CEO SUMMARY: In their respective earnings reports for the fourth quarter and the full year of 2018, executives at both Laboratory Corporation of America and Quest Diagnostics told financial analysts that the Medicare fee cuts of 2017 and 2018 were reducing revenue and operating margins. More significantly, both lab companies told analysts they expect greater acquisition activity as hospital administrators respond to lower Medicare prices by selling some or all of their lab businesses.
DURING THEIR LATEST QUARTERLY CONFERENCE CALLS with Wall Street analysts, the nation’s two largest publicly-traded clinical lab companies reported this month that the effects of the federal Protecting Access to Medicare Act (PAMA) of 2014 are rippling through the clinical lab industry in four significant ways.
Executives from Laboratory Corporation of America and Quest Diagnostics said the following:
- PAMA has cut into the earnings of the nation’s two largest clinical lab companies, LabCorp and Quest Diagnostics.
- PAMA will have a negative effect on earnings this year.
- PAMA is having an even more adverse effect on the revenue of smaller labs and hospital labs, causing some to report no profit at all.
- Those smaller labs and hospital labs may be forced to sell out to larger labs, LabCorp and Quest reported.
In essence, this fourth effect is a silver lining for LabCorp and Quest because both reported that they expect to acquire more lab test volume by striking deals with these smaller labs and hospital labs.
Some deals may be an outright purchase of the lab organization. In other deals, the national lab may take over some of the testing those labs do now.
Drop in State Medicaid Rates
In addition to these four known PAMA effects, executives from Quest said PAMA could be causing a decline in payments from Medicaid plans. Medicaid payments dropped in 2018, they added, and they assumed that this reduction resulted from Medicaid payers following Medicare’s lead. Under PAMA, Medicare cut payments for many lab tests by 10% last year, by 10% again this year, and Medicare is due to cut what it pays labs by 10% again next year.
One result of all these negative effects is the potential shift of lab market share away from smaller labs and hospital labs to larger lab companies, executives from LabCorp and Quest said.
To emphasize this point, Quest CEO Steven Rusckowski said the pressure that lower payments under PAMA put on all labs is a “catalyst for structural change in the lab business.”
“The impact of these [PAMA] cuts will be more significant on smaller independent hospital outreach laboratories which we believe could eliminate the majority of their profit, and will provide a catalyst for market consolidation,” he added. “Most hospital CEOs and CFOs are still not fully aware of how PAMA impacts hospital outreach labs.
“We believe that as this impact of PAMA becomes increasingly more visible, hospitals will be more motivated to work with us on their laboratory strategy,” he commented. By harming all labs—particularly those that are not market-leading labs—PAMA will cause smaller labs to sell to larger ones, he said.
But as these smaller labs struggle, Quest could benefit by acquiring lab test volume from smaller labs to offset the decline in revenue from PAMA, he explained. “When you go through the math, we believe there’s an opportunity for us to pick up [market] share in 2019, and that will continue in 2020,” he said.
Later, Rucskowski returned to this theme. “Hospitals and health systems face unprecedented financial pressures, and are therefore motivated to discuss ways we can help them with their lab strategy,” he commented. “We recently signed two new professional lab services agreements in the Southeast region. In both relationships we will provide full lab management employing technical lab staff, providing operational lab oversight, and maintaining responsibility for the lab supply chain.”
Reporting on PAMA’s effect on finances, Rusckowski said revenue declined in the fourth quarter by 1.4% to $1.84 billion versus 2017, reflecting what he called “increased reimbursement headwinds.” In all of 2018, revenue rose by 1.7% to $7.53 billion.
Quest said requisition volume in 2018 increased 3.4% over 2017 and organic requisition volume rose by 1.1%. Organic requisition volume comes from sales and not by acquiring volume from other labs.
This year, Quest expects net revenue to rise by 1% to 3%. Much of this revenue will come from adding 43 million lives and about $1 billion in revenue as a result of being in-network with UnitedHealthcare, Horizon Blue Cross Blue Shield of New Jersey, and Blue Cross Blue Shield of Georgia. (See TDR, “Lower Prices, More Data in UHC’s New Lab Network?” TDR, Feb. 4, 2019.)
“We have already seen encouraging volume growth early in 2019 resulting from this expanded network access,” Rusckowski commented.
