enough. Maybe if I could ask a more structural question long-term. We're obviously in a, based on economic forecast, sort of protracted period of sluggishness. To the extent that continues to be a headwind for volumes, how do you look at maybe taking the asset base you have?. You obviously touch millions and millions of people in the healthcare system. Are there other verticals that you might consider expanding into?. You've obviously bolted on with incremental capabilities, but I'm just trying to think out of the box here regarding other ways in which you can try and monetize the access you have to the healthcare system.

David King (Chairman and CEO)

I think, as I've said in response to Ricky's question, we always look at things that might be interesting that could be complementary. Again, the question is, is it going to create value for shareholders?. Are we going to get an acceptable rate of return on invested capital?, Do we have the—does it fit with our core competencies?, Do we have the management capabilities to run these things?. Obviously, I mean, we've all read the reports of a number of recent acquisitions that one could argue are, if not outside the fairway, at least on the edges of the fairway for some sizable services businesses. We continue to look at opportunities.

I don't have anything specific that I can point to and say, "This is a terrific opportunity for us." We continue to look at what might be out there in the marketplace that we would have the capabilities to run and that would enhance value for our shareholders.

Isaac Ro (VP)

Got it. If you guys talk at maybe a board level, sort of a horizon, I mean, if we're in a period of protracted sluggishness, I mean, there sort of becomes this question of rates stay low, there's tons of cash flow in the business. I understand the comment on returns, but I mean, we've seen a lot of other adjacencies in healthcare where companies maybe take a short-term hit to returns in the interest of a long-term strategic shift. If we sort of stay in this current volume environment, is there a deadline here where you might start to revisit your hurdles there to kind of pivot into a new business?.

David King (Chairman and CEO)

I think I'm not going to comment on what we talk about at the board. I think at every level of the company, we consistently review our strategic focus, and we review what the business opportunities are in healthcare services generally and the laboratory industry specifically. I'm hesitant to say that there's a deadline by which we're going to do something simply because we're in a rapidly changing environment. Granted, we're in a low-growth environment, but with 2014 ahead, if the ACA is implemented, there could be dramatic change in the overall healthcare environment. As I've mentioned earlier on the call, we're in an environment in which the center of gravity in healthcare services is moving towards broader integrated delivery networks and broader health systems, larger and larger physician groups. These are all things that continue to evolve, and we're going to continue to evolve with them.

Isaac Ro (VP)

Fair enough. Thanks so much.

Operator (participant)

Your next question comes from the line of Kevin Elledge of Piper Jaffray. Please proceed.

Kevin Elledge (Analyst)

Good morning, guys. Thanks for taking the questions. First, just wanted to congratulate Adam again on joining the company.

David King (Chairman and CEO)

Thank you.

Kevin Elledge (Analyst)

Not to beat the dead horse on the volume environment, but I was just wondering if there's any way you can quantify or how much of this do you think is cyclical versus structural?.

David King (Chairman and CEO)

I think it's hard to come up with a number, Kevin. I mean, if we look back at the first quarter of 2011, when I think people had the general sense that the economy was getting better, that we were kind of coming out of the 2009, 2010 funk, organic volume growth was about 3%. Pretty good. Very good. As we went through 2011 and it became clear to, I think, that we weren't coming out of the funk and that, in fact, Europe was going into the funk and employment was not improving and the fundamentals of the U.S. economy were not really getting much better, we saw organic growth decline. At the beginning of this year, again, we had a little bit of a pickup, and this quarter, we saw a decline.

I continue to believe that the data suggests that when the economy gets better, we are going to return to better utilization trends. There's no question that there is more focus on cost management and on utilization management in every aspect of healthcare services than there was three years ago. I still think this is more cyclical and less structural.

Kevin Elledge (Analyst)

Okay. Got it. Thank you. Just going back to the molecular diagnostic initiatives that have been put in place by Palmetto and the new codes that are coming out in 2013, I do not think you guys have ever really quantified what % of your revenues might be impacted by this. Could you give us any update on that?.

