Quest Diagnostics and LabCorp Report Q-4, Full Year Earnings

Modest gains in revenue, volume, and operating profit reflect some contribution from lab acquisitions

IN RECENT WEEKS, each of the nation’s two largest public laboratory companies reported earnings for fourth quarter 2011 and full year 2011. Organic growth at both lab companies continues at low single-digit rates.

This continues the pattern of relatively modest growth that has been posted by each of the two lab behemoths. On the other hand, both lab companies continue to generate significant amounts of cash for their shareholders.

At Quest Diagnostics Incorporated, revenue and operating income for Q4-11 was up 3.0% and 10.5%, respectively. Revenue totaled $1.9 billion and operating income was $325.1 million.

For the full year 2011, Quest Diagnostics posted revenue of $7.5 billion, compared to $7.4 billion in 2010. This was an increase of 1.9%. Operating income was $1.3 billion in 2011, versus $995 million in 2010, for an increase of 30.2%.

At Laboratory Corporation of America, Q4-11 revenue grew by 5.5% and operating profit for Q4-11 grew by 3.6%. Revenue was $1.4 billion and operating profit was $47.4 million.

Helped by its acquisitions, LabCorp posted revenue growth of 10.8% for the full year 2011, to $5.5 billion, compared to $5.0 billion of revenue in 2010. Operating profit (before adjustments) for the full year 2011 decreased 3.1% from $979 mil- lion in 2010 to $948 in 2011.

Quest Diagnostics stated that its acquisitions of Athena Diagnostics, Inc., (closed April, 2011) and Celera Corporation (closed May, 2011), contributed 2.2% to its revenue growth during 2011. LabCorp stated that Genzyme Genetics (which LabCorp purchased before the end of 2010) contributed 3% to its Q4-2011 revenue growth.

Visits to Doctors’ Offices

One aspect of the lab testing marketplace that was closely-watched by financial analysts during 2009, 2010, and into 2011, was the change in patient visits to office-based physicians. During these years, executives from both Quest Diagnostics and LabCorp had commented that quarterly declines in patient visits were one factor in why specimen volume growth at their respective firms was nearly flat, or as reported in some quarters by Quest Diagnostics, even declining.

During the Q4-2011 conference calls, there was not much discussion about this aspect of the lab testing market. However, Amanda Murphy CFA, Analyst at William Blair & Company, LLC, in her coverage of the Quest Diagnostics earnings report, included a chart that showed, for fourth quarter 2011, patient visits to doctors’ offices in the United States increased by about 0.5% over the fourth quarter of 2010. (See sidebar below.)

For pathologists and lab administrators competing against the two blood brothers, the conference calls provided useful insights about the primary business strategies and outcomes for each lab company. Quest Diagnostics, for example, wants to drive revenue growth in three ways.

Quest’s Growth Strategy

Its CEO, Surya N. Mohapatra stated to analysts, “As we have said before, our growth strategy is based on three elements: driving innovative new tests and advanced healthcare IT services, enhancing sales effectiveness, and strengthening our relationship with health plans and other payers.”

Mohapatra then noted that esoteric and gene-based testing grew 17% for the quarter and by 11% for the full year. He said that Vitamin D testing volume had increased by 12% and that SureSwab volume was up by 40%.

Quest Diagnostics has told analysts that it intends to achieve a $500 millon reduction in costs in the next few years. This is an ambitious goal for a company that, early in 2007, had similarly pledged to remove $500 million in costs over the subsequent 36 months.

To achieve this goal, Quest’s CFO, Robert A. Hagman, explained that specific teams had been organized and were focused on “specimen acquisition, which includes all the costs associated with obtaining and transporting samples; client support, which includes billing and customer service; the labs themselves and all the costs associated with operating them; IT and customer connectivity costs; procurement and supply chain; and SG&A, both in the field and at corporate.”

$500 Million in Cost Savings

Hagman explained that about 1/3 of the targeted savings of $500 million will come from client support, procurement and supply chain. “We plan to leverage technology to eliminate manual work, further standardize systems and processes, implement more self-service options for customers, and leverage Lean Six Sigma to further streamline activities,” he stated. “In client support and billing, we plan to reduce manual work and customer call volume by enabling customers to do more online, including supplying insurance information, making payments, checking on the status of a bill, and obtaining test results.

“…In the area of procurement and supply chain, we will further consolidate suppliers, rationalize SKUs, standardize and optimize specs, and work more closely with our suppliers in sharing information and managing costs from design to manufacture to distribution,” continued Hagman. “We plan to… unlock the savings associated with bulk buying and the administration associated with handling all these different choices.”

Simplifying Processes

As much as 1/3 of the targeted savings at Quest Diagnostics are “…expected to come from SG&A, including information technology (IT),” Hagman stated. “We are flattening the organization structure and simplifying management processes, which will not only reduce costs but drive increased accountability.

“In the area of IT, we will place greater emphasis on connectivity solutions which don’t require computer hardware,” he said. Over time, this will dramatically reduce the cost of serving the tens of thousands of pieces of equipment we have in the field. In addition, connectivity installations will be done quicker and at lower costs.”

