Labcorp Holdings - Earnings Call - Q4 2012
February 8, 2013
Transcript
Operator (participant)
Good day, ladies and gentlemen, and welcome to the Quarter 4, 2012, Laboratory Corporation of America Holdings’ earnings conference call. My name is Sean, and I’ll be your operator today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session toward the end of this conference. If at any time during the call you require assistance, please press star and zero, and an operator will be happy to assist you. As a reminder, this call is being recorded for replay purposes. I would like to turn the call over to Mr. David King, Chairman and CEO. Please proceed, sir.
David King (Chairman and CEO)
Thank you, Sean. Good morning and welcome to Labcorp’s Fourth Quarter 2012 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 Fourth Quarter and full year 2012 financial results, provide 2013 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 the telephone and internet. Please refer to today’s press release for replay information. This morning, the company filed a Form 8-K that included additional information on our business and operations. This information is also available on our website. Analysts and investors are directed to this 8-K 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, 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 2011 10-K and will be in our 2012 10-K and subsequent filings. 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’ll review four key measures of our financial performance: cash flow, revenue growth, margin, and liquidity. I’ll also provide our 2013 guidance. First, cash flow. Our cash flow remains strong. Free cash flow for the trailing 12 months into December 31, 2012, was $667.6 million. Free cash flow was below our expectations as a result of lower operating cash flow and higher capital spending. Operating cash flow was lower in part due to payments to certain key vendors to take advantage of favorable economics, as well as the negative impact due to weather. Also, operating cash flow was reduced by one-time out-of-period adjustment of $34 million related to a balance sheet reclassification between cash and accounts payable. Without this adjustment, 2012 operating cash flow would have been $875 million.
Certain capital expenditures were made in the fourth quarter to take advantage of favorable economics. These factors are included in our 2013 guidance. The DSO was 46 days at the end of December, a decrease of two days sequentially and flat year over year. During the quarter, our bad debt rate was 4.3%. Second, revenue growth. Revenue increased 2.9% year over year in the fourth quarter. During the quarter, total company volume increased 2.8%. Organic volume increased 0.7% year over year, adjusted for the impact of inclement weather, which we estimate reduced volume growth by approximately 1% during the quarter. Revenue per acquisition was essentially flat year over year. Third, margin. For the fourth quarter, our adjusted operating income margin was 17.2%, compared to 18.9% in the fourth quarter of 2012. We estimate that inclement weather lowered margin by approximately 80 basis points during the quarter. Fourth, liquidity.
We remain well capitalized. At the end of December, we had cash of $466.8 million and no borrowings outstanding under our $1 billion credit facility. During the fourth quarter, we repurchased $136 million of stock, representing 1.6 million shares. For the full year, we repurchased $516.4 million of stock, representing 5.9 million shares. At the end of December, $68 million of repurchase authorization remained under our share repurchase program. This morning, we announced that Labcorp’s board of directors authorized a new $1 billion share repurchase program. Further, as part of our updated capital allocation strategy that we announced last month, we will raise our leverage ratio to 2.5× debt to EBITDA over time. This strategy reflects our continued commitment to return capital to and create value for our shareholders through acquisitions and share repurchase. This morning, we announced our 2013 financial guidance.
We expect revenue growth in the range of approximately 2-3%. Adjusted EPS, excluding amortization, of $6.85-$7.15, which includes a negative impact of approximately $0.35 due to Medicare payment reduction
David King (Chairman and CEO)
Thank you, Brad. We are pleased with our performance given that we continue to face a very difficult operating environment. During 2012, we grew revenue 2.3%. We grew adjusted EPS, excluding amortization, by 7.1%. We continued to generate strong operating and free cash flow, which we invested in the business and returned to shareholders through share repurchase. We repurchased $516 million of our stock, representing 5.9 million of our shares, and we kept a tight lid on expenses, measurably reducing our selling, general, and administrative expenses as a percentage of revenue. We continue to make 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.
Last month, we announced a target leverage ratio of 2.5× debt to EBITDA, which, all other things being equal, we intend to achieve over time. We expect to continue to deploy our capital toward acquisitions and share repurchase. Over the last several years, we have deployed our free cash flow almost evenly between acquisitions and share repurchase. Going forward, we would expect to deploy our free cash flow similarly, and in the absence of sizable acquisition opportunities, we anticipate deploying our additional leverage largely toward share repurchase. The second pillar of our strategy is to enhance our IT capabilities to improve the physician and patient experience. As planned, we completed the nationwide rollout of our Beacon Patient Portal in Q4, which is now available to all patients in right-to-know states.
The portal is a secure and easy-to-use online solution that enables patients to receive and share lab results, make appointments, pay bills, set up automatic alerts and notifications, and manage health information for the entire family. We experienced fast adoption of the portal in 2012 and are now seeing accelerated growth as we enter 2013, adding more than 1,000 new patient registrations per day. The patient portal is a valuable tool that allows patients to better manage their healthcare, and we will expand its capabilities over time. Our electronic medical record (EMR) connectivity continues to expand. We added over 8,200 new client EMR interfaces in 2012, and we are setting the bar higher for 2013. We remain committed to our open platform strategy, allowing our customers to connect seamlessly to Labcorp directly or via the EMR of their choice.
