Pathology Valuation

[email protected]© 2012 Sinaiko Healthcare Consulting, Inc. Proprietary and Confidential 1

Valuation of Medical Laboratories

Amy Graham, MBACurtis Bernstein, CPA/ABV, ASA, CVA, MBA

Kyle Rudduck, CFA


Presentation Outline

What is Pathology? Revenue Cycle Expenses Valuation


What is Pathology

Clinical pathology – diagnosis of disease through the study of bodily fluids, such as blood, urine, or tissue– Drug or cholesterol testing

Anatomic pathology – diagnosis of disease through the gross, microscopic, chemical, immunologic and molecular examination of organs, tissues, and whole bodies– Autopsy– Analysis and diagnosis of tissue samples


REVENUE CYCLE


Medicare Payment Overview – Lab Services

Note: The vast majority of claims are paid at the National Limitation Amount.

Lab Service

Payment is

the lesser of

Provider’s Charge

Fee Schedule Amount set by

carrier

National Limitation Amount (NLA) (74%

of median fee schedule amounts

set by carriers)

Payment


What is a CPT Code?

Current Procedural Terminology

Documents information about treatment and other medical services

Developed and maintained by the American Medical Association

Pathology is its own section of Category I CPT Codes


Understanding Medicare Billing Medicare Physician Fee Schedule (“MPFS”)

•The Centers for Medicare and Medicaid Services uses the MPFS to reimburse physician services. The MPFS became effective January 1, 1992 and replaced the old “customary, prevailing, and reasonable” (CPR) charge system. The MPFS is funded by Part B and is composed of resource costs associated with physician work, practice expense and professional liability insurance.

•Under the MPFS, each of these three elements is assigned a Relative Value Unit (RVU) for each Current Procedural Terminology (CPT®) code. These RVUs are then adjusted based on the Geographical Practice Cost Index (GPCI) associated with various geographic areas for different medical costs and wage differentials. The conversion factor is the national dollar amount that is multiplied by the total geographically adjusted RVU to determine the Medicare allowed payment amount for a particular physician service.

•There exist a multitude of “Modifiers” that can be applied to certain CPT codes to reflect variations of a certain procedure that was performed. Some of the most common modifiers among them are: multiple procedure (51 or 59 modifier), professional services only (26 modifier), or technical services only (TC modifier).


Billing for Lab Services

Clinical labs - The patient and insurance company is billed

According to MedPac, Medicare is the single largest purchaser of clinical laboratory services– Services are covered under Medicare Part B (does not cover routine tests

unless required by law)

Medicare sets payment rates for more than 1,100 HCPCS codes used to bill various laboratory services– According to Medicare approximately 40% of all claims are not billed

correctly and a significant portion of denials are never refiled


Billing for Lab Services (cont’d)

Many insurance companies use the Medicare rate as a basis for developing their own reimbursement schedules.– As goes Medicare, so goes the insurance companies.

There is no beneficiary cost sharing for clinical lab services (the fee schedule payment reflects the total payment received for the service)

Billing client vs. billing insurance


Understanding Medicare Billing Professional vs. Technical Split

Technical Component

• Practice Expense RVUs x PE GPCI

Professional Component

• Work RVUs x wRVU GPCI

• Practice Expense RVUs x PE GPCI

Professional Liability

• Professional Liability RVUs x PL GPCI

Conversion Factor

• Universal amount for all CPT codes.

In the physician office setting, Medicare provides professional (physician services) and technical (facility fees) reimbursement to the appropriate party, according to the formula below:

The formula is set such that the payments made to physicians (professional reimbursement) plus the payments made to facilities (technical reimbursement) equal “global reimbursement.” This means that the total payment is the same regardless of whether separate payments are made to the physician and the facility or, in the case of physician owned facilities, a lump sum payment is made only to the facility.