On the subject of physician adoption of Quest Diagnostics’ IT solutions, Mohapatra told analysts that up to 200,000 physicians and clinicians cur- rently use the company’s Care360 system for lab test orders and lab test results. “Our Care360 electronic health record (EHR) is now utilized by 4,400 physicians and has enabled them to receive payments for meaningful use,” added Mohapatra. “Last week, we announced a plan to help physicians nationwide adopt EHRs through our Care360 EHR grant program.” On Quest’s website, it states that, in selected states, the company will pay for up to 85% of the cost of the Care360 EMR and pharmacy management solution.

In the area of anatomic pathology (AP), Quest Diagnostics continued to see an erosion of revenue. In 2011, the decline in AP revenue was 5%, which was an improvement from 2010, when AP revenue decreased by 10%. “…that’s a piece of our business that we expect will continue to be under pressure from insourcing,” stated Hagman during the conference call.

Quest Diagnostics wants to leverage its low prices, particularly when compared to how hospital laboratory outreach programs bill for testing services. In response to an analyst’s question about what steps Quest Diagnostics is taking to help managed care plans drive lab testing to the cheaper labs in payer networks, Mohapatra replied that, along with discussions with payers “…we’re talking to the employers, and the whole objective is… to meet their goals, they [the payers] have to persuade the doctors to send the testing to our network and to avoid the high-cost providers [like hospital labs].”

In its conference call with financial analysts, LabCorp specifically called attention to projects to improve lab operations and change the patient experience. For example, during the call, LabCorp CEO David King talked about how his company is automating certain patient service functions.

In specimen collection, the centerpiece of this strategy seems to be LabCorp’s “Touch AccuDraw” system. “The system is now deployed in more than 1,100 sites across the country and is processing over 1 million accessions per month,” observed King. “We continue to enhance the system that allows our phlebotomists, a critical link in our sample flow, to improve accuracy, workflow and processing time to enhance the patient experience in our patient service centers (PSC).”

Automation in PSCs

LabCorp wants to deploy this solution across all its patient service centers and even into physician offices where it maintains its own phlebotomists. The company plans to implement voice-activated appointment scheduling for patients, so those patients “who do not want to use computers can schedule an appointment without a live operator,” noted King. “We will explore collecting demographics in advance of patient encounters so that we can further expedite the blood-drawing process and improve the patient experience.”

Vitamin D testing and histology/ anatomic pathology trends at LabCorp are similar to those at Quest Diagnostics. Without mentioning a specific number, LabCorp CFO Brad Hayes told analysts that, when measured by volume, there is a “flattening of Vitamin D and also flattening in our histology business.”

LabCorp’s cost-cutting energies are directed toward workflow redesign in lab operations and more use of automation. King specifically mentioned efforts involving “lab automation, patient service center automation, and improvements in throughput of instrumentation.”

How To Deliver More Growth

Both national laboratory companies must deal with more challenges to deliver the level of growth that is sought by investors. The truth of that conclusion is reflected in the topics emphasized by the executives at each lab firm, particularly the emphasis given to internal cost-cutting initiatives.

Clearly both companies are spending substantial capital to increase their use of information technology, particularly in ways that improve patient service levels. In this way, the service bar in the competitive marketplace will be raised.

Process improvement and workflow redesign via the use of Lean, Six Sigma, and similar management methods are getting more attention within both national lab firms. There will be increased deployment of laboratory automation in ways that support Lean work flow.

But what may turn out to be the most interesting development for the national laboratory market is that—if Quest Diagnostics and LabCorp have reached a plateau in their ability to increase market share—then continued use of deeply-discounted lab test prices will begin to work against them. After all, how can any lab make money when it sells tests at prices that are less than its fully-loaded cost? (See related story.)

Thus, with options for increasing specimen volume ever more limited, will both lab companies quietly begin to raise prices on their existing business? After all, that is one proven way to increase net profits in ways that please shareholders.

Patient Visits to Office-Based Physicians Rose Slightly during the Fourth Quarter of 2011

THE GRAPH BELOW SHOWS THE PERCENT CHANGE each quarter in the number of patient visits to physician offices from quarter one 2007 through quarter four 2011, as reported by IMS Health. The recession did not start until December 2007, yet a sustained trend of quarterly declines in patient visits to physician offices began as early as quarter one 2007.

Some experts connect the trend of declining office visits over this five-year period to both the recession (more unemployed individuals who don’t have health insurance) and the higher deductibles and co-pays employees must pay as employers shift some of the increased cost of health benefits onto their employees. During 2010, in particular, financial analysts believed the ongoing quarterly declines in the number of patient visits to physician offices was a factor in the lackluster financial performance of the national laboratory companies. The start point and end point of the last recession is marked.

One notable observation is that, in only two quarters over the past five years did patient visits to physician offices increase in that quarter, compared to one year earlier. In fact, in each of the 10 quarters since the end of the recession, patient visits declined or remained flat, when compared to the same quarter in the previous year.

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