We piloted a number of new population health analytics modules during the fourth quarter to provide healthcare business intelligence tools to hospitals, physician practices, and ACOs. These tools assist customers in their compliance and reporting requirements with respect to efficient management of their productivity, quality, and patient outcome metrics. The company’s robust rules engine maintains more than 600 clinical quality measures that are highly customizable and provide full compliance with meaningful use requirements and ACO, JCO, and PQRS reporting requirements. Real-time clinical alerts help identify gaps in care for patients and patient populations. These industry-leading data-driven services position Labcorp as a trusted partner to healthcare stakeholders, providing the knowledge to optimize decision-making, improve health outcomes, and reduce treatment costs. The third pillar of our strategy is to continue to improve efficiency to offer the most compelling value in laboratory services.
During the fourth quarter, we implemented our Propel robotic technology in our primary Burlington lab. Over time, we expect this technology to replace manual splitting and sorting throughout our major laboratories, enhancing efficiency and increasing quality. We look forward to providing updates on our Propel initiative over the next several quarters. We also made significant progress in the rollout of the Vantage Positive ID system, which is now implemented in more than 90% of our core histology sites. This system standardizes workflow, eliminates waste, and positively identifies specimens throughout processing. We completed the rollout of our new handheld courier communication devices during the quarter. This enhancement provides greater visibility into specimen collection, enables more accurate route engineering, and increases courier efficiency. Finally, given the persistently challenging environment, we continue to review and rationalize our cost structure.
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 physicians and patients with the most scientifically advanced testing in our industry. During the fourth quarter, we launched a program to assist clinicians in the screening, assessment, diagnosis, confirmation, and management of cardiovascular-related disorders. The program uses Labcorp Beacon for test orders, result delivery, analytics, trending, and a cardiovascular disease risk assessment for lipid analysis. This decision support tool is provided by our Litholink division, which focuses on chronic disease management. As we discussed last quarter, the rapid evolution of next-generation sequencing technology is enhancing our molecular diagnostics testing. Consistent with these enhancements, we are launching the GeneSeq CardioTest, which allows us to identify more than 90 genetic causes of familial cardiac disease through next-generation sequencing methods.
We believe that GeneSeq Cardio will be a useful prognostic tool to identify positive family history and symptoms of cardiomyopathy, arrhythmia, aortopathy, Noonan syndrome, congenital heart disease, and early-onset coronary artery disease. This testing will help establish and confirm the diagnosis of familial cardiac disease and identify the need for regular cardiac screening, lifestyle changes, or intervention to prevent progression of cardiac complications. Additional clinical utility could include the identification of first-degree relatives who have inherited a disease-causing genetic variant and may be at risk for myocardial infarction, stroke, or sudden cardiac death. The fifth pillar of our strategy is to develop alternative delivery models. As we have said, there are fundamental changes taking place in our industry. We see healthcare moving toward large health systems, integrated delivery networks, accountable care organizations, patient-centered medical homes, and mega-physician practices. We also see managed care companies organizing ACOs and buying physician practices.
Our capabilities provide an end-to-end lab solution for these customers, meeting the requirements of new care models with population health management tools, decision support programs, patient counseling, integrated clinical reports, and patient-centric data solutions. These offerings are focused around IT, but it is the completeness of our solution for lab needs that differentiates Labcorp and provides value for our customers. Our Beacon LBS platform is a point-of-care decision support service that interfaces with test ordering systems to help guide physicians in lab and test selection. Physicians, patients, healthcare delivery systems, and payers will benefit from this innovation, which will improve quality and more effectively manage costs without disrupting physician workflow. Our rules engine interfaces with provider and payer policies for ordering, utilization, adjudication, and payment.
Our pilot programs are going well as Beacon LBS continues to receive high marks for its ease of use and its ability to help practices enhance patient care. Health systems provide adequate lab services, but most of these businesses make a small profit or operate at a loss. Changes in test mix, reduced reimbursement for government and private payers, and cost inflation continue to pressure health systems, and thus they are increasingly interested in broad collaborations. Because of our scale, we offer a broader menu of tests more affordably for patients and payers and the ability to maintain the highest levels of quality and service to health systems and the community they serve. We will continue to pursue these collaborations to offer an enterprise-wide solution that provides health systems, patients, physicians, and payers with the highest quality diagnostic testing through the lowest-cost delivery model.
As healthcare reform continues to evolve, we will continue to focus on providing all of our customers with the highest value for their laboratory spend, improving quality, reducing costs, and improving outcomes. In summary, we are pleased with our performance and the progress we achieve on our five-pillar strategy this year. 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 describe the impact of Medicare payment cuts you will face in 2013? The Affordable Care Act baseline for the 2013 update to the clinical lab fee schedule was negative 0.95%. The Middle Class Tax Relief and Job Creation Act rebaselined the fee schedule an additional 2% lower. These fee schedule reductions became effective on January 1, 2013. If mandatory sequestration is implemented, we will receive an additional 2% reduction to the clinical lab fee schedule and a separate 2% reduction to the physician fee schedule effective April 1, 2013. We also face significant impacts as a result of a variety of other government payment reductions, including the reduction to CPT code 88305 and the full-year impact of the TC Grandfather Clause. Summed together, we estimate that these payment reductions will lower our 2013 EPS by approximately $0.35.
Why is the midpoint of your initial 2013 EPS guidance approximately $0.25 below consensus? Our guidance encompasses a wide range of potential outcomes, and we are just beginning 2013. We continue to note that the diluted share counts in analyst estimates differ considerably from our own and from each other. In reviewing these forecasts, we note that the average share count across sell-side models implies a $0.17 benefit in 2013 from share repurchase. As we stated in our press release this morning, our guidance excludes the impact of share repurchase effective after December 31, 2012. Further, as I noted in my previous comments, we face several Medicare reductions in 2013.
