Q3 Earnings Are Mixed Bag For the Two Blood Brothers

Consistent with earlier guidance, Quest Diagnostics

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IF THERE IS A NOTABLE EVENT in the laboratory testing marketplace during 2010, it is that one of the nation’s billion-dollar lab testing behemoths has reported three consecutive quarters of declines in the number of test requisitions it handled, when compared to the same quarters during 2009.

In the memory of THE DARK REPORT, one would have to go back to the 1990s to find a comparable year when any of country’s largest public laboratory companies reported a multi-quarter decline in patient requisitions. Certainly since the year 2000, neither Quest Diagnostics Incorporated nor Laboratory Corporation of America has ever reported such an unbroken string of quarterly declines in specimen volume.

Investors were not surprised when, during its third quarter earnings conference call, Quest Diagnostics Incorporated reported a slight decline in specimen volume. The company said that patient requisitions were 0.3% less in the third quarter, compared to the same quarter in 2009. This was consistent with its earlier guidance to financial analysts.

Third Quarter Performance

For third quarter, Quest Diagnostics also reported that its revenue of $1.86 billion was 1.7% less than Q2-2009 revenue of $1.90 billion. Revenue per requisition declined by 1.3% from the previous quarter in 2009, but was unchanged compared to second quarter 2010. These numbers were also consistent with earlier guidance that Quest Diagnostics had provided to Wall Street.

Meanwhile, at LabCorp, the numbers moved in a more positive direction. For example, LabCorp reported that specimen volume, as measured by requisitions, increased by a more typical 3.0% for the third quarter, compared to Q3-2009.

Decline in Specimen Volume

Like Quest Diagnostics, LabCorp had reported declines in specimen volume for both the first and second quarters of 2010. LabCorp’s declines in the number of patient requisitions were 3.0% and 2.0% for the first and second quarters, respectively.

LabCorp’s revenue increased by 7.7%, from $1.18 billion in Q3-2009 to $1.27 billion in Q3-2010. Revenue per requisition increased 2.5% during the same period.

It is interesting to speculate about why Quest Diagnostics is experiencing a string of quarterly declines in the number of patient requisitions it handles, particularly since it has been more than a decade since any similar pattern was reported by a major public laboratory company.

Two factors are different in 2010 compared to other years of the past decade. One factor is the sluggish economy, which is only marginally stronger in 2010 than it was in 2009. The popular wisdom has been to attribute declines in specimen volume throughout 2010 to the reduced number of patient visits to office-based physicians. (See chart on page 9.)

During second quarter conference calls in July, both lab companies discussed the drop-off in patient visits to physicians’ offices as one reason for the declines in patient test requisitions during the quarter. (See TDR, August 2, 2010.) However, during the third quarter, LabCorp enjoyed a 3% increase in patient requisitions while Quest Diagnostics saw the small reduction of .03%.

As a point of comparison, when Bio-Reference Laboratories, Inc. (BRLI) announced its fiscal third quarter earnings for the quarter ending July 31, 2010, it reported a healthy increase in patient requisitions. BRLI said that patient requisitions had grown 17%, climbing from 1.2 million in Q3-2009 to 1.5 million in the current quarter. Similarly, Sonic Healthcare, Ltd, of Sydney, Australia, disclosed that, for its full fiscal year ending on June 30, 2010, its laboratories in the United States posted organic revenue growth of 6.3%.

Strong Growth Rates in 2010

Thus, throughout 2010, two of the larger lab competitors serving physician offices have reported positive increases in specimen volume. This is a stark contrast to the three consecutive quarters of fewer patient requisitions at Quest Diagnostics.

Lab acquisitions—or the lack thereof—is another market dynamic in 2010 that is different from the past 12 years. Quest Diagnostics has not done a sizeable laboratory acquisition since it closed its purchase of AmeriPath, Inc., in May, 2007. This falls outside Quest Diagnostic’s laboratory acquisition pattern of the 1997-2007 period.

Thus, for the past 40 months, the primary source of new specimens for Quest Diagnostics would be its internal sales and marketing programs. During this time, direct competitors in major markets, including LabCorp, Bio-Reference Labs, and Sonic Healthcare, have been busy working to woo away clients of Quest Diagnostics.

But another market dynamic may be contributing to a steady erosion in the number of patient requisitions flowing into Quest Diagnostics. Around the nation, in major cities and rural towns, a host of hospital laboratory outreach programs are working diligently to win physician clients away from the two blood brothers.

Hospital Lab Outreach Trend

Wall Street may be underestimating the influence and market impact of the nation’s hospital laboratory outreach programs. Informed pathologists and laboratory administrators know two things about the hospital laboratory outreach trend.

First, each year, the specimen volumes at the most successful hospital laboratory outreach programs grow at double-digit rates. Quietly and off the record, these hospital laboratory outreach programs often confirm that a large number of the new clients brought in by their sales force were formerly clients of either of the two blood brothers. This is to be expected, since the combined market share of Quest Diagnostics and LabCorp is dominant in most regional markets across the United States.

Second, and equally interesting, is the fact that, in every year since the late 1990s, more hospitals and health systems have initiated a laboratory outreach testing program. Thus, the number of hospitals competing for the test referrals of office-based physicians in 2010 is significantly larger than it was, say, in 2000.

More Lab Outreach Today

To illustrate this principle, assume that there were 200 professionally-operated hospital laboratory outreach programs in the year 2000. Assume that, in the year 2010, there are now 500 hospital lab outreach programs. This implies that, not only are the two blood brothers directly confronted with more lab competitors, but these competitors are operating in a larger number of regional sub-markets across the nation. One might describe this competitive pressure against the two national laboratories as “death by a thousand cuts.”

Certainly “death by a thousand cuts” describes the steady erosion of histology and anatomic pathology case referrals experienced by the two blood brothers, as many physician specialty groups build in-house pathology labs. Both national lab companies publicly acknowledge that this single market trend has retarded their growth of specimen volume in anatomic pathology case referrals in recent years by a noticeable amount.

Thus, couldn’t it be equally true that the collective sales efforts of hundreds of professionally-operated hospital laboratory outreach programs now similarly eat into the total number of specimens reaching the two national laboratories from physician office referrals?

If the scenario described here by THE DARK REPORT is accurate, it means hospital lab outreach programs are responsible for a measurable portion of the decline in patient requisition volume reported by the two national laboratories during 2010. That would be a factor as yet unrecognized by either the lab industry or Wall Street.

It is notable that, after more than a decade of aggressive growth, 2010 has proved to be a challenging year for the national lab companies. With continuing growth in the number of hospitals launching a serious laboratory outreach program, this portends more intense competition for the lab test referrals of office-based physicians in coming years.

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THIS CHART SHOWS THE PERCENT CHANGE IN THE QUARTERLY YEAR-OVER-YEAR GROWTH OR DECLINE in the number of physician office visits for the specialties of primary care, ob-gyn, and oncology for the years 2005-2010. One interesting observation is that, during this five-year period, the trend was mostly down. Primary care office visits increased in only nine of 22 quarters. Ob-gyn office visits increased in just four of 22 quarters. Oncology office visits increased in 13 of 22 quarters, probably because patients with cancer have a motive not to delay diagnosis and treatment.

The other useful insight is that, since the beginning of the recession in the second half of 2008, the number of patient visits to primary care and ob-gyn offices has consistently declined when compared to year-over-year periods. The drop-off in patient visits to physician offices in 2010 appears to continue a general declining trend established as early as the second half of 2007.

 

 

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