Labcorp - Q1 2014
April 28, 2014
Transcript
Operator (participant)
Good day, ladies and gentlemen, and welcome to the first quarter 2014 Laboratory Corporation of America Holdings earnings conference call. My name is Glenn, and I will be your operator for today. At this time, all participants are in a listen-only mode. Later, we will facilitate a question-and-answer session. If at any time during the call you should require audio assistance, please press star followed by zero, and we will be happy to assist you. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. David King. Please proceed, sir.
David King (CEO)
Thank you. Good morning and welcome to Labcorp's first quarter 2014 conference call. Joining me today from Labcorp are Brad Hayes, Executive Vice President and Chief Financial Officer, Ed Dodson, Senior Vice President and Chief Accounting Officer, and Steve Anderson, Vice President, Investor Relations. This morning, we will discuss our first quarter 2014 financial results, update 2014 guidance, highlight our progress on our five pillar strategy, and provide answers to several frequently asked questions. I'd now like to turn the call over to Steve Anderson, who has a few comments before we begin.
Steve Anderson (VP of Investor Relations)
Before we get started, I would like to point out that there will be a replay of this conference call available via telephone and internet. Please refer to today's press release for replay information. This morning, the company filed a Form 8K that included additional information on our business and operations. This information is also available on our website. Analysts and investors are directed to this 8K and our website to review this supplemental information. Additionally, we refer you to today's press release, which is available on our website for a reconciliation of non-GAAP financial measures discussed during today's call to GAAP. These non-GAAP measures include adjusted EPS excluding amortization, free cash flow, and adjusted operating income. I would also like to point out that we are making forward-looking statements during this conference call.
These forward-looking statements include, among others, statements about our expected financial results, the implementation of our business strategy, and the ongoing benefits from acquisitions. These statements are based upon current expectations and are subject to change based upon various factors that could affect the company's financial results. Some of these factors are set forth in detail in our 2013 10-K and will be included in subsequent filings with the SEC. The company has no obligation to provide any updates to these forward-looking statements, even if our expectations change. Now, Brad Hayes will review our financial results.
Brad Hayes (EVP and CFO)
Thank you, Steve. On today's call, I will review four key measures of our financial performance: cash flow, revenue growth, margin, and liquidity. I'll also update our 2014 guidance. First, cash flow. Our cash flow continues to be solid. Operating cash flow for the quarter ended March 31, 2014, was $142.3 million. We estimate that weather had a negative impact on operating income and a corresponding impact on cash flow of $32 million. DSO at the end of March was 52 days, which was up three days sequentially and up two days year over year. We continue to experience claims being subject to higher deductibles and co-insurance. Accordingly, we raised bad debt by 25 basis points in the quarter and continued to focus on initiatives to improve patient collections. Second, revenue growth. Revenue decreased 0.7% year over year in the first quarter.
Excluding the impact of weather, revenue would have grown approximately 2% compared to last year. During the quarter, total company volume increased 2.6%. Excluding the impact of weather, volume growth would have been approximately 5%, and organic volume would have increased approximately 2.5% year over year. Revenue per requisition decreased 3.3% year over year, primarily accounted for by Medicare payment reductions, test mix, and the Canadian business. It is important to note that managed care revenue per requisition was flat sequentially. Third, margin. For the first quarter, our adjusted operating income margin was 14.7% compared to 18.7% in the first quarter of 2013. During the first quarter, weather reduced the company's margins by approximately 180 basis points. Fourth, liquidity. We remain well capitalized. At the end of March, we had cash of $338.9 million and no borrowings outstanding under our $1 billion credit facility.
During the first quarter, we repurchased $106.2 million of stock, representing 1.1 million shares. At the end of March, approximately $946.3 million of repurchase authorization remained under our share repurchase program. Our share repurchase activity during the first quarter reflects our continued disciplined capital allocation program and commitment to return capital to our shareholders. Despite losing $42 million of revenue and $0.22 of earnings to weather in the first quarter, we raised our 2014 earnings guidance. Our updated guidance is for revenue growth of approximately 2%, adjusted EPS excluding amortization of $6.40-$6.70, operating cash flow of approximately $780 million-$820 million, and capital expenditures of approximately $185 million-$205 million. The guidance excludes the impact of any share repurchase activity after March 31, 2014. I'll now turn the call over to Dave.
David King (CEO)
Thank you, Brad. We are pleased with our first quarter results. During the quarter, we delivered volume growth of 2.6%. Excluding the impact of weather, volume growth would have been 5%, and organic volume would have increased approximately 2.5% year over year. We continue to execute well on our key growth initiatives. Although our revenue per requisition was down 3.3% year over year, managed care revenue per requisition was flat sequentially. During the first quarter, inclement weather negatively impacted revenue by an estimated $42 million and EPS by approximately $0.22, yet we raised our full year 2014 earnings guidance. In addition to our continued development of Beacon LBS, we significantly expanded the fifth pillar of our strategy by introducing Enlighten Health during the first quarter. I would now like to update our progress on each aspect of our five pillar strategy.
The first pillar of our strategy is that we deploy capital to investments that enhance our business and return capital to shareholders. We repurchased $106.2 million of stock during the first quarter, representing 1.1 million shares. Our share repurchase brings us almost to our stated target leverage ratio of 2.5 times debt to EBITDA and demonstrates our continued commitment to return capital to shareholders. Our acquisition pipeline remains robust, and acquisitions should continue to provide an attractive way to expand our test menu and geographic footprint for several years. We will maintain a disciplined approach to valuation as we seek optimal strategic opportunities. The second pillar of our strategy is to enhance our IT capabilities to improve the physician and patient experience. We continue to see strong customer adoption of our Enlighten Health care intelligence platform for managing practice and population health data.