It appears that most analysts did not model the full impact of these reductions in their 2013 estimates, as we projected the negative impact of the major 2013 Medicare reductions at $0.22 on our third-quarter conference call, $0.13 lower than the full projected impact of the 2013 Medicare reductions that we described this morning. Why are capital expenditures so high in 2013? We typically spend approximately 3% of revenue on capital expenditures. As Brad previously mentioned, our capital expenditure increase in 2013 is driven by near-term investments in facility consolidation and replacement of a major testing platform. Can you update us on the mix of your business coming from esoteric testing? For the year, approximately 40% of our revenues were in the genomic, esoteric, and anatomic pathology categories.
Operator (participant)
Ladies and gentlemen, if you wish to ask a question, please press star followed by one on your touch-tone telephone. If your question has been answered or you wish to withdraw your question, please press star followed by two. Press star one to begin. Please stand by for your first question. Your first question comes from the line of Tom Gallucci, Lazard Capital Markets. Please proceed.
Tom Gallucci (Analyst)
Good morning, everybody. I guess I had two questions. The first one was on the 2013 outlook. Obviously, Medicare is a big negative, but I’m wondering if you could highlight some of the positive drivers that overcome some of the pressures on the business as you look out. I know in the past you’ve talked about Genzyme and MedTox, etc., sort of ramping up. Is that still the case? If you could explore some of the positives versus the negatives as we think about the 2013 moving parts.
Brad Hayes (EVP and CFO)
Good morning, everybody. I guess I had two questions. The first one was on the 2013 outlook. Obviously, Medicare is a big negative, but I’m wondering if you could highlight some of the positive drivers that overcome some of the pressures on the business as you look out. I know in the past you’ve talked about Genzyme and MedTox, etc., sort of ramping up. Is that still the case? If you could explore some of the positives versus the negatives as we think about the 2013 moving parts.
Steve Anderson (VP of Investor Relations)
Tom, it’s Dave. Just to add one further point, we’re encouraged that organic volume growth increased sequentially from 3Q to 4Q. We have some cautious optimism that we’re going to see better organic volume growth as we go forward through 2013.
Tom Gallucci (Analyst)
In that 2–3% you mentioned, Brad, are there small acquisitions in there as you normally would have? Maybe half a percent or a percent or so, or?
Brad Hayes (EVP and CFO)
Not really. I mean, just the annualized impact of MedTox and some of the smaller ones that we did in 2012. I’m sorry.
Tom Gallucci (Analyst)
Okay. So nothing new or incremental that you haven’t done yet in terms of top-line that would add to the top line?
Brad Hayes (EVP and CFO)
No.
Tom Gallucci (Analyst)
Okay. Good. That’s good. And then just, I guess, a big-picture question. I don’t know if you want to take a stab at it, Dave, but obviously, for a lot of healthcare these days, thinking about healthcare reform in 2014 and beyond has become a major focus for investors. So any updated thoughts on how reform will impact your company and your industry?
Steve Anderson (VP of Investor Relations)
Tom, I think reform will be a net positive to us. There are a lot of moving parts, and some of them, such as how the exchanges will actually work, what pricing will be through the exchanges, and how many states will participate in Medicaid expansion, remain unclear at this point. At a high level, I think we will see volume growth offset to some extent by reduced pricing on the business coming through the company now that is uninsured, but will be subject to insurance rates, and a net benefit from a reduction in the bad-debt rate. We view it as a net positive, but again, there are a lot of moving pieces and it’s too early to begin to quantify it.
Tom Gallucci (Analyst)
Okay. Thank you.
Operator (participant)
Thank you. Your next question comes from the line of Robert Willoughby, Bank of America. Please proceed.
Robert Willoughby (Analyst)
Dave or Brad, does the larger share repurchase authorization suggest any kind of moratorium on acquisitions near-term or any comment on deal pricing that you're seeing?
Steve Anderson (VP of Investor Relations)
Bob, it’s Dave. It does not suggest a moratorium on acquisition activity. The pipeline remains quite active. The share repurchase commitment and the board’s endorsement of the $1 billion share repurchase authorization reflect our continued commitment to using share repurchase as a way to return capital to shareholders.
Robert Willoughby (Analyst)
Okay. Just another broader question. Who are you talking to now with your greater level of technology and electronic connectivity that you were not talking to previously? Is there somebody out there more intrigued with your data and connectivity now?
Steve Anderson (VP of Investor Relations)
Bob, it is Dave. I would say the increasing prevalence of ACOs and mega-physician practice groups that are thinking about transitioning to an environment in which they either share risk or take risk has made them a lot more interested in population health management and data analytics. Obviously, a lot of people are working on population health management and data analytics. One of the great benefits that we have is the enormous amount of information and data that we have on the unique patients that we see every year and the longitudinal database that we have on those same patients as they come back to see us over time. I think as we continue to see the development of ACOs, the consolidation of physician practices, and even the consolidation of health systems, the value of those data analytics will continue to increase.
Robert Willoughby (Analyst)
Okay. Thank you.
Operator (participant)
Thank you. Your next question comes from the line of Ricky Goldwasser of Morgan Stanley. Please proceed.
Ricky Goldwasser (Analyst)
Good morning. This has been the strongest volume you reported, I think, if I go back since 2001. Can you just share with us a little bit more about what the contribution from acquisitions in the quarter was? How big was MedTox to the numbers, and is there anything else? What are you seeing overall in the marketplace? Are you taking share, or are you seeing just an overall improved environment?
