Quest Diagnostics & SmithKline Release Third Quarter Financials

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It appears that 1997 will be kinder to Quest Diagnostics Inc. and SmithKline Beecham Clinical Laboratories (SBCL) than the last three years. Both companies reported improved financial results for third quarter and mixed results for year-to-date.

As of press time, Laboratory Corporation of America had not released third quarter earnings. But early indications are that LabCorp will not disclose any surprising financial news.

Throughout the year, THE DARK REPORT highlighted the changing business strategies of the three blood brothers. Third quarter earnings data demonstrate consequences of the different business approaches incorporated by Quest and SmithKline.

Early this year Quest Diagnostics stated that they intended to exert strong pricing discipline and either reprice or walk away from unprofitable business. Quest’s third quarter revenue declined 7.9% from same quarter last year, indicating they were willing to give up some amount of existing business.

Aggressive Pricing Strategy

SmithKline Beecham Clinical Laboratories pursued an aggressive pricing strategy designed to capture increased market share. Revenues at SBCL increased 9.0% from same quarter last year, as would be expected from SmithKline’s strategy of increasing business volume. Comparing how these different pricing strategies impacted profit is difficult, because SmithKline does not provide detailed financial data on the laboratory division. SmithKline did state that operating profit within the laboratory division increased for the quarter by 26%, to $39.0 million.

Quest reported that earnings before interest, taxes, depreciation and amortization (EBITDA) was $35.7 million for third quarter. Comparing the Quest number against SBCL’s is not precise, because they don’t represent the same accounting definition. But it is interesting to note that SmithKline, on a revenue base of $350 million for the quarter, earned an operating profit of $39.0 million. Quest, with a revenue base of $373.7 million, earned $35.7 million.

Similar Profit Margins

Despite different pricing and business acquisition strategies, the profit margins of both companies are quite similar. This demonstrates that the national marketplace for clinical laboratory services remains highly competitive. Prices continue to be bid to the absolute lowest levels in most regional markets.

Quest Diagnostics chose to comment on some other business statistics which are relevant for gauging the nature of the marketplace. Quest states that its revenue decline came from three basic sources: changes in government and private payer reimbursement policies, intensified competition from hospital outreach laboratories in several regions, and Quest’s strategy of refusing business which does not meet minimum profitability objectives.

Hospital laboratories considering whether to launch laboratory outreach programs should take careful note of Quest’s statement that one source of declining revenues was losing business to hospital outreach programs.

This is validation of THE DARK REPORT’S prediction several years ago, and again at the Executive War College in New Orleans last May, that the movement towards managed healthcare and integrated delivery systems would give hospital laboratory out- reach programs a competitive advantage over the national laboratories.

Phoenix provides a good example of how a well-run laboratory outreach program owned by an integrated healthcare system can gain a strong market position. Quest Diagnostics, after years of struggle to improve the market share and financial performance of its laboratory division in Phoenix, chose to join forces with a local competitor, Sonora Laboratory Sciences, owned by Samaritan Health System. The joint venture, called Sonora Quest Laboratories, LLC, combined both laboratory operations and became operational this summer.

Billing Operations

Quest Diagnostics also reported that improvements in billing operations were showing results. Number of days sales outstanding was 67 days at the end of third quarter, compared with 65 days at the end of second quarter. This stands in contrast to LabCorp’s woes in the same area earlier this year, when days sales outstanding was as high as 120 days.

Although the third quarter performance by Quest and SBCL was significantly improved over the same quarter last year, financial data for the nine months of 1997 shows mixed results over 1996. SBCL’s nine month revenues were only up 2.2% over 1996, from $982 million to $1.004 billion. Operating profit actually declined 1%, going from $94 million in 1996 to $93 million in 1997.

Putting these earnings releases into perspective, third quarter financial performance demonstrates that management strategies at Quest Diagnostics and SBCL are taking root.

Quest Diagnostics saw nine month revenues decline 5.5%, from $1.63 billion in 1996 to $1.23 billion this year. Operating profit is not relevant, as special charges in 1996 related to the divestiture from Corning Incorporated were significant.

Putting these earnings releases into perspective, third quarter financial performance demonstrates that management strategies at Quest Diagnostics and SBCL are taking root. In the last three months, cumulative management efforts are beginning to impact revenues and earnings. The question is whether recent performance gains can be sustained during the next two years.

Indications are the three blood brothers continue to endure cost cutting initiatives, staffing cutbacks and reduced capital budgets. This means that nimble regional competitors still have the opportunity to outperform the national competitors in their local markets. One such example of a nimble hospital laboratory outreach program is Presbyterian Laboratory Services, profiled on pages 9-15 of this issue.

Earnings releases by the public laboratories provide valuable evidence as to how pricing and other business strategies adopted by these laboratories are succeeding in the marketplace.


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