This platform helps clients unify the multiple components of population health management, providing primary care physicians with complete access to their patient's healthcare picture, rules for monitoring gaps in care, and reporting that addresses more than 600 quality measures. Enlighten Health care intelligence helps providers reduce expenses, improve outcomes, and enhance patient satisfaction. The robust rules engine is highly customizable and provides compliance with meaningful use requirements as well as ACO, JCO, and PQRS reporting requirements. These industry-leading data-driven services position Labcorp as a trusted partner to healthcare stakeholders, providing knowledge to optimize decision-making, improve health outcomes, and reduce treatment costs. We continue to improve tools that assist physicians and patients in understanding test results and optimizing decision-making. We are pleased with the recent HHS ruling, which provides access to lab results for all patients.
Our patient portal, which has over 475,000 patient registrations and is growing daily, is well-positioned to support this need, and we can also deliver results directly to physician and health system portals where patients can conveniently review them. Looking ahead, we will focus on providing additional content to our patient portal to further assist patients in understanding their lab testing results and needs. We will assist our customers in analyzing their population health and clinical practice data with new tools for hospitals, physician practices, and ACOs, supplemented with insights derived from our extensive patient database. We are working with clients to use our data to benchmark ordering patterns and to determine preclinical markers in specific diseases. Insights gained from these efforts help payers and physicians better manage healthcare expenses and optimize patient outcomes.
The third pillar of our strategy is to continue to improve efficiency to offer the most compelling value in laboratory services. We are in the assessment stage of our comprehensive enterprise-wide cost structure review. It is too early for us to estimate the magnitude of opportunities to further streamline our operations and reduce costs. We will provide additional color on these initiatives on our second quarter earnings call in July. The second installation of our Propel robot is live at our major laboratory in Tampa and is now processing approximately one-third of the facility's volume. We intend to begin the next installation of Propel in our Dublin, Ohio facility early next year. Propel continues to drive expense reduction, increased throughput and accuracy, and enhanced specimen management at our Burlington lab.
We continue to consolidate facilities into our new Phoenix campus, and we are now processing more than 23,000 specimens per day at this state-of-the-art facility. As part of our cost structure assessment, we will evaluate our potential to consolidate additional facilities. The fourth pillar of our strategy is to continue scientific innovation at reasonable and appropriate pricing. We introduce new tests and collaborate with leading companies and academic institutions to provide our physicians and patients with the most scientifically advanced testing in our industry. We recently announced the availability of ImmunoCap allergy testing products from Thermo Fisher Scientific. Allergies affect approximately 60 million individuals in the United States annually, and this population is growing. There is also a well-documented relationship between allergies and asthma.
Labcorp offers an extensive test menu to assist medical practitioners in determining whether a patient's systems support or rule out an allergy diagnosis, thereby suggesting other etiologies. We continue to see strong growth across our suite of BRCA tests for the assessment of breast cancer risk. Our BRCA testing menu includes a comprehensive panel of BRCA1 and 2 complete gene sequence analysis and deletion duplication testing, targeted analysis tests for other family members once a mutation is identified, and a panel for mutations prevalent among people of Ashkenazi Jewish descent. In combination with our care coordination pre-authorization service, Labcorp offers an end-to-end program that includes compliance with insurance requirements, comprehensive testing, and expert interpretation from our licensed directors and a team of 123 board-certified genetic counselors and nine medical geneticists.
In addition to our next-generation sequencing offerings for familial cardiac diseases and the preclinical and clinical development of new HIV and HCV antiviral drugs, we recently announced the launching of our first multi-gene oncology panel primarily for solid tumors on the NGS platform. Over the next several quarters, we will continue to expand our NGS offerings. To support this growth in next-generation sequencing opportunities, we recently acquired the former Covance Genomics Lab in Seattle, Washington. The capabilities of this leading next-generation sequencing laboratory include whole genome and whole exome sequencing, RNA-seq, mRNA-seq, and other specialty NGS sequencing technologies. The fifth pillar of our strategy is to develop knowledge services. We are now just a few months from launching Beacon LBS across United Healthcare's physician and patient base in Florida.
Beacon LBS provides decision support tools to help guide lab and test selection, access to a lab of choice network, and clinical and administrative rules engines for claim adjudication. Beacon LBS assists physicians in managing lab ordering, leading to better management of patient conditions and lower costs. We are excited about the valuable services that Beacon LBS offers physicians, patients, and payers, and we will provide updates on this important initiative later this year. Last month, we launched Enlighten Health, which offers multiple capabilities to patients, physicians, health systems, and pharmaceutical companies. Enlighten Health will include our patient-facing capabilities, including ambulatory monitoring and the patient portal, physician and health system-facing capabilities, including clinical decision support, care intelligence, and advanced analytics, pharmaceutical capabilities, including our clinical trial center laboratory and data management businesses, and several capabilities that touch multiple stakeholders, such as our genetic counselors.
Enlighten Health will continue to build capabilities organically and through acquisition to capitalize on our unique assets, diversify our revenue base, and meaningfully differentiate Labcorp from the competition. We look forward to providing updates on these initiatives over the next several quarters. We have positioned Labcorp to grow and excel through healthcare reform, an era in which quality, efficiency, scale, and a central role in improving patient outcomes will be the key measures of success. Now, Steve Anderson will review anticipated questions and our specific answers to those questions.
Steve Anderson (VP of Investor Relations)
Thank you, Dave. Can you elaborate on Labcorp's capital allocation policy? As we have stated, we are committed to achieving a 2.5 times debt to EBITDA ratio. Based on our capital allocation history, we target half of our free cash flow for acquisitions and half for share repurchase. We have a strong history of returning capital to our shareholders. Over the last decade, we have repurchased $5.6 billion of our stock, representing 78.1 million shares at an average price of approximately $71. Can you provide us with an update on your MOPATH payment issues? We are engaged with a number of states and Tricare to receive payment for these tests, most of which have long been covered, are standard of care, and are included in physician practice guidelines. We are making progress with some states, but the process is slow and resolutions are still uncertain.