Brad Hayes (EVP and CFO)
Ricky, this is Brad. On the volume side, there is a significant contribution from MedTox. We had that for a full quarter in the fourth quarter as opposed to two-thirds of a quarter in the third. That is a significant contributor. As we look beyond that, as we pointed out, and Dave mentioned a second ago too, adjusted for weather, because that was about a point drag on the volume growth, we still saw organic volume in the quarter of 0.7%. Sequentially, that is better than we saw in Q3 and any other quarter, I believe, of 2012. On the volume side, a lot for MedTox, but some organic there as well.
Ricky Goldwasser (Analyst)
When you think about organically, are you growing with the market, or do you think that you are taking share?
Steve Anderson (VP of Investor Relations)
Ricky, it’s Dave. That is a very difficult question to answer just because it’s hard to know how the market is growing. I think we are growing with the market. I will say we continue to see in our patient and physician satisfaction surveys very strong satisfaction with the quality of our service level. I think that is a very important aspect of why organic volume has increased sequentially.
Ricky Goldwasser (Analyst)
Okay. Can you just break down for us the weather impact? I think it was about $13 million to the EBIT line, by cost of goods and SG&A?
Brad Hayes (EVP and CFO)
Yeah. Ricky, this is Brad. Really, when we think about the weather impact, the only costs that are involved are our supply cost, the direct variable cost of the testing, as well as bad debt. The supply cost would be in cost of goods. The bad debt would be in SG&A.
Ricky Goldwasser (Analyst)
Okay. We can assume just the bad debt that kind of at the corporate level?
Brad Hayes (EVP and CFO)
Yes.
Ricky Goldwasser (Analyst)
Thank you.
Operator (participant)
Thank you. The next question comes from the line of Gary Lieberman, Wells Fargo. Please proceed.
Gary Lieberman (Analyst)
Morning. Thanks for taking the question. Can you discuss any impact at all that you have seen on the competition from the reimbursement cuts, either from a business perspective or a willingness to try to go after acquisitions?
Steve Anderson (VP of Investor Relations)
Darius, Dave. Obviously, the reimbursement impact hits all laboratories and indeed hits hospitals that perform Medicare laboratory services as well. The biggest impact we’ve seen in the marketplace is in the anatomic pathology-focused specialty businesses, simply because, as you recognize from Steve’s commentary, the clinical lab fee schedule, the physician fee schedule, and the 88305 reduction all have a direct impact on them. The entire industry has been affected by this. I think we’re seeing some of the smaller and some of the specialty players be more cognizant of the opportunity to monetize their businesses than maybe they were earlier in 2012.
Gary Lieberman (Analyst)
Okay. That’s helpful. And then just in terms of thinking about the additional leverage that you guys plan to take on, I mean, it would indicate a fairly sizable dollar amount. It would seem like it would leave you more than enough capital to do share repurchases at at least the rate that you’ve been for the past year or so, and also acquisitions. Is there anything specific or general that you’re thinking you’re going to use it for? I guess the timing in terms of how long you think it’s going to take you to increase the leverage?
Steve Anderson (VP of Investor Relations)
Yeah. Obviously, we do not guide to our share repurchase activity. I want to make sure that nobody is interpreting this as giving guidance on our share repurchase activity. As I said in the prepared comments, if you look at the last five years, it has been almost exactly half of our free cash flow to acquisitions and half to share repurchase. Going forward, we would expect to deploy our free cash flow similarly, about half to acquisitions and half to share repurchase. The additional leverage that we have talked about, by and large, and again, all other things being equal in the absence of sizable acquisition opportunities, we would expect the additional leverage to be deployed towards share repurchase. We do not have a specific time frame for when we would achieve the target leverage, largely because, going back to your last question, the acquisition market is very active.
The environment is very fluid. We are going to be strategic about how we deploy that additional leverage and how we reach the leverage point over time.
Gary Lieberman (Analyst)
Okay. Great. Thanks very much.
Operator (participant)
Thank you. The next question comes from the line of Gary Taylor, Citigroup. Please proceed.
Gary Taylor (Analyst)
Hey. Good morning, guys. As I kind of do my math on the volume, I just want to see if you agree with this. Reported 2.8, I guess, really would have been 3.8 adding back the weather. Then you’re saying 0.7 of that is organic. MedTox and other deals added about 3.1% year over year?
Steve Anderson (VP of Investor Relations)
Darius, Dave. The only observation I would make on that is, and I do not mean to split hairs, but some of that 1% that we lost due to weather would have been organic as well. Your numbers are close. I do not think there is a material difference there. As reported, if you do not take account of that 1%, then I would agree with you. 0.7% organic and the rest acquisition. I think some of that 1% would have been driven by organic growth as well.
Gary Taylor (Analyst)
Okay. That’s a fair point. I guess what I’m interested in is you commented that the underlying organic was better sequentially, and I see that as well. Shouldn’t we believe that the very widespread flu activity and presumably physician office activity might have contributed to some of that sequential improvement and maybe not to read too much into that heading into 2013?
Steve Anderson (VP of Investor Relations)
It’s Dave again. I mean, far be it for me to suggest how you should interpret the data. The only thing that I will say is our business is not driven by flu. Most of the flu that we test for at all is going to be rapid point-of-care testing in patient service centers. As you probably know, most rapid flu testing is done in physician offices and is not sent out. My view is the flu season really does not have an impact, a strong impact one way or the other. Again, that’s my view, and you may have a different view of how to interpret the data.
Gary Taylor (Analyst)
Sure. For Brad, on the amortization acceleration, I assume that is in the amortization line. If we exclude that, that means the recurring amortization number drops to 17, which looks low. Is that the right quarterly run rate into 2013?