Revenue Sources / Payor Mix

Referring Physician / Client Office– Dependent upon payor mix of physician office

Hospital– Dependent upon payor mix of hospital– Medical Director fee (paid under Medicare Part A)


Physician Fee Schedule

Medicare’s fee schedule for clinical lab services can be found at:– http://www.cms.gov/ClinicalLabFeeSched/

Medicare’s fee schedule for physician services can be found at:– http://www.cms.gov/PhysicianFeeSched/

http://www.cms.gov/ClinicalLabFeeSched/

http://www.cms.gov/PhysicianFeeSched/


Market Forces – Revenue Considerations

2000 - 2006* 2007 2008 2009 2010-2.0%0.0%2.0%4.0%6.0%8.0%

10.0%12.0%

9.7%

-0.5%

4.4%

11.2%

2.4%

Year Over Year Change in Medicare Spending

Change in Medicare Spending

• 9.7% reflects the average change per year over this time period.• Pathology labs represent 30% of all claims received by Medicare but only 2% of total Medicare spending


Market Forces – Revenue Considerations – Medicare Reimbursement

Despite the variance in Medicare spending detailed in the chart on the previous page, since 1997 payments for procedures have increased only twice

– In 2003, there was an increase of 1.1% and in 2009 there was an increase of 4.5%

– In 2011, there was a negative adjustment reflecting a 1.75% decrease (see next slide)

– The Clinical Lab Fee Schedule (“CLFS”) has been frozen or reduced in 9 out of the last 10 years (2003 – 2012)


Reimbursement – Medicare - Technical

Medicare National Average - Technical 2008 2009 2010 2011 2012 CAGR88304Tissue Exam by Pathologist $51.04 $50.49 $50.88 $56.42 $55.78 2.2%88305Tissue Exam by Pathologist 66.65 66.72 66.37 69.65 69.78 1.2%88307Tissue Exam by Pathologist 124.54 128.76 132.37 160.36 169.94 8.1%88309Tissue Exam by Pathologist 169.11 176.37 182.52 222.72 236.5 8.7%88312Special Stains 65.89 71.41 73.38 87.97 74.00 2.9%88313Special Stains 58.27 59.87 61.21 72.38 59.13 0.4%88331Path Consult Intraop, 1 Bloc 28.95 29.21 29.13 31.94 33.70 3.9%

Source: Medicare Physician Fee Schedule

Interesting Note: CPT Code 88305 is one of the top five codes billed to Medicare


Reimbursement – Medicare - Professional

Medicare National Average - Professional 2008 2009 2010 2011 2012 CAGR88304Tissue Exam by Pathologist $10.28 $10.82 $11.06 $10.87 $10.89 1.5%88305Tissue Exam by Pathologist 36.18 37.15 37.24 36.35 36.08 -0.1%88307Tissue Exam by Pathologist 77.70 78.99 80.38 79.5 78.97 0.4%88309Tissue Exam by Pathologist 131.40 135.97 140.49 138.96 138.87 1.4%88312Special Stains 25.90 26.33 26.55 26.16 25.87 0.0%88313Special Stains 11.43 11.54 11.8 11.55 11.57 0.3%88331Path Consult Intraop, 1 Bloc 58.27 59.51 60.47 59.46 58.89 0.3%

Source: Medicare Physician Fee Schedule


Market Forces – Revenue Considerations: Payor Mix

Source: LabCorp and Quest Diagnostics

49.6% 49.2% 48.9%51.3%

48.8%51.3%

17.6%

20.2% 18.1%19.8%

17.8%20.1%

32.8%30.6%

33.0%

28.9%

33.4%

28.6%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

LH DGX LH DGX LH DGX

Managed Care Medicare & Medicaid Other

12/31/11 12/31/0912/31/10


Market Forces – Revenue Considerations – Health Reform

Healthcare Reform Legislation impact on clinical laboratories

– Included as a component of the legislation, was a requirement that Medicare reduce the CLFS by 1.75% for each of the next five years (beginning in 2011).

– This reduction was accompanied by a productivity adjustment that reduces the CPI market basket update beginning also in 2011


Market Forces – Revenue Considerations – Analyte Codes

The American Medical Association CPT® Editorial Panel is continuing its process of establishing analyte specific billing codes to replace codes that describe procedures used in performing molecular tests. The 2012 CPT manual adopts approximately 100 of such codes and, it is anticipated that such codes will eventually cover hundreds of molecular tests.

While CMS has deferred adoption of the new molecular codes until 2013, a handful of commercial health plans are implementing them.