The MOPATH code changes, system problems, and the complex procedures in some states have led to unconscionable delays in reimbursement. As ACLA noted, these coverage denials for standard of care tests establish a second-class healthcare system for Medicaid and military beneficiaries. The refusal to pay laboratories for these critical tests is not sustainable, and patients will ultimately suffer. In addition, we will continue to raise these non-payment issues with members of Congress that have key interests in the healthcare needs for and appropriate treatment of active duty personnel and their families. We are finally starting to see recognition by some payers that they have to constructively address this situation. We will update you on these important initiatives on future earnings calls until they are resolved. How big of an opportunity is the recently released Alberta RFP?
The size of this opportunity is approximately $200 million annually, and the RFP is for a sole source private provider. DynaLife is currently the sole source private provider in Alberta, and we are a minority partner in this business. The performance of this joint venture is captured on the equity method income line item on our P&L and is not consolidated in our revenue line. Can you remind us of how drugs of abuse volume trended over recent quarters? In the first quarter, our organic drugs of abuse volume increased approximately 10% year over year. This compares to year-over-year organic increases of 15% in Q4 of 2013, 14% in Q3 of 2013, 10.6% in Q2 of 2013, and 10.2% in Q1 of 2013. We also delivered strong year-over-year growth this quarter in our wellness and pain management businesses, which fall within our occupational testing services operations.
We believe wellness and pain management testing will provide a great growth opportunity for Labcorp over the next several years. Now, I'd like to turn the call back over to Dave.
David King (CEO)
Thank you, Steve, and thank you very much for listening. We are now ready to take your questions.
Operator (participant)
Ladies and gentlemen, if you would like to ask an audio question, please press Star 1 on your touchstone phone. If your question has been answered or you would like to withdraw your question, please press star two. Questions will be taken in the order received. Please press star one to begin. Our first question comes from the line of Robert Willoughby, Bank of America, Maryland. Please proceed.
Robert Willoughby (Managing Director and Equity Research Analyst)
Hey, Dave and Brad, can you comment on specific M&A in the quarter? What you may have acquired and perhaps after the quarter, what kind of activity have you participated in?
Brad Hayes (EVP and CFO)
Hey, Bob, it's Brad. Nothing significant in the quarter to talk about in terms of its contribution especially, and we take all of that out when discussing our organic volume growth number and then on the future and what's in the pipeline for today.
David King (CEO)
Yeah, good morning, Bob. Obviously, there have been some transactions. We've looked at a number of things that we, for a variety of reasons, including valuation, have not felt were good opportunities for us. The pipeline is quite robust, and we're looking at a number of opportunities that we think are both exciting for the long term and have the potential to continue on the growth trend that we've established here.
Robert Willoughby (Managing Director and Equity Research Analyst)
I guess I'm a little surprised, Dave, this magnitude of the share buyback wasn't bigger given where the stock was and the absence of many deals. Why wouldn't you have taken advantage of the stock price at the lower levels?
David King (CEO)
Our philosophy is we try to be consistent in terms of share repurchase. Yes, the stock was at a lower point throughout much of the quarter. I will say, however, that also for much of the quarter, there was quite a bit of overhang from the potential for significant government reductions, the CMS administrative proposal to be able to cut the fee schedule, the looming SGR fix. I think there was a lot of concern about how the share price was going to perform. We do not try to be market timers. We try to take a very consistent approach to we buy more when the price is down. We did buy more this quarter given that the price was down than we would have bought if the price was higher.
Robert Willoughby (Managing Director and Equity Research Analyst)
Okay. Just the last one, Brad, can you just remind us what's in the guidance and what's excluded from the guidance? There's no incremental share repurchase or incremental acquisitions, but do you have the Brock analysis in there now on the oncology panels in the guidance?
Brad Hayes (EVP and CFO)
Yes. You're right on share repurchase. I mean, it excludes anything after March 31, 2014.
Robert Willoughby (Managing Director and Equity Research Analyst)
Okay. Any other items out there that you are still excluding?
Brad Hayes (EVP and CFO)
I mean, I think some of our stance on some of the items that we said in the past is similar. So MOPATH, for example, no assumption of any recovery there. Steve, there's, I know, a laundry list of things we went over, but I can't think of a significant change from the last time we updated.
Robert Willoughby (Managing Director and Equity Research Analyst)
No. No significant.
Brad Hayes (EVP and CFO)
I don't see anything on any of those items.
David King (CEO)
Correct.
Robert Willoughby (Managing Director and Equity Research Analyst)
Okay. Thank you.
Operator (participant)
Your next question comes from the line of Bill Bonello, Craig-Hallum. Please proceed.
Bill Bonello (Senior Research Analyst)
Morning, guys. Dave, I have a question. You spent a lot of time talking about Beacon Health and especially Enlighten Health. I'm just wondering if you can give us a little bit more color on how those programs actually generate revenue and maybe some sense of the magnitude of the opportunity with those programs, the kind of profit margin that they have, just anything that lets us get our arms around whether this is a significant new driver of revenue and profit for you. I have a follow-up.
David King (CEO)
Sure. The answer to the question is today, they're not significant drivers of revenue and profit other than the clinical trial central lab business will reside within Enlighten Health. As we've said, I think a number of times, that's approximately a $150 million revenue business. That's a business that is evidenced by our acquisition of the genomics lab in Seattle, which we're very, very pleased about that opportunity. We continue to grow. The other aspects of Enlighten Health, I would describe them as internal startups. They're businesses that we are starting to capitalize on, for example, our genetic counselors and the asset we have with genetic counseling and ways in which the genetic counseling capabilities can be independent revenue generators, for example, with interpretations of genetic testing results, with interpretations of sequencing.