Brad Hayes (EVP and CFO)
Gary, the 6.2 is in the number for the amortization line. I think some things are rolling off. Generally, amortization is coming down as some things get fully amortized. Again, since that’s a number that we add back for our adjusted EPS and the way we guide and the way we report, it’s interesting, but I don’t think it affects our guidance or our results.
Gary Taylor (Analyst)
I guess I’m thinking the run-rate amortization has been roughly 21. If we exclude the $6 million, this quarter was 17. That lower run rate sounds like it carries into 2013 because things are rolling off.
Brad Hayes (EVP and CFO)
Yeah. The only thing I’d add to that not being exactly the way to extrapolate it is, as we do the acquisitions and there are adjustments to amortizations as we get final valuations and things of that nature, those go into that line as well.
Gary Taylor (Analyst)
Okay. Then last question. I guess absent from the Medicare headwinds you outlined were some of the changes to the molecular diagnostic payments that obviously are coming out of the Palmetto fee schedule that a lot of us have been trying to compare apples to apples and understand what’s being paid for and not paid for, etc. It seems like there is a headwind there, but not something that you explicitly identified today. Can you comment on that a little more?
Steve Anderson (VP of Investor Relations)
Darius, Dave. First of all, as we have consistently said, only about 4%–5% of our total revenue base is impacted by the Medicare molecular DX coding changes. And molecular DX is about 6% of the total revenue base. We have been saying all along that we did not expect a material impact. In fact, we expect these Medicare repricing of molecular codes to be a slight positive for us. We’re continuing to discuss the appropriate payment rates with our managed care partners, and whether that’s a headwind or a tailwind remains to be determined.
Gary Taylor (Analyst)
Okay. The 6%, does it include the commercial side?
Steve Anderson (VP of Investor Relations)
Yes.
Gary Taylor (Analyst)
Okay. Great. Thank you.
Operator (participant)
Thank you. Your next question comes from the line of Lisa Gill, JP Morgan. Please proceed.
Ricky Goldwasser (Analyst)
Hi. Good morning. This morning, Dave, you talked about an increase in payment from other payers when you answered Tom’s question about positives. Can you maybe just talk about what you’re seeing? We heard from your large competitor that they’re actually seeing a decline and talked about a tough reimbursement environment. If you can give us some color as to where you’re seeing some opportunities to actually increase price. Is that actual increase in price, or is it more of a mix issue that you’re seeing? Thanks.
Steve Anderson (VP of Investor Relations)
Lisa, it’s Dave. Obviously, the Medicare reductions are a direct price headwind. All of those go straight to price. As Brad commented earlier, we do have some price increases in other payer groups, which will help offset the payment reductions. Those consist of actual unit cost increases. I’m not going to go into detail about those unit cost increases, but suffice to say they go broadly across all of our other payer groups besides government. There also will be some benefit from test mix, and there will be some benefit from, if history continues to repeat, some benefit from a slightly larger number of tests per requisition. Those are the pricing aspects of what we see in 2013 that will help us to offset, to some extent, the Medicare headwind.
Ricky Goldwasser (Analyst)
Just in your conversations with ACOs and some of the big IDNs that you talked about as we could see consolidation of healthcare, have you had those conversations around maybe narrower lab networks or being the lab provider of choice for any of these ACOs as we move forward?
Steve Anderson (VP of Investor Relations)
We have. I would say one of the complications is that the ACO environment is evolving quite rapidly. You have many large ACOs forming that provide services to members of many different managed care plans. Even being the preferred lab provider, obviously, does not mean you are going to get all of the volume. Most of those payment rates are going to be based on managed care contracts. I think over time, as we see the evolution where ACOs and other providers are actually sharing or taking risk, that is when you will start to see much more clarity on what the impact of that transition will be on pricing.
Ricky Goldwasser (Analyst)
Okay. Great. Thank you.
Operator (participant)
Thank you. The next question comes from the line of Amanda Murphy. William Blair, please proceed.
Amanda Murphy (Analyst)
Hi. Thanks. Sorry, a question on some commentary you made about Beacon and some of the alternative models that you’re looking at pursuing. Is there a way to think about that sort of at a high level in terms of how that might impact the P&L relative to your core lab business? Would it be lower margin or higher revenue? I’m just trying to think about how that would flow through the P&L specifically.
Steve Anderson (VP of Investor Relations)
Amanda, it’s Dave. I don’t think we’re in a position to talk about how Beacon might impact the P&L because there are so many different potential ways in which Beacon LBS could be deployed. I think it’s just too early to give a sense of what that would do from a revenue and a margin perspective.
Amanda Murphy (Analyst)
Got it. For the TC Grandfather, I recognize that’s probably not a huge impact. Are there any lessons to be learned there in terms of how that may or may not have changed reimbursement just in terms of having to deal with a hospital directly versus what you were billing to a payer before?
Steve Anderson (VP of Investor Relations)
I think it would be self-evident that the rates that we receive when we bill the government are really not negotiated rates. They’re rates that are provided in the fee schedule. Anytime that we deal with non-government payers, we typically have a negotiation. I don’t know that there are necessarily any lessons to be learned. The TC Grandfather was a long-standing provision of law that Congress saw fit to change. Again, I think it reflects a broader movement in the marketplace where the government fee-for-service environment is migrating more towards either direct relationships with other payers or towards managed government beneficiaries and dealing with them in a managed rather than a fee-for-service environment.
Amanda Murphy (Analyst)
Yeah. I guess the reason for the question was, can we extrapolate anything from that if the world moves more toward an ACO-type model where your, I guess, your customer becomes a provider versus the payer? Is there anything that we can extrapolate from that experience, or is it just too specific? That was really the point of the question, I suppose.