David King (Chairman and CEO)

Yeah. I mean, let me just say, as I think I've said a number of times, in our view, first of all, we support enhanced transparency in billing and coding. The amount of molecular testing that is billed to Medicare is quite small, and this is not a material component of our revenue, and it also is not going to have a material impact on our financials.

Kevin Elledge (Analyst)

Got it. And then just last question. Could you give us an update on the managed care contracts?. I think Humana was coming up at the end of this year. Has that been renewed?. And then you have, what, Cigna and WellPoint next year?.

David King (Chairman and CEO)

Humana is coming up at the end of this year, and we're deep in discussions with Humana. Cigna is the middle of next year, and we're in discussions with Cigna as well. As we mentioned earlier on this call, we extended WellPoint on a multi-year basis with stable pricing and retaining exclusivity in all of our key markets.

Kevin Elledge (Analyst)

Got it. Thank you.

Operator (participant)

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

Gary Taylor (Managing Director)

Hi, guys. Good morning. One question I wanted to ask about—you may have talked about this and I missed it—but what are trends on tests per requisition or accession and what really drives that?. Is that just product selection as a primary driver on that?.

Brad Hayes (EVP and CFO)

Hey, Gary, it's Brad. We continue to see an increase in that trend. If we look back over a long time of history, it has continued to go up. I would say that just new tests—I mean, vitamin D would be a good example that we've talked about many times on the call today—new tests or tests that have a new application or new use in the practice of medicine, we believe, drives that trend. The other thing that's helping that trend, I believe, is the aging population because we do know from looking at our different parts of our business that older patients receive more tests per encounter than do younger patients. I think it has many factors, but the ones I just mentioned, I think, are the primary drivers.

David King (Chairman and CEO)

Gary, it's Dave. Just a little more color on that. I mean, first of all, there are small increases in the number of tests per requisition year-over-year. They are not a test per requisition. They are tenths of a test per requisition. The second thing is, just to be clear, it is one of our fundamental principles that we offer physicians a wide variety of choices in how they select and order tests. We offer them a very broad menu. They may choose to have groups of tests that they have pre-selected, but we offer them a very broad menu and the ability to order every test individually, other than the tests that are grouped into panels by CMS, for example. It is physician choice that is changing the number of tests per requisition, not product choice, to use the word you used to describe it.

Gary Taylor (Managing Director)

One sort of pseudo follow-up on that, just kind of thinking forward, I mean, obviously, you guys have mentioned ACOs a little bit, and those are just getting started, and some of the financial incentives for physicians are initially much more limited than you could see down the line, or we have seen, for example, in California where physicians are in capitated models. I mean, do you have enough experience, I mean, maybe in California with groups like HCP, which DaVita bought, which are on a full capitated model, and what sort of impact there is on lab utilization versus fee-for-service?. I mean, all of these big integrated medical groups that have taken capitation talk about really substantial reductions in imaging and hospital inpatient utilization. I would guess that, to a certain extent, lab testing falls into something as well where utilization is impacting negatively.

Do you have enough experience with that to comment on that?.

David King (Chairman and CEO)

Yeah. Normally, in that type of an environment, Gary, we would be subcapitated to the capitated provider. We might have, and we would have, carve-outs for specific types of testing that would not fall within the subcapitation, whether they're molecular testing or things that are not included in a capitated rate. Even in our capitated managed care plans and in our subcapitation with IPAs, I don't think there's huge negative impact on utilization. Obviously, there are pricing implications of subcapitated models, but I don't think we see huge impact on utilization. Again, I think that just goes to the point of I do not think that doctors are deliberately over-ordering lab testing or even deliberately over-ordering images or, I mean, that's not what physicians do. I think there's liability concerns for many physicians.

There's patient demand for many physicians where a patient comes in and says, "My knee has been hurting for three weeks, and I want an MRI done." I don't think any, other than truly bad people, I don't think anybody sets out as a physician to overuse services. I think that there are a number of drivers in the system that lead to utilization. This is the whole intention behind the LBS. It's not to tell people you can't order lab testing. It's to help physicians order the right test for the right patient at the time the patient needs it from the highest quality provider at the most effective cost.