Obviously, we'll continue to give you more color around this, Bill, as these turn into revenue-generating businesses. I think this is a terrific opportunity for us from a strategic perspective, putting all the data analytics capabilities, all of the assets that we already have into a business that's focused on capitalizing them, facing the patient, facing the physician and health system, and facing the pharmaceutical sponsors is a great long-term opportunity for us.
Bill Bonello (Senior Research Analyst)
On the Beacon LBS side?
David King (CEO)
Yeah. I mean, I think Beacon LBS is a, again, in the long term, is a terrific opportunity because, as I think is fairly well recognized, lab is one of the last aspects of ancillary services in healthcare that basically has very, very limited management. The management tools that are there, such as blanket pre-authorization policies for all molecular testing that we're seeing from some payers, are the proverbial blunt instrument using the sledgehammer to address a much more targeted concern. I think Beacon LBS will be a significant tool that will not only help with trend management, but will also help with selecting the correct test for the patient at the correct time.
I will say parenthetically, with regard to Beacon LBS, there's no question that the margin in that business will be a lot different from the margin in our core testing business because it's not a testing business. It's more of an administrative decision support and management business. We need to think about that as we roll it out over time. I think in terms of generating revenue and enhanced opportunity for the company, it's a terrific long-term opportunity.
Bill Bonello (Senior Research Analyst)
At this point, are you prepared to give us any more specifics about how you actually generate revenue, what the source of that revenue is?
David King (CEO)
Let us get it up and running, and then we'll give you more detail around exactly how the revenue is generated. We will be prepared to address that once we get the pilot up and running.
Bill Bonello (Senior Research Analyst)
Okay. Thanks. Thanks a lot.
Operator (participant)
Your next question comes from the line of David Clair Piper Jaffray. Please proceed.
David Clair (VP of Investor Relations)
Okay. I was hoping just to get some additional color on the MOPATH reimbursement issues we've seen. What was the impact in the quarter? When you say you're making progress, are you getting paid on the backlog in some of these states?
David King (CEO)
David, it's Dave. The impact on the quarter was not terribly significant. It was probably a little bigger than the impact on the quarter last year just because in the first quarter of last year, we didn't see a huge denial rate. When we say we're making progress, we're engaged with some of the key states where we have been experiencing difficulties. Of course, we've been heavily engaged with Tricare, which is one of the real pain points for us. I think there's increased receptiveness from their perspective. There have been some commitments made about payments going forward and retrospective payments. Commitments made and dollars delivered are two different things, and we haven't seen the dollars delivered. This is a high-priority issue for us.
Unfortunately, this is an issue where at some point, I think the industry and ACLA has been very much engaged in this. At some point, the industry is going to have to make a decision about providing free services to these beneficiaries given that the payers are simply indicating that they've decided not to pay for tests that are standard of care, that have always been covered, and that are critical to delivering appropriate and proper healthcare to the patient population.
David Clair (VP of Investor Relations)
Okay. Thank you. And just a quick question on Braccasure and your NIPT business. Maybe you can give us an update on how these are performing compared to your original expectations.
David King (CEO)
I would say BRCA is performing in terms of volumes very well and probably better than our original expectations. NIPT at this point has been in the mix for quite some time, and we're continuing to see strong growth there in terms of volume. We are pleased with both of those businesses.
David Clair (VP of Investor Relations)
Okay. Thank you.
Operator (participant)
Your next question comes from the line of Darren Lyrick. What do you think? Please proceed.
Speaker 17
Thanks. Good morning, everybody. My question really is about the guidance. You absorbed a little over $0.20 of weather impact, which was not in the original outlook, and you are adding a nickel back in. Dave, if you could just maybe step back and help us think about what is in the outlook that has changed versus where we were and if there are any things that you feel like need to be called out around what were in your original assumptions, it would be helpful just to kind of square that over $0.25 differential.
David King (CEO)
Daren, good morning. It's Dave. Obviously, there were a couple of positives during the quarter. The SGR fix was resolved in a way that did not have any near-term impact. ICD-10 was postponed for a year, so some expenses that we expected that we were going to have to absorb this year, we don't have to absorb. Obviously, we had a pretty significant weather impact. The positives, we have some expectations that BRCA is going to be positive from a volume and a price perspective. We have not changed our assumptions on MOPATH. That is, we assume it will be about the same. We continue to exclude the impact of any significant M&A transaction that might occur. We continue to exclude the impact of share repurchase, and we haven't factored anything in for the cost reduction program.
There was in the quarter a gain on an investment that we made in a publicly traded company that benefited us. All of those things and we still own some shares in that company. There is the potential for us to realize an additional gain if we sell those shares during the balance of the year. Obviously, the full-year impact of the repurchase that we did in the quarter also is in whatever we are going to do, even if we did not do any more share repurchase. I am not saying we are not going to do any more share repurchase, but the full-year impact of that share repurchase is something that we take account of, although, again, we do not assume any further share repurchase in the numbers.
If you just look at our reported EPS, which is $1.51 net of the $0.22 of weather, and you look at what the expectation was, which was $1.60, we're 9 cents under. What we're saying is that we feel, given the strength of the business in the quarter and given what we see unfolding for the rest of the year, that we will be able to make up that 9-cent differential and add an additional 5 cents of earnings. That's how we come up with the revised guidance, which basically raised the top and bottom end by 5 cents. I hope that's a sufficiently thorough accounting of kind of how we get there. Again, the guidance is a range. It's not a point. The guidance is a range.
We're looking at the entire range of outcomes that might occur during the year and trying to provide you with an accurate expectation of where we think we're going to come in.
Speaker 17
Yeah. That's very helpful. And just so my math is close on the gain, it looks like it comes out to about a $0.05 gain in the period. Is that about right?
David King (CEO)
That's right.
Speaker 17
Okay. And then just maybe just to follow up, and I'll jump off after this, but just to clarify, in your mind, the biggest sort of swing factor now in the guidance, I mean, aside from M&A and buyback, which we generally are used to seeing, but the biggest swing factor would just be some resolution of this molecular pathology issue. Is that the right way to think about it?