LabCorp’s PAMA Experience
While Quest reported extensively on the effects of PAMA, LabCorp’s CEO David King and CFO Glenn Eisenberg had similar comments, but LabCorp’s executives did not offer as much detail as Quest did.
“Although we continue to see judicial and legislative relief on the second round of PAMA price reductions, there is increasing industry-wide awareness about PAMA’s true impact,” King commented. “This presents us with a number of attractive tuck-in lab acquisition opportunities, which typically deliver significant synergies and high return on invested capital.”
Just as Quest reported a decline in fourth quarter revenue, LabCorp did too. LabCorp’s fourth quarter revenue was $1.84 billion, down 1.4% versus 2017 and full year revenue was $7.53 billion, an increase of 1.7% from 2017.
Declining Income, Margin
PAMA had the biggest effect on LabCorp’s lab-testing business. Adjusted operating income from laboratory testing was $279 million (or 16.5% of revenue) in the fourth quarter compared with $357 million (or 20.5% of revenue) in 2017, Eisenberg said. The decline in operating income and margin was primarily due to the impact from the PAMA cuts to lab test prices of about $18 million in the fourth quarter and about $20 million for the year, he added.
In addition, revenue per requisition decreased by about $8 million in 2018 and was partially offset by test mix, he said, without explaining how test mix affected revenue.
LabCorp reported that revenue per requisition in 2018 dropped by 0.4% as a result of PAMA. Total volume rose by 0.3% in 2018, including an increase of 0.4% in acquisition volume and a decline of 0.1% in organic volume.
Later, during the call with analysts, LabCorp’s CFO Eisenberg predicted that revenue in 2019 would be flat or would decline by 2% “primarily due to the impact from PAMA.”
“We have assumed that PAMA will reduce our diagnostics revenue by approximately 1.6% in 2019 consisting of lower direct Medicare reimbursement of approximately $85 million and the indirect impact of approximately $30 million on other reimbursement; primarily Medicaid-related plans,” he said.
Medicaid Program Payments
LabCorp’s executives did not mention that Medicaid payers may be cutting payments for lab tests as a result of PAMA. But they did say that Medicaid plans have been more aggressive in denying payment for certain tests, such as those for vitamin D, cystic fibrosis, and for panels of tests. Also, Medicaid plans have added more prior authorization rules, which often lead to denials, they added.
These earnings reports are a first look at how the Medicare Part B price cuts for lab tests are affecting the financial performance of the nation’s biggest lab companies. If operating margins have fallen by 4% to 5% for a billion-dollar lab company with Medicare testing making up about 15% to 20% of total testing, then the financial consequences for a small laboratory generating 50% to 80% of revenue from Medicare patients means such labs are operating at a loss. Closure of these small labs will affect access for many Medicare patients.
Sonic’s Half-Year Revenue Growth is 6%
ON FEB. 20, SONIC HEALTHCARE USA reported revenue results for the last two quarters of 2018 and so reflect only six months of the company’s annual results. As a division of Sonic Healthcare in Australia, the company’s fiscal year ends on June 30.
For the six months ending Dec. 31, Sonic Healthcare USA generated US$441.8 million. That projects to annualized revenue of US$883 for its U.S. lab operations. The U.S. division represents about 21% of the company’s total revenue worldwide, making the U.S. operations the second largest division after Sonic’s operations in Australia. In its operations worldwide, the company reported a net profit for the half year ending Dec. 31 of US$159.3 million on revenue of US$2.076 billion.
Unlike Quest and LabCorp, Sonic Healthcare USA reported that the federal Protecting Access to Medicare Act of 2014 had a relatively minor effect on revenue. Sonic said the effect of reimbursement under PAMA is expected to be only about 1.3% reduction of total revenue for its lab U.S. lab division.
In the last two quarters of 2018, revenue from U.S. operations rose by 6%, the company said. Revenue from U.S. operations would have been higher by about $9 million if Sonic had not contributed to a joint venture with ProMedica in Toledo, Ohio, effective Sept. 1. Sonic now owns 49% of that joint venture. (See “ProMedica, Sonic Form Lab Outreach Joint Venture,” TDR Aug. 20, 2018.)
In the U.S., Sonic said other hospital lab opportunities and acquisitions are in the pipeline. On Jan. 30, Sonic completed a significant acquisition in the United States, paying $540 million for Aurora Diagnostics, a company that had annual revenue of $310 million, Sonic said.