Steve Anderson (VP of Investor Relations)
I think that, again, I think it’s very early to try to think about what would happen as you move toward a more comprehensive, let’s call it ACO health system environment. We negotiate with the payers. We negotiate with other providers who want to use our services. I think that will continue to be, in 80% of our business, that will be the model. There will be negotiated rates of payment for services provided and for other services like Beacon LBS or data analytics or population health management.
Amanda Murphy (Analyst)
Got it. And then just one last one. You had mentioned something about having to reinvest in a testing platform. Can you just provide a little more color around what that is exactly?
Steve Anderson (VP of Investor Relations)
Yeah. Without giving you a lot of specifics, we have a testing platform that has reached the expiration of its natural life and is not going to be supported anymore. It’s a sizable platform, and we have to replace the instruments basically in all of our laboratories.
Amanda Murphy (Analyst)
Okay. Is that something to be, from a risk standpoint, that could be an issue, or is this just, I'm sure you've gone through these replacements before, but.
Steve Anderson (VP of Investor Relations)
Yeah. I mean, this is a 10-year-old system that we need to upgrade from a risk perspective. I don’t think it entails an unusual amount of risk. We go through system replacements frequently, and we do them on a rolling basis so that we don’t disrupt workflow.
Amanda Murphy (Analyst)
Got it. Thanks very much.
Operator (participant)
Thank you. Your next question comes from the line of Kevin Ellich, Piper Jaffray. Please proceed.
David King (Chairman and CEO)
Good morning. Thanks for taking the question. Dave, I just wanted to go back to the volume growth in Q4. How much growth are you guys getting from number of tests per requisition and mix shift to the higher-acuity tests? Also, what about partnerships like with Ariosa Diagnostics? How much contribution did you guys see to the top line in volume from that?
Steve Anderson (VP of Investor Relations)
Kevin, it’s Dave. I don’t think it benefits us to break down every single component of volume growth. I will say that test per requisition is a slight help on a comparative 2012 to 2011 basis, but it doesn’t change from 3Q to 4Q. We have gotten some nice top line growth from Ariosa, which is the non-invasive prenatal screening test. That is what we do. We introduce new tests that are scientifically innovative, cutting edge, and provide better, and in this case, less invasive patient care. It is our expectation that that is part of our growth over time.
David King (Chairman and CEO)
Got it. No, that’s helpful, Dave. Then kind of going back to one of the earlier questions on ACOs, you talked about alternative delivery models in your prepared remarks. Just wondering how the discussions are going with hospitals and other providers and any developments or updates from Adam’s efforts since he’s been with the company.
Steve Anderson (VP of Investor Relations)
I think Adam has been terrific, but Adam is part of a very large team of people at Labcorp who are working on enhancing our hospital presence. I’m not going to call the names of every single one of them on the call, but we have a very robust hospital business already, and everybody is working to grow it. I think we’ve had very constructive discussions with a number of health systems about a broad range of relationships going from reference testing to lab management to joint operating and joint equity ventures. We will continue to push forward with that initiative, and I expect it to pay significant benefits as we come out of 2013 and go into 2014 in terms of revenue and volume growth.
David King (Chairman and CEO)
Okay. And then just one last quick thing here, Dave. Brad talked about facility consolidation with the higher CapEx. Just wondering, is that enough to move the needle with some of the operating costs? It looks like you’ve done a good job of keeping a tight lid on expenses, as you always do. Just wondering how much more we could see in 2013.
Steve Anderson (VP of Investor Relations)
The facility consolidation, by its nature, is time-consuming. It’s not just a question of moving a facility from one place to another because we have instrumentation, we have interfaces, we have to make sure that the customers are receiving the same level of service. There is opportunity around facilities, and I put that into two categories. One is planned consolidations for acquisitions where we know that over time we have a plan to reduce or consolidate space. The other is a comprehensive review of our existing footprint and what are ways in which we can deploy it better. The particular investment that we spoke about in facility consolidation falls into the latter category where we’re looking at our existing footprint, and we are consolidating. We will be consolidating multiple facilities into one facility during 2013, and we will continue to look at that.
Again, very hard to put a specific cost number on it, Kevin, but what I would say is, without a lot of fanfare around here, every year we reduce costs by $45 million–$50 million. That’s just part of our business. It’s part of what we do, and it’s going to continue to be part of what we do.
David King (Chairman and CEO)
Got it. Okay. Thanks, Dave.
Operator (participant)
Thank you. Your next question comes from the line of AJ Rice, UBS. please proceed.
Steve Anderson (VP of Investor Relations)
Thanks. Hi, everybody. Just a couple of quick questions, hopefully. Just first of all, and I know you were given that comment last quarter pretty early, and I applaud you for just even making the guess at it, but you said $0.22 last quarter for the Medicare headwind, and now it’s $0.35. I just was trying to understand what is the clarification or the change in thinking that happened that resulted in the $0.35?
AJ, this is Brad. I think the major difference as we look at the $0.22 for Q3 and the $0.35 that we’ve updated now for our 2013 outlook is the 88305, which we did not know about at the time. The full impact, the full-year impact of the TC Grandfather change, which we did not consider in the $0.22, and a few other changes that are related to all the government changes and reductions in payment. That is the difference.
Okay. And then another sort of broader question on the pricing trend. Is there anything, when you step back and look at the aggregate business, a payer mix, that is the places, the different sources of payers, is that changing and having an impact on pricing if you look at 2012 versus 2011 and maybe your expectation for 2013?