David King (CEO)
I do not really think about it that way. I think the biggest factor in where we come out in the guidance range is the underlying growth of the business and the price. We had a terrific, from a volume perspective, I think we had a very, very strong quarter. The pricing, a combination of we had the impact of sequestration, which we did not have in the first quarter of last year. We had a little bit of MOPATH. We have a small, well, we have a reduction in the physician fee schedule based on some code revaluation and a reduction in the clinical lab fee schedule, which is part of the original ACA. We still have the 1.75% reduction. We had some test mix issues with big growth in toxicology, which depresses price.
We had the impact of the Canadian business, which both the government price cut, increasing utilization, and the exchange rate all dragged on price. Certainly, if we get paid for MOPATH, that will help us in terms of the guidance. What will also help us is continuing to grow the business and seeing some positive movement in the pricing.
Speaker 17
Got it. Okay. Great. That's helpful. Thank you.
Operator (participant)
Your next question comes from the line of Gary Taylor, Citi. Please proceed.
Gary Taylor (Managing Director and Equity Research Analyst)
Hey. Good morning, guys. Not to be redundant, I just want to go back to the guidance for a second. I certainly understand all the mechanics and the pluses and minus. I guess just broadly, when you think about you gave guidance. Weather was certainly much worse than the guidance had anticipated. You had a gain in some repurchase, a couple of other things. Still, generally, to raise the guidance in the face of that weather headwind, you just generally have to feel better about something. I guess it just sounds like there wasn't any explicit singular item, but just in general, when you look at the total range, you feel good about where you're at. Is that fair?
David King (CEO)
I think that's fair. I think we've answered the question in great detail in terms of what the components are. Obviously, we wouldn't be raising guidance if we didn't feel that there was a reason why we would do better than the initial guidance that we put out.
Gary Taylor (Managing Director and Equity Research Analyst)
Yeah. I just couldn't understand in that what isolated got better, but I know it was a very detailed answer. On the gain in the public company, could you share with us what that was, or is that private?
David King (CEO)
Yeah. It's Foundation Medicine, and we were an original investor in the company. When it went public, our shares obviously became public shares. When the lockup expired, we had the ability to sell them.
Gary Taylor (Managing Director and Equity Research Analyst)
Okay. Great. One more small question. I just wanted to make sure. On the 2.5% organic growth adjusted for weather and so forth, that's pretty close to our number. I think Brad had said that excludes all tuck-in acquisitions. I apologize. I know this has been asked in prior quarters, but I was under the impression that some of the small tuck-ins were kind of captured in that number. I just want to make clear that 2.5% excludes any of even the small tuck-ins you do?
Brad Hayes (EVP and CFO)
Oh, Gary. It's Brad. That was probably back to Bob's cash flow question. No, the small, small tuck-ins, we don't go through the exercise of excluding those. What's excluded from that number are larger-type acquisitions where they have an impact on the especially on the volume.
Gary Taylor (Managing Director and Equity Research Analyst)
Great. Last question for Dave. Just going back to the new lab pricing methodology that was in the doc fix legislation. I know the ACLA was in favor of that. A couple of the other lab lobbies voiced some opposition to kind of how the final rule came down. It is very clear that the new price that would be developed would apply to any hospital billings under a clinical lab fee schedule. What is a little less clear is if the legislation explicitly mandates that hospital pricing information be captured in that. I just wondered, do you agree that that latter part is less clear? And kind of what's your view as CMS develops the regs around that?
David King (CEO)
No, I don't agree that it's less clear. I think it was explicitly stated in many discussions that we had with Congress and with congressional staff that market pricing has to include the entire market. If what you want to do is make sure that Medicare laboratory testing is priced at market, then you can't look at three or four examples as the flawed OIG study did and say that that is market. Market is market. That includes large independent labs. It includes small independent labs. It includes hospital outreach labs. I think the intent of Congress is very clear. I think, obviously, the devil will be in the details when the rule is promulgated.
I think the rule should be very clear that the market has to include the determination of market pricing has to include all components of the laboratory services market, not selected or cherry-picked components. That certainly includes hospital outreach pricing.
Gary Taylor (Managing Director and Equity Research Analyst)
Okay. Appreciate that. Thank you.
Operator (participant)
Your next question comes from the line of Gary Lieberman, Wells Fargo. Please proceed.
Ryan Halsted (Managing Director)
Morning. This is Ryan Halsted on for Gary. I guess appreciate all the detail on the guidance, but I was hoping you could speak specifically to any change on your views on impact from healthcare reform, especially considering the better-than-expected enrollment.
David King (CEO)
It's Dave. I think our view on healthcare reform is that it's still basically not material to 2014, that it's basically a net neutral. So we're not counting healthcare reform as a positive as we think about the guidance. Obviously, if our views change, we'll update that perspective, but that's where we are today.
Ryan Halsted (Managing Director)
Okay. Thanks. On your cost structure, I realize you're not prepared to provide any guidance on that, but just curious if any improved visibility on your reimbursement outlook, does that potentially change how you're thinking about your cost structure and timing as you're reevaluating your cost structure?
David King (CEO)
No.
Ryan Halsted (Managing Director)
Okay. All right. Thank you.
Operator (participant)
Your next question comes from the line of Amanda Murphy, William Blair. Please proceed.
Amanda Murphy (Senior Analyst)
Hi, Vince. I just had a quick question on M&A. I think you guys have been pretty consistent in terms of the types of assets that you've pursued over the years. I am just curious going forward, should we expect you to pursue a similar strategy? Also, have you seen a change at all in maybe the types of assets that are coming to market just given all the reimbursement pressure for the past few years here?
