Second-Quarter Earnings Less Than Stellar for Quest, LabCorp

The first-half whistle has blown for the laboratory sector in 2013, and Quest Diagnostics and LabCorp are still tackling softness in testing volumes and reimbursement. Analysts are mildly optimistic about how those plans will unfurl over the coming months and years. And while companies are enjoying strong cash flow and sit on large money reserves, they are taking their lumps on the bottom line and, for Quest, in revenue as well. Quest, the larger of the two nationals, reported net income of $165 million on revenue of $1.8 billion for the quarter, both figures down from the net income of $177.7 million on revenue of $1.9 billion for the second quarter of 2012. “We saw a continued revenue softness in the second quarter due to lower health care utilization, which impacted many health care providers, as well as reductions in our reimbursement,” Quest Chief Executive Officer Steve Rusckowski said in a July 18 call to discuss earnings. According to Rusckowski, overall test volume was down 1.5 percent compared to a year ago, a marginal improvement over the 2 percent decline in volume that occurred during the first quarter of 2013. LabCorp fared a little better: Its revenue was up 3 percent, to $1.47 billion for the quarter compared to $1.42 billion for the second quarter of 2012. But net income was down to $152.3 million, compared to $153.8 million for the year-ago quarter, a drop of 1 percent. Although test volumes were up 5 percent, that was undercut by declines in Medicare reimbursements that reduced revenue per requisition by 1.8 percent (Quest took an even larger hit on revenue per requisition, which was down 3.7 percent for the quarter). “We were absorbing approximately $55 million in payment reductions in 2013 due to Medicare fee schedule reductions, from sequestration, the 88305 reduction, and other reductions,” LabCorp CEO Dave King said during the earnings call. He added that his company was concerned by proposed changes to the clinical laboratory fee schedule (CLFS), which has already been reduced 8 percent since 2010. King also expressed disappointment in the delays in properly pricing the molecular test codes placed on the CLFS. “It is our expectation that we will receive appropriate payment for our services and that these unprecedented nonpayment policies will be reversed, which would result in upside to our guidance,” he said. Altogether, pending payments for molecular tests total about 4 percent of revenues, officials said. Yet LabCorp is far from impoverished: The company bought back $362 million in stock during the second quarter, compared to $113.9 million during the first quarter of 2013. King also said progress had been made in cutting the ratio of LabCorp’s debt to pretax earnings, beefing up the company’s IT systems, and in improving efficiency at its lab near its Burlington, N.C., headquarters. Its 240,000 square-foot Phoenix lab will go online this fall, resulting in the consolidation of four smaller regional labs. Rusckowski believes that the implementation of the Affordable Care Act will be an upside for the company but that its rollout will be stretched out. “It’s now seemingly likely that the expected entry of the uninsured people into the health care systems will ramp up more slowly than initially anticipated,” he said, adding that only half the states are expected to participate in Medicaid expansion, and that the state exchanges are ramping up more slowly than expected. In the meantime, Rusckowski reported that Quest is on schedule for its plans to deliver $600 million in cost reductions by the end of the next year—it has already delivered $250 million more in savings this year than in 2012. The company has also reorganized its sales force and has inked key contracts with payers offering diagnostic services through the health insurance exchanges. Additionally, Quest sold its rights to the royalties of the drug ibrutinib to Royalty Pharma for $485 million—a transaction the company believes will net $300 million after taxes. Both LabCorp and Quest also reported strong growth in workplace drug testing assays. Analysts Cautious Analysts are taking a wait-and-see attitude with the companies. They were particularly concerned by Quest’s decision to revise its 2013 guidance downward. The company projects that revenues will decline 1 percent to 2 percent compared to 2012. It also narrowed its range for earnings per share. “While Quest is doing an admirable job of monetizing non-core assets, we believe the current fundamental environment remains challenging due to slower underlying volume trends and reimbursement pressure,” said Bradley D. Maiers and Kevin K. Ellich, research analysts with Piper Jaffrey. Although they praised Quest’s cost-cutting and noted that its long-term strategies are gaining traction, it maintained a neutral rating on its stock due to “weaker volume trends and pricing pressure.” Maiers and Ellich also noted that while LabCorp’s organic volume growth of 1.4 percent beat estimates, the decline in revenues per requisition was worse than expected. “We believe the Medicare reimbursement environment will remain challenging given recent cuts, uncertainty around the proposed physician fee schedule cuts, and the longer-term potential cuts to clinical lab fee schedule, which keeps us on the sidelines.” They maintained neutral ratings on LabCorp and Quest’s stock. Takeaway: Quest Diagnostics and LabCorp are still confronting soft test volumes and flat growth, but they are endeavoring to strengthen their fiscal position and reverse the trend.