AJ, it’s Brad again. The biggest change I can think of that we see in that is mostly as a result of acquisition. If I think about MedTox, for example, that’s hitting in the client or direct to the company sort of billing, which is typically lower nature in price. I think beyond that, and some of the other things that we’ve done in the past few years, clinical trials related are also showing up in that same area. If I take those things away, I don’t see a major shift going on between the payer mix schedules, especially on a year-over-year basis. We can see some variations in quarters and sequential views and things of that nature, but no real change in dramatic change in capitation or managed care fee-for-service patient, the other categories that come to mind.
Okay. That’s good. Then just a last question. I appreciate the comments on health reform. I wondered specifically about the exchanges. Do your contracts with commercial payers, managed care today, just automatically apply to those people that are on the exchanges, or do you have to go out and negotiate new contracts for those new health plans that maybe with payers you have current contracts with? If so, have you had any early discussions in any sense that the exchange-related patients may be priced somehow differently or set up differently?
AJ, it’s Dave. It’s a great question, and I wish there were a clear answer that we could give you. I think the way that the exchanges are going to operate is still very unclear. We have had many conversations with our managed care partners about how the exchanges are going to work, and I think they are as uncertain as we are. I think the best we can give you is we’re in frequent and detailed discussions, but it’s not clear what the outcome will be from a pricing or an offering perspective.
Okay. All right. Thanks a lot.
Operator (participant)
Thank you. Your next question comes from the line of Darren Aleric of Deutsche Bank. Please proceed.
Tom Gallucci (Analyst)
Thanks. Good morning, everybody. I wanted to just ask a couple of things here. First, as it relates to buyback, I understand you’re not going to guide us on the cadence of your buyback, etc., but just curious, just given the size of it, should we expect anything different as it relates to how you approach it? In other words, historically, we’ve seen more opportunistic buybacks in the quarter. Do you think you might do some larger forward purchase agreements? Just structurally, how are you thinking about the buyback given the size that you’ve announced here?
Steve Anderson (VP of Investor Relations)
Darren, it’s Dave. I think the share buyback has been an extremely important way of returning capital to shareholders. I think over time, we’ve done a very good job of doing it in a disciplined way that has created a lot of value. That’s our goal. That’s what we’re going to continue to do. Beyond that, we’re not going to guide to how we’re going to do it structurally or otherwise, other than to say that this is the way we return capital to shareholders. We’re committed to it, and we’re going to continue to do that.
Tom Gallucci (Analyst)
Sure. Okay. That’s fair. I guess just on the cash flow outlook, Brad, it seems like you maybe pulled a little bit more of working capital from the 2012 period. It sounded like maybe just inventory build around some vendor discounts that you got. I’m curious just why the cash flow outlook for 2012 or 2013, rather, wouldn’t reverse that. Is there anything else in working capital that we ought to be thinking about for 2013?
Steve Anderson (VP of Investor Relations)
Not specifically in working capital. I mean, I think about the other things related to earnings that we talked about. The payment reductions are obviously a headwind for the cash flow. Just generally speaking, the growth environment. Again, back to our comments of most of the growth driven by the MedTox acquisition in 2013 that’s in our range. I think it’s just the muted earnings growth environment and the payment reductions are the only thing that come to mind specifically, and nothing really in the other areas of working capital.
Tom Gallucci (Analyst)
Okay. And then just so I'm clear, severance and other restructuring is excluded from that outlook or contemplated in it?
Steve Anderson (VP of Investor Relations)
It's excluded from both the EPS, so we don't project in our guidance at all any sort of restructuring activities. Therefore, it's also not considered for the cash flow guidance either.
Tom Gallucci (Analyst)
Okay. Given some of the ongoing nature of what you're describing in terms of cost reductions and consolidations, what would be a rough cash impact from that in 2013 and any range you'd put on it?
Steve Anderson (VP of Investor Relations)
Now, I wouldn't want to estimate it because, again, it has a lot of things that it depends on as we execute on those things.
Tom Gallucci (Analyst)
Okay. All right. Then just last thing is really around margins and what’s sort of baked into your guidance implicitly. It does assume margin improvement just if you take the midpoint and walk it up from the EPS line. I guess, Dave, you made the comment that you’re taking $50 million of costs out per year, and you’ve already commented about some managed care pricing that you’ll be able to benefit from. I guess just given the environment and the growth of what we’re seeing here, is there anything else that we ought to be considering in terms of your margin outlook that would get us to an improvement—my math, close to a point of year-over-year improvement in margin?
Steve Anderson (VP of Investor Relations)
Okay. All right. Then just last thing is really around margins and what’s sort of baked into your guidance implicitly. It does assume margin improvement just if you take the midpoint and walk it up from the EPS line. I guess, Dave, you made the comment that you’re taking $50 million of costs out per year, and you’ve already commented about some managed care pricing that you’ll be able to benefit from. I guess just given the environment and the growth of what we’re seeing here, is there anything else that we ought to be considering in terms of your margin outlook that would get us to an improvement, my math, close to a point of year-over-year improvement in margin?
Tom Gallucci (Analyst)
Okay. All right. Thanks very much.
Operator (participant)
Thank you. Your next question comes from the line of Isaac Rowe, Goldman Sachs. Please proceed.
Brad Hayes (EVP and CFO)
Thanks for taking the question. Just maybe wanted to touch on the organic volume trend this quarter when you just heard Sandy. Was there anything else in there? You mentioned flu being sort of not that important, but maybe deductibles are another item there that helped the business sequentially.