David King (CEO)
Amanda, it's Dave. I don't think you should expect to see us do anything dramatically different. Obviously, with Enlighten Health, there are some aspects of those businesses as we start them up that there may be acquisitions that are a little bit different from kind of core diagnostic testing. However, those will be small exploratory-type transactions. They're not going to be anything significant in there. In terms of assets coming to market, I think the mix is pretty much the same as what we've historically seen. There's nothing in my mind that looks very different from what we've seen over the last several years. Again, I think it's what are the right assets from a strategic perspective for us, and then what's the right valuation.
Amanda Murphy (Senior Analyst)
Got it. Then a question on next-gen sequencing. You're bringing a number of tests to market now. Just curious, do you have any insights into how payers may look at paying for those tests? It does not seem like there is, well, there is not really an infrastructure in place for payment around those tests for the most part. Any insights into how that might evolve over time?
David King (CEO)
No, I think your question has exactly the right premise, which there isn't really an infrastructure for payment of the testing using that methodology. There isn't an established payment system. You can't just send somebody a bill and say, "We perform next-generation sequencing." Currently, obviously, we'll continue to bill using the procedure codes that apply to the testing that we're doing. I think there are very robust discussions going on with some of the payer community right now about how they might think about paying for those tests in the future. We'll continue to keep you updated on the developments there.
Amanda Murphy (Senior Analyst)
Okay. Thanks very much.
Operator (participant)
Your next question comes from the line of AJ Rice, UBS. Please proceed.
AJ Rice (Managing Director)
AJ Rice, actually. Thanks. Hello, everybody. Two quick questions. First of all, just comment on Hep C testing, how big that is for you, if you're seeing any change because of the new drug capabilities we're hearing. People want to get tested maybe more now since they have an option that could potentially cure them. Any thoughts on that?
David King (CEO)
Yes, AJ, it's Dave. We've highlighted Hep C for the last really since the CDC put out the screening guidelines as a growth opportunity, and we have seen nice growth there. I think that's been probably for 12-18 months. I think these targeted drugs do give us additional opportunities both in our clinical trials business because of the expertise that we have at Monogram, which is probably the leader in development of hepatitis C testing, as well as the cost of these drugs means that efficacy really needs to be demonstrated. We think the diagnostic test is an excellent way to show which patients are going to benefit from the drugs and which patients are probably not going to gain as much benefit.
We like hepatitis C as a long-term opportunity and think we have the right assets in place to build that.
AJ Rice (Managing Director)
Okay. I was just going to ask a little bigger-picture question. I do not know if I have heard you guys comment in a while about the nature of the competitive landscape and whether you see it having changed much between the competition for hospital outreach labs, small labs, and then competition among you and your biggest competitor. I did notice I think I saw a press report that maybe you had won an exclusive contract with independent Blue Cross Blue Shield this quarter. I wonder, wrapping that into the comments about broader competitive landscape, is there any update to offer there?
David King (CEO)
I think the industry remains extremely competitive. It remains highly fragmented. There are still many thousand clinical labs that we compete with on a daily basis. I do not think that there is a lot that has changed. We have a lot of respect for our competitors, large and small. We do some things better than some of them, and they do some things better than we do. We are always trying to improve our levels of service. We are always fanatical about our commitment to quality. It is a tough industry, and obviously, there is a lot of competition. Our job is to go out there and grow the business and excel in what we do. I think our frontline people and our operational people have done a terrific job in doing that.
AJ Rice (Managing Director)
Okay. Thanks.
Operator (participant)
Your next question comes from the line of Lisa Gill, JPMorgan. Please proceed.
Lisa Gill JPMorgan (Managing Director)
Hey, Dave. I noted in your comments that you talked about managed care pricing was flat sequentially. Can you give us an update of what it looked like year over year would be my first question. Secondly, do you have any major managed care contracts that are up for renewal this year?
David King (CEO)
Lisa, it's Dave. We don't have any major contracts that are up for renewal this year. Year over year, the managed care pricing was down very slightly, not materially at all.
Lisa Gill JPMorgan (Managing Director)
Okay. Great. I guess my second question would be I know a lot of people are asking about acquisitions. I know in the past you've talked about not having as much interest in some of these outsourcing deals with hospitals or outreach programs. I'm just wondering if that's changed at all, especially as we think forward and think of you as being a lower-cost provider than some of these hospitals as we move towards ACA. Are they looking more enticing?
David King (CEO)
It's Dave again. I think that all other things being equal, we would prefer to do a more comprehensive deal with the hospital or with the health system than just buy an outreach program. I mean, we would like to work with them on their internal lab. We'd like to work with them on rationalizing where the testing is performed and the utilization. We'd like to work with them on population health management, on delivering the tools that we deliver in terms of analytics and decision support. That has been our preference. Most of the hospital deals that we have done recently have focused on a more comprehensive global approach. Part of the challenge in acquiring a hospital outreach program is because of the pricing that the hospital outreach labs typically command from the managed care payers.
When that pricing moves to our fee schedule, there is significant revenue compression, which also leads to significant profitability compression, which makes it hard to pay the multiple that those outreach programs are looking for because of how those businesses look when they move over to our pricing structure. Again, that's why our focus, Lisa, is more on the comprehensive partnership with the health systems than it is on individual hospital outreach lab acquisitions.
Lisa Gill JPMorgan (Managing Director)
Okay. Great. Thank you.
Operator (participant)
Your next question comes from the line of Isaac Rowe, Goldman Sachs. Please proceed.
Isaac Rowe (Analyst)
Clearly an area of focus for the business. At a high level, can you just walk us through your marketing pricing strategy versus competition for these tests? Just trying to frame how you're thinking about pricing schemes either versus an intrinsic player in BRCA testing or a new developing market, for example, like tumor profiling, where formal reimbursement just hasn't been established yet?
David King (CEO)
Isaac, I'm sorry, but the first probably 15 seconds of your question got cut off. Maybe you could just recapitulate.