Gary Taylor (Managing Director)

Yeah. I don't disagree with that, I guess. Obviously, we've seen if there's a financial incentive to use less services or incur less costs, that marginal test or diagnostic might fall to the wayside. If you're subcapitated, I mean, if you saw a growth of that, clearly, you're not going to, I guess, be willing or able to make some of the pricing or revenue concessions you've made in some of your existing capitated book. I guess that would be a fair conclusion, right?.

David King (Chairman and CEO)

Yes. By the way, I do agree with you that one of the things that can change the equation is when physicians have a financial interest in the services that they're ordering. That is a negative for the system, and it's a negative for utilization, and it's a negative for the highest quality patient care.

Gary Taylor (Managing Director)

Okay. Thanks.

Operator (participant)

Your next question comes from the line of Dane Leon of Macquarie. Please proceed.

Dane Leone (Research Analyst)

Hey, thanks, guys. Thanks for taking the questions. I had a question on Genzyme Genetics, actually, and how that integration process is going. Maybe you could just provide a high-level update on when you think you'd hit your ROIC hurdle rate for that deal in the future, 2013 or 2014, be it. It seemed like you nuanced something in the press release, and I was just wondering if it was a change in the integration strategy or timeline than what had been previously stated.

Brad Hayes (EVP and CFO)

Yeah. Dane, this is Brad. Just wanted to comment. The integration's going well. I mean, we started out this process with a multi-year integration plan, and I would say so far we are on track. We would expect to come out of 2013 with some improvement still in early 2014 at the levels that we started out believing that we would achieve. Nothing in our thinking has changed in terms of that timeframe or that experience as part of the integration.

Dane Leone (Research Analyst)

Okay. Great. Just, I know this question's been asked over and over, but just on the, I guess, high-level on the volume growth, just trying to parse out the macro issues here. Because, I mean, the comps year-over-year on the volumes have obviously been affected by some of these high deductible health plans, but should have been boosted a little bit by just that natural demographic shift. Employment year-over-year has kind of comps out to zero, I think. Maybe it's incrementally more negative. Just what is, I mean, why is there something structurally different? I mean, what can you do in terms of content to help drive it?. You've had a number of introductions of interesting tests in oncology. Is it just really sluggishness with a routine business that's kind of overwhelming everything else?.

Or is it a temporary fact, that hiccup maybe in the esoteric business, that we could see a re-acceleration in potentially later this year?.

David King (Chairman and CEO)

Dane its Dave. I do not really think there is much to add. I think we have covered this topic in as much detail as we can really offer you. The macro environment is tough. Unemployment is not getting better. Managed care enrollment is not getting better. I think we are doing a very good job in terms of executing on our company priorities and our five-pillar strategy, but we cannot make the external environment improve for us.

Dane Leone (Research Analyst)

Okay. Just the last question. Can you just give an opinion or some color on the market for acquiring hospital outreach programs or customer lists at the smaller scale, something that you do not really report?. Is that environment becoming more competitive?. We have heard some private equity groups getting into the roll-up game with the smaller labs. I am just curious for your thoughts on that.

David King (Chairman and CEO)

I think the acquisition market is always competitive. I wouldn't describe it as any more competitive or less competitive today. The industry remains highly fragmented. The barriers to entry remain extremely low. It is a very intensely competitive market for starting businesses and for acquiring them and for running them.

Dane Leone (Research Analyst)

Okay. Thank you.

David King (Chairman and CEO)

Guys, we have about five minutes left, so we're going to try to, if you're asking, if you're going to ask again about the environment, maybe we can go over, not pass over that. And if you have substantive questions, we'll be happy to address them.

Operator (participant)

Your next question comes from the line of Anthony Vendetti at Maxim Group. Please proceed.

Anthony Vendetti (Executive Managing Director)

Yes. Thanks. You had talked about the weakness in histology and vitamin D. I guess vitamin D had been strong for a while, and that's dropped off. Can you talk about some of the other tests that you think will help drive genomic and esoteric testing to 45% of revenues in the next three to five years?.