The adoption of analyte specific codes will allow payors to better determine tests being performed which could lead to limited coverage decisions or payment denials.


Market Forces – Revenue Considerations – Non-Governmental Payors

Trend of consolidation among healthcare payors has resulted in decreased number of payors with increased negotiating leverage

Some healthcare plans have been willing to limit the PPO or POS laboratory network to only a single national laboratory to obtain improved fee-for-service pricing

Some healthcare plans also are considering steps such as requiring preauthorization of testing

An increasing number of patients enrolling in consumer driven products and high deductible plans that involve greater patient cost-sharing.


Revenue Considerations – Quest Diagnostics Lawsuit Settlement

On May 19, 2011 Quest Diagnostics (NYSE: DGX) announced the settlement of a lawsuit with the State of California in regards to alleged violations of the state’s False Claims Act

– In a qui tam case filed by a competitor of Quest, the Government alleged that Quest offered deeply discounted, private rates to physicians for laboratory services in exchange for the physician’s referral of Medi-Cal business to Quest.

– In many cases, the private rates charged by Quest to the physicians were below the costs incurred by Quest in providing the test.

– Competitors alleged that the deeply discounted pricing created large barriers for new laboratories attempting to gain market share and stifled competition.


Revenue Considerations – Quest Diagnostics Lawsuit Settlement (cont’d)

On May 19, 2011 Quest Diagnostics (NYSE: DGX) announced the settlement of a lawsuit with the State of California in regards to alleged violations of the state’s False Claims Act

– Quest then allegedly would offset the losses incurred on the private business by overcharging Medi-Cal for services.

– This would have violated the law that requires Medi-Cal providers to bill Medi-Cal at their lowest reimbursed rate received for services.

– California’s penalty for violation of its False Claims Act is up to $10,000 for each false claim.

– The case resulted in a settlement of $241 million paid by Quest to the state of California.


Revenue Considerations – Anti-Markup Rule

2009 Medicare Physician Fee Schedule final rule

If the anti-markup payment limitations apply, the payment to the billing physician for the technical or the professional component of the diagnostic test may not exceed the lowest of the following amounts:

– The performing physician’s “net charge” to the billing physician

– The billing physician’s actual charge

– The fee schedule amount


Revenue Considerations – Hospital Based Stipends

Commonly paid when fees generated by services provided to hospital by physician practice are not sufficient enough to cover market salaries to physicians

– Must take into consideration any fees paid to physician for services provided and reimbursed to hospital under Medicare Part A (i.e., bundled payments)

Based on hospital’s required staffing and overhead expenses, and expected reimbursement to practice.


EXPENSES


Market Forces – Expense Considerations

Healthcare Reform Legislation impact on clinical laboratories

– Beginning in 2013, the legislation imposes an excise tax on the seller for the sale of certain medical devices in the U.S., including those purchased and used by laboratories


Market Forces – Expense Considerations

New FDA Regulations

– In 2011, the FDA issued several draft guidance statements including, among others, guidance documents regarding software applications used for handheld devices, companion diagnostics, products labeled RUO and IUO and enhancements to the 510(k) process

– If enacted this could result in increase product costs and/or delays in obtaining supplies


VALUATION


Valuation Multiples

Labs generally trade on multiples of revenue and EBITDA

In our experience, we generally observe ranges of 4.0x to 6.0x EBITDA for controlling interest purchases

– Most purchases are for a 100% controlling interest.


Publicly Traded Company Market Data

2.1x 1.6x 1.4x 1.9x 1.7x1.x

1.9x 1.7x.8x

8.9x7.3x

10.7x9.3x

7.9x7.2x 7.9x 7.8x

6.1x

16.1x

12.6x

21.2x

17.1x

19.4x

14.7x13.4x

12.4x13.6x

0.0

5.0

10.0

15.0

20.0

25.0

LH DGX BRLI LH DGX BRLI LH DGX BRLI

EV/Revenue EV/EBITDA P/E

12/31/10 Last 12 Months Next 12 Months

* LTM and NTM Data as of 2/15/2012


Publicly Available Market Transaction Data

Implied Enterprise Value/ Target LTM Financials (at announcement)