Isaac Rowe (Analyst)
Yeah. No problem. It's actually Joel in for Isaac this morning. Just genetic testing. Just trying to get an idea of your overall pricing and go-to-market strategy versus the competition. Just trying to frame how you're thinking about going against an intrinsic player, for example, in BRCA or a new developing market like tumor profiling, where we just haven't seen formal reimbursement.
David King (CEO)
I think it's hard to comment in a lot of detail on those areas because obviously, they are strategic, and we assume there's competitors who listen to our calls. I think generally, our go-to-market approach is that we try to come to market with a high-quality, reasonably priced, comprehensive test offering with BRCA. We're especially proud of the capabilities that we've been able to build around the database and around the pre-authorization so that we can help to make sure that patients are getting the services and that the services are going to be paid for. I don't know that there's much more to say than that is our consistent philosophy in terms of go-to-market. It fits exactly within the fourth pillar of our strategy. We're going to continue to follow that.
Isaac Rowe (Analyst)
Thanks. And then just a quick one on capital allocation. Any updates from the board regarding the dividend?
David King (CEO)
The decision about how to allocate capital is management's decision. Obviously, we speak to our board about it quite a bit. It is management's decision. Our view continues to be at this point that acquisitions and share repurchase are appropriate deployments of capital, and we are going to continue to deploy them that way.
Great. Thanks.
Operator (participant)
Your next question comes from the line of Ricky Goldwasser, Morgan Stanley. Please proceed.
Ricky Goldwasser (Senior Adviser)
Hey, good morning. I have two follow-up questions here. First one on the volumes. I might have missed it. But when you talked about same-store volume growth of 2.5%, can you just help us understand what was the contribution for that for drug-of-abuse? I know you talked about the year-over-year growth rate. But off that 2.5%, what was drug-of-abuse testing?
Brad Hayes (EVP and CFO)
Ricky, it's Brad. I don't think we're going to get into that much detail, but we did have an acquisition that contributed, but that was stripped out of the organic. Our regular drugs of abuse testing business, I think Steve went over earlier, was 10% growth in that business.
Ricky Goldwasser (Senior Adviser)
Right. No, no. I understand that. I'm just trying to understand. Is it half of the 2.5%? It is very clear that.
Brad Hayes (EVP and CFO)
Oh, no, no, no. Small contributor, but not close to half.
Ricky Goldwasser (Senior Adviser)
Okay. And then, Dave, going back to the hospital system question, you talked about more kind of like holistic type of relationship with the hospital as kind of like is a preferred partnership. What do you think is the appetite of the healthcare systems given the fact that over time, we are moving or we will be moving toward the episode-of-care type reimbursement? We're hearing kind of like the non-for-profit hospitals talking a lot about that. Are you being involved in these type of conversations? I think that kind of like changes the whole kind of like approach toward reimbursement.
Brad Hayes (EVP and CFO)
Yeah. Ricky, I know it's been your thesis that we're rapidly moving into a bundled payment world. I would simply say that even within payment bundles, there are clear fee-for-service components. The movement toward payment bundles is going to be incremental and evolutionary. We're not going to be in two years in a 100% bundled payment environment. It is not going to work that way. Certainly, we're involved in many conversations with health systems, with large physician practices about how they think the payment system is going to evolve and how the diagnostic testing is going to play into that.
We welcome those conversations because, again, given our cost position, I think we're in a great position to be a huge contributor of value there and to show integrated delivery networks and large health systems that we can really help them move the needle not only on the cost of their lab services, but on the quality of the results they're delivering and on the analytics and the data and all of the things that we can do that will make them winners in whatever the new models are. One, I think bundled payments will go slowly and incrementally because there are a lot of questions about how those payment systems are going to work and whether they're going to work and how providers are going to be rewarded.
Yes, we're very much engaged in those conversations and look forward to the opportunity to demonstrate our value.
Ricky Goldwasser (Senior Adviser)
Okay. Thank you.
Operator (participant)
Your next question comes from the line of Glen Santangelo with Credit Suisse. Please proceed.
Glen Santangelo (Director of US Equity Research)
Yeah. Thanks. And good morning. Hey, Dave and Brad. I just wanted to follow up on the revenue per requisition. I mean, down another 3.3% this quarter. I do not think that is really surprising. If you look at the different components, I think you cited Medicare, TestMix, and the Canadian business. I am wondering if you could sort of break down those different factors and maybe give us a sense for what is really driving that revenue per requisition the most. Ultimately, as you think about that on a little bit longer-term basis, I mean, obviously, we have greater clarity on the Medicare side. How do you think about the other factors driving revenue per requisition throughout the balance of the year and into next year?
Brad Hayes (EVP and CFO)
Glenn, it's Brad. I'll start with the 3.3 that we've reported. We talked about the impact there as being MIX, our Canadian business, and the government. I'm not going to break that down any more specifically. If you think back to the MIX, the drugs-of-abuse testing business is having an impact there as well as an acquisition in that space. We also have the Canadian business that we speak of where the exchange rate's about 8% lower this Q1 than last Q1. We've had some erosion there. Plus, there's volume growth in that business, which is essentially a capitated model. That drives down the price per. The government reductions that we've already talked about, the physician fee schedule, the clinical fee schedule, and sequestration are all year-over-year impacts to that number that we see.
Our goal is to have that number be more positive than 3.3 negative. I think we'd look at that by focusing on the TestMix in our business and trying to grow the higher-value tests that we've spoken about, several of those on this call. We certainly know with a little more clarity what's ahead in the government reimbursement world. We realize that to be successful, we need to have solid and growing revenue per requisition as well as volume of requisitions.
Glen Santangelo (Director of US Equity Research)
Thanks for that, Colin. Maybe I just follow up, Brad, on the margin side. I think if I heard you correctly, you seem to suggest that margins were impacted by about 180 basis points due to weather, which would kind of imply about an incremental margin of about 70% on that weather-related lost revenues. I'm kind of curious, is that the right number? As we think about the margins throughout the balance of the year within the context of your full-year guidance, it kind of sounds like to get to that midpoint of the range based on what you've talked about in terms of revenues where we're assuming margins are down about 150 basis points year-over-year. How should we think about that ramp throughout the balance of the year?