David King (Chairman and CEO)

Yes. We've seen really nice growth in our specialized endocrinology business, our specialized coagulation business. We have seen good performance in cardiovascular where our chronic kidney disease program is having terrific success in terms of year-over-year growth. We're very pleased about the progress with NuSwab, with the age-based guidelines for sexually transmitted disease testing, which specifically follows the ACOG recommendations. The physician is able to select based on what ACOG tells them to do. The universal carrier screening tests, Genzyme Genetics, Integrated Genetics, the Ariosa non-invasive fetal trisomy tests, a number of oncology markers, and of course, continued development of our next-generation sequencing platform for even broader analysis of tumors, cancers, and oncology generally. I think there are a lot of terrific things going on at Labcorp. Again, outside of this environment, I think we will see nice improvement in utilization and esoteric testing growth.

Anthony Vendetti (Executive Managing Director)

Okay. Great. Thanks a lot.

Operator (participant)

Your next question comes from the line of Hima Inguva of Bank of America. Please proceed.

Hima Inguva (Managing Director)

Thanks for taking my question. I'd like to know your outlook on M&A for the remainder of the year. Do you expect to see smaller bolt-ons?. Would you be open to doing a larger transaction?. I have a follow-up.

David King (Chairman and CEO)

I think it would depend on what larger transaction. But I think if an attractive transaction became available, of course, we would look at it. We're in the process of doing a sizable integration with Integrated Genetics, Integrated Oncology, and we have another not insignificant integration coming up, assuming that we're able to close MedTox in relatively short order. The focus will clearly be on the fold-in, bolt-on type deals for the rest of the year.

Hima Inguva (Managing Director)

Thank you. Do you expect to access debt markets this year?.

David King (Chairman and CEO)

We haven't made a decision on that, but we're always looking at whether there's the opportunity to improve our overall capital structure.

Hima Inguva (Managing Director)

Great. Thank you. Congratulations to Adam again.

David King (Chairman and CEO)

Thank you.

Operator (participant)

Your next question comes from the line of Sandy Draper of Raymond James. Please proceed.

Sandy Draper (Director)

Thanks very much. Most of my questions have been asked and answered. Just maybe a quick clarification. I think at some point you guys have talked about either how much organic volume growth or total topline growth you need to get margin expansion, excluding any cost-saving activities. Could you just remind me what that is and tell me if it's total topline growth, indiscriminate of price or volume, or if it needs to be dependent on volume?. Thanks.

Brad Hayes (EVP and CFO)

Sandy, this is Brad. I don't know that we've ever put that out there in terms of a hard and fast number. I go back to kind of the way we think about the business in that 4%-6% topline growth range, which, as Dave mentioned earlier, has some tuck-in acquisitions built into it. It creates nice leverage in our business regardless of any cost structure to grow our margins and our earnings. I don't think I have a grid of, "Okay. At this level, it's this. At this level, it's that." We're always working on the efficiencies that Dave mentioned as part of our prepared remarks.

David King (Chairman and CEO)

Sandy, it's Dave. I mean, obviously, if you get 3% unit pricing growth, it's easy to get margin expansion. There is a lot of leverage in the volume. We tend to think of it as it's a combination, like everything in this business, it's a combination of the impact of volume and price.

Sandy Draper (Director)

Great. Thanks for the comment, guys.

Operator (participant)

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

Darren Lehrich (Managing Director)

Thanks. Just a quick housekeeping item. On the equity method income, you obviously had a $2.9 million increase there that you've disclosed. I guess the question I had is, will you have a new Canadian partner in this calendar year, or should we expect the equity method income to remain pretty consistent now that you own basically 100% of that?.

Brad Hayes (EVP and CFO)

Daren, this is Brad. One thing I'd like to point out too on that $2.9 million, that was excluded. That gain was excluded from our adjusted EPS. I want to make sure people appreciate that. On the second question, we're always looking at our business structure in Canada and thinking about partners and how we own and operate that business. It would be speculation to think about what might happen between now and the end of the year.

Darren Lehrich (Managing Director)

Okay. Thanks very much.

Operator (participant)

At this time, there are no further questions. I would now like to turn the call back over to David King.

David King (Chairman and CEO)

Thank you very much, Reg. We appreciate everyone listening this morning and wish you all a good day.