Transaction Buyer Target Close Date

Total Enterprise

Value Revenue EBITDA EBIT

1 Sonic Healthcare Ltd. CBLPath, Inc. 12/2/2010 123.5 1.5x n/a n/a2 Physician's Automated Laboratory, Inc. Central Coast Pathology Consultants, Inc. 2/7/2011 28.0 1.4x n/a n/a3 Aurora Diagnostics, LLC Biopsy Diagnostics, LLC 10/8/2010 23.2 n/a n/a n/a4 Ventana Medical Systems, Inc. BioImagene, Inc. 8/31/2010 100.0 n/a n/a n/a5 Laboratory Corp. of America Holdings Esoterix Genetic Laboratories, LLC 11/30/2010 925.2 2.5x n/a n/a6 Novartis Finance Corporation Genoptix, Inc. 3/4/2011 310.9 1.6x 6.6x 7.3x7 Laboratory Corp. of America Holdings Labwest, Inc. 6/16/2010 57.5 0.6x n/a n/a8 Quest Diagnostics Inc. Celera Corporation 5/10/2011 330.4 2.6x n/m n/m

High 925.2 2.6x 6.6x 7.3xMedian 111.8 1.6x 6.6x 7.3xLow 23.2 0.6x 6.6x 7.3xAverage 237.3 1.7x 6.6x 7.3x

Source: Capital IQ Transaction database


M&A Observations

The median and average EV / Revenue multiples over the past three years have been 1.6x and 1.7x respectively.

While there is insufficient data available to determine the correlation of value with EBITDA and EBIT multiples, the correlation between revenue and enterprise value is 94.8%. This equates to an R^2 of 89.8% which tells us that, based on market data, revenue is a relatively good predictor of enterprise value.


Additional Acquisitions – Lab Corp

While financial data related to all transactions is not necessarily available, in the past six years LabCorp has made the following acquisitions (12 Total):

Orchid Cellmark, Inc. (2011) Clearstone Holdings Ltd. (2011) Esoterix Genetic Laboratories, LLC (2010) DCL Medical Laboratories (2010) Labwest, Inc. (2010) Monogram Biosciences, Inc. (2009) PathNet Esoteric Laboratory Institute, Inc. (2008) NWT Inc. (2008) PA Labs, Inc. (2007) DSI Laboratories (2007) Protedyne Corporation (2007) Litholink Corporation (2006)

Source: Capital IQ Transaction Database


Additional Acquisitions – Quest Diagnostics

While financial data related to all transactions is not necessarily available, in the past six years Quest Diagnostics has made the following acquisitions (10 Total):

AHS S.E.D. Medical Laboratories, Inc. (2011) Celera Corporation (2011) Athena Diagnostics, Inc. (2011) Genomic Vision, S.A. (2010) Caritas Medical Laboratories, LLC (2009) OralDNA Labs, Inc. (2009) Pathway Diagnostics Corporation (2008) AmeriPath, Inc. (2007) HemoCue AB (2007) Enterix, Inc. (2006)

Source: Capital IQ Transaction Database


Accounts Receivable Data

2008

2009

2010

2011

- 10.0 20.0 30.0 40.0 50.0 60.0

43.3

40.6

41.4

42.6

51.0

46.9

44.9

44.6

Average Days in Accounts Receivable 2008- 2011

Lab Corp Quest Diagnostics

Source: Lab Corp and Quest Diagnostics via Capital IQ


Bad Debt Data

Source: Quest Diagnostics via Capital IQ. Lab Corp data was not available.

12/31/2008 12/31/2009 12/31/2010 12/31/20110.0%

1.0%

2.0%

3.0%

4.0%

5.0%

4.5%4.3%

4.0%3.7%

Quest Diagnostics Bad Debt as a % of Revenue


Contact

Curtis H. BernsteinCPA/ABV, ASA, CVA, MBA

Sinaiko Healthcare Consulting

[email protected]

www.altegrahealth.com

Amy GrahamMBA

[email protected]

Kyle W. RudduckCFA

Sinaiko Healthcare Consulting

[email protected]

www.altegrahealth.com

mailto:[email protected]

http://www.altegrahealth.com/



http://www.altegrahealth.com/

Health & Medicine

Pathology Valuation