Brad Hayes (EVP and CFO)
Yeah. You're right on the weather. It's probably a little higher drop down than you computed. We take out the cost of our supplies and our bad debt to get there. So yeah. And if you think about our original guidance for the year, it would imply some margin compression as well. So I don't think of any besides not having a negative weather impact, I don't think of any ramping of the margin performance over the course of the year. It will get better as we lapse some things and we have continued growth in our business. And then as some of the cost items and opportunities potentially start to contribute, that will help as well. But nothing significant counted on in guidance for that. So I think you've got it about right, generally speaking, on the margins.
Given our guidance for the year that we initially gave, we expected those margins to be under pressure.
Glen Santangelo (Director of US Equity Research)
Okay. Thanks very much.
Operator (participant)
Your next question comes from the line of Michael Cherny, ISI Group. Please proceed.
Michael Cherny (Managing Director and Equity Research Analyst)
Hi. Good morning, guys. So just one last quick question from my end. When you think about the increase in the market, I know you talked about a little bit of ACA over the course of the day, but we've seen a big rise in consumer-directed health plans. How does that factor into the way you see your business performing? And what impact has that had, at least both recently as well as in your expectations for the next maybe a few quarters or a couple of years?
David King (CEO)
Michael, it's Dave. The plus of consumer-directed health plans is that with greater consumer responsibility and with greater pricing transparency, our price point will be much more attractive. The minus is it puts pressure on patient collections because we have to collect more and more dollars from the patient. And that's the reason that you saw the bad debt increase in the quarter.
Michael Cherny (Managing Director and Equity Research Analyst)
Got it. Thanks.
Operator (participant)
Your next question comes from the line of Brian Brockmeyer, Maxim Group. Please proceed.
Brian Brockmeyer (Analyst)
Hi. Thanks for taking the questions. You previously stated that the ICD-10 expenses this year would probably be in the 5 to 10 million dollar range. Are those the expenses that you're now pushing off to 2015, or were some of them already spent this year?
David King (CEO)
Brian, it's Dave. Some of them were already committed, and some of them were able to defer.
Brian Brockmeyer (Analyst)
All right. And given the longer time frame, will you be able to better work those costs into the regular workflow, or should we not expect all of those? I guess, let's say you spent a couple of million. Should we not expect all of that 5 to 10 million to be additive to 2015 expenses?
David King (CEO)
I think it's too early to tell with certainty. It gives us more time to work on some of the things that we'd like to do in a more automated and less manual fashion. We will know about that as we get closer to the compliance.
Brian Brockmeyer (Analyst)
Okay. And you discussed the possibility previously of some significant expense reductions that you're currently evaluating, which were also excluded or continue to be excluded from guidance. Has that decision progressed at all?
David King (CEO)
I think we've answered the question three times that we'll update it on the July call.
Brian Brockmeyer (Analyst)
All right. And just last quick one. You said that volume ex weather would have been 5%. So weather negatively impacted volume by about 2.4%. Could you remind us what the weather impact in the fourth quarter was?
David King (CEO)
Fourth quarter weather was actually, on a year-over-year basis to the fourth quarter of the previous year, a better comp, an easier comp. I don't remember the specific weather number in Q4.
Brian Brockmeyer (Analyst)
Okay. Thanks a lot.
Operator (participant)
Your next question comes from the line of Wick Mayo, Robert Baird. Please proceed.
Speaker 18
Thanks for squeezing me in. I just wanted to go back for a second to the fee schedule repricing. ACLA's been very supportive of the DocFix legislation. It seems like you guys concur. One thing that they have highlighted is a study that was performed by Avalir that attempts to illustrate that average Medicare pricing is probably not too dissimilar from commercial pricing when you actually do include hospitals. They also seem to suggest that when CMS establishes these private payer rates, that in some instances, some of the non-hospital lab test rates could actually increase. I just wanted to get your broad perspective on that study and whether or not you agree or disagree with their conclusions.
David King (CEO)
With the Avalir study's conclusions?
Speaker 18
Yes.
David King (CEO)
Yeah. It's Dave. Yeah. I think the Avalir study was a very comprehensive look at a large number of data points and multiple MSAs, as big as New York City, as small as, I think, Boise, Idaho. And what Avalir did was look at paid claims data, look at pricing data, look at a variety of sites of service, independent labs, small labs, nursing home labs that were paid under the fee schedule, and hospital labs, commercial pricing, Medicare pricing. And I think what the study demonstrated quite clearly is that Medicare is at or below market for almost all the tests that were reviewed, whether routine testing or esoteric, high-complexity, low-complexity testing. So I think the Avalir study was a very detailed and comprehensive approach to determining what is market.
I think it rebutted the notion that's been going on for a long time that somehow Medicare is above market in the way that it pays for lab tests. Obviously, how CMS implements this rule is going to be significant. We at Labcorp, and I trust ACLA, are going to be very significantly engaged in the rulemaking process. I do think that there was a very strong policy view in Congress that they wanted Medicare pricing to be compared to and based off of market pricing. There was a very strong policy view from the ACLA and from Labcorp and from the constituents that the market had to be a true market, not a manufactured market, to make it look like Medicare was overpaying. The Avalir study shows that in the true market, Medicare's pricing is very, very competitive.
So I think that in the long term, this was a policy-driven decision by Congress. And I think it's great that we have policy-driven decisions as opposed to financially-driven decisions. And we're going to be very much involved in making sure that the policies are implemented in accordance with the way that Congress wanted them to be carried out.
Speaker 18
Great. Very helpful.
Operator (participant)
We have no further questions. I will now turn the call over to Mr. David King for closing remarks.
David King (CEO)
Thank you all very much for listening this morning. Good day.