Steve Anderson (VP of Investor Relations)
No. I think what helped the business sequentially is that more people came to our patient service centers. I mean, in our view, we had a strong organic volume growth in a quarter that typically is not one of our stronger growth quarters. So we’re pleased with it, and I don’t know that there’s anything we can do to kind of break it down into bits and pieces.
Brad Hayes (EVP and CFO)
Okay. Just on the testing platform switch there, is there an opportunity for you guys to maybe get better pricing terms or upgrade the technology you’re using in a material way? I’m just trying to put that into context as to how important that is for the overall business, how sizable it is.
Steve Anderson (VP of Investor Relations)
Whenever we switch out a testing platform, it is to improve technology, and in almost every case, it’s to reduce expenses. In this case, the change in the testing platform will have both impacts, although obviously there is a capital component that comes back as an expense once it’s deployed into service. Isaac, this is Brad. I would add that because of our standardization and the way we go about this from a supply chain perspective, we do the whole network at one time. Not on the same day, but we make the decision, and it applies to the entire network. It takes some time to roll it out. We think by approaching it that way, we are able to get the best economics on those kinds of activities.
Brad Hayes (EVP and CFO)
Can you maybe offer some color as to what type of a testing platform it is? Is it routine testing or molecular? Just trying to get a sense of how important this is to the business mix.
Steve Anderson (VP of Investor Relations)
No, we're not going to give any color on what platform it is.
Brad Hayes (EVP and CFO)
Great. Thank you.
Steve Anderson (VP of Investor Relations)
It's 10:00, and we're going to try to take a couple more questions, but let's please try to limit it to one question so that everybody has a chance.
Operator (participant)
Thank you. Your next question comes from the line of Glen Santangelo from Credit Suisse. Please proceed.
Robert Willoughby (Analyst)
Oh, yeah. Thanks. I was wondering if I could just maybe follow up on that previous sort of EBIT question. It kind of feels like if I look over the last six months, your operating profit was shrinking a little bit by about maybe 3% sort of year-over-year in the second half of 2012 if I normalize for Sandy.
Steve Anderson (VP of Investor Relations)
Glenn, it's Brad. Are you talking about absolute dollars or on a margin basis?
Robert Willoughby (Analyst)
On a dollars basis.
Steve Anderson (VP of Investor Relations)
Okay. Because I can see that, but I could not get to on the margin side what your question was. So Glenn, it is Dave. I think as I have mentioned, and I am not sure that I can say it in a different way from what I have said before, we have some opportunities around the acquisition integration. We have some opportunities around the consolidation of facilities, and we always are working on cost reductions across the organization with SG&A this year being a prime example. I cannot really give you much more than what I have said before, which is these are the expense opportunities and the expense reduction opportunities that we are always looking at.
Robert Willoughby (Analyst)
That’s fine. Maybe if I could just ask one quick one on the anatomic pathology side. You talked about obviously the major cut in your sort of prepared remarks. Could you give us your updated view maybe on this trend of physician insourcing of these tests? Do you see it moderating at all? Or with the reimbursement cut, do you think it reverses over time this trend?
Steve Anderson (VP of Investor Relations)
I do think that the reduction in the technical component of 88305 will discourage physician insourcing because it becomes considerably less of a profit center. Again, the reduction only occurred on January 1st, so it's really too early to call it a trend.
Robert Willoughby (Analyst)
Okay. Thank you.
Operator (participant)
Okay. Thank you. Your next question comes from the line of Dane Leon from Macquarie. Please proceed.
Ricky Goldwasser (Analyst)
Thanks for taking the questions. Quick one for me. You kind of always highlight some new tests that you have in the pipeline and outlook. I think it’d be helpful if you could just give some color going into 2013 on expectations for new products to add to the growth of the franchise. I know you don’t really break it out specifically, but any type of characterization you can give this year versus last year, any real impact towards the growth of the esoteric mix overall would be helpful.
Steve Anderson (VP of Investor Relations)
Yeah. I think the Ariosa test will be a significant contributor, the non-invasive prenatal screening test. I think that we're going to continue to see some growth in specialized testing around hepatitis C as more of these compounds are successful and come to market, and there are tests associated with the efficacy of the new compounds. I think that the next-generation sequencing and the GeneSeq CardioTest will continue to grow. I also think that even though it would not be described by itself as esoteric, I think that the chronic kidney, the cardiovascular, the bone, all of the services that we've launched through Litholink that help physicians manage patients will continue to see nice growth there.
There are a lot of things that obviously I have not mentioned, but those are probably some of the highlights for where we think we'll see growth in new tests in 2013.
Ricky Goldwasser (Analyst)
Okay. Great. For context, is there a hurdle rate where you would consider something an impactful contributor, generally speaking, of a new test or growth of a test?
Steve Anderson (VP of Investor Relations)
I think the reality is that most new tests that we introduce are relatively specialized and meet needs of a certain physician community or a certain part of the clinical community. For us, the hurdle rate is, is there an unmet need in the population? Is this something that's going to be helpful to clinicians? Will it give us the ability to better diagnose and treat disease? Obviously, we want to be financially successful with these tests, but it would be unrealistic to say there has to be a financial hurdle rate for everything that we launch.
Ricky Goldwasser (Analyst)
Okay. Thank you.
Operator (participant)
Thank you. I would now like to turn the call over to David King for closing remarks.
Steve Anderson (VP of Investor Relations)
Thank you, Sean. Thank you, everyone, for attending our fourth quarter and full year 2012 earnings call today, and we hope you have a great day.
Operator (participant)
Thank you for joining today's conference. This concludes the presentation. You may now disconnect. Good day.