Is Bio-Reference Laboratories As Healthy As It Seems?

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Editor's note: The following story is the first article in a two-part investigative report on Bio-Reference Laboratories (NASDAQ:BRLI); see Part II.

Three years ago, Bio-Reference Laboratories introduced an elaborate – and expensive – version of the standard pap smear that has since become a celebrated, if controversial, driver of growth for the company.

With that test, known as GenPap, Bio-Reference greatly expanded the scope of a routine screening tool used on more than 50 million American women each year. By the time that GenPap hit the market, however, gynecologists had already spent decades effectively utilizing traditional pap smears and (if warranted) cheap supplemental tests to diagnose the most prevalent disorders suffered by the patients they treat.

While those mainstream laboratory tests narrowly focus on a handful of widespread conditions, singled out as relevant by government authorities, GenPap screens for about 20 different organisms (some of them viewed as harmless) linked to both common and rare disorders alike. In fact, as detailed more extensively below, at least one of those 14 ailments - virtually absent except for occasional cases in a limited number of states - barely registers as a disease in this country at all.

Nevertheless, Bio-Reference promotes GenPap as a valuable test for “essentially all women” and employs an aggressive nationwide sales force to court the doctors who take care of them. Although Bio-Reference has reported explosive growth in its young women’s health division since launching GenPap, however, even some fans of the test question its suitability for such a broad swath of the female population.

“I use it selectively,” says Dr. John Siegle, a veteran obstetrician/gynecologist who trains third-year residents in the field. “It’s very, very pricey and not really cost-effective for society.

“If used selectively and appropriately, there is a place for it,” he adds. But “they’re pushing us to do this on everybody. (And) that can’t – that shouldn’t – be done.”

Indeed, as a so-called esoteric lab test, GenPap should (by definition) target only a “select few” who form a tiny subset within the population at large. But if esoteric tests serve a limited market, research indicates, they also carry outsized investor appeal. Typically designed to identify specific health conditions (such as various types of leukemia), records show, esoteric tests cost far more than the routine blood work that accounts for the bulk of the otherwise highly commoditized – and increasingly stagnant – laboratory business.

Thanks to GenPap and other specialty tests, which now account for most of the company’s total revenue, Bio-Reference has kept up its breathless expansion despite sluggish demand for traditional lab services. Bio-Reference has enjoyed impressive stock gains as a result, with its share price doubling over the course of the past few years.

In recent weeks, however, TheStreetSweeper has interviewed experts across the healthcare arena who painted a dark picture of the company and raised serious questions about the lasting power of its current success. Together, they portrayed Bio-Reference as a company that relentlessly pushes excessive specialty tests – even bribing healthcare providers for their business - and then routinely utilizes improper billing practices (such as “upcoding” and “code stacking”) in order to inflate the payments that it receives.

Bio-Reference did not respond to questions for this story.

Last fall, investigators for the Medicaid office in New York – where Bio-Reference controls a sizable chunk of the traditional laboratory market – published a troubling report on the company that indicated widespread billing violations as well. That Medicaid audit, so far largely overlooked by Wall Street, reviewed hundreds of random claims submitted by Bio-Reference over a four-year period and found that almost one-quarter of them failed to comply with mandatory state guidelines. Normally, experts say, a so-called “error rate” of 10% - less than half that seen at Bio-Reference - will set off loud alarms.

Private health insurers, estimated to supply Bio-Reference with half of its overall revenue (based on disclosed receivables), have reportedly begun conducting detailed reviews of their own. A fraud investigator at one major insurance company told TheStreetSweeper that his firm uncovered problems in a huge chunk of the Bio-Reference claims that it examined – including one bill for a male patient who supposedly underwent a test performed on female patients alone - and stopped doing business with the lab as a result.

“We can overlook human errors,” he says. “But we figure the error rate should be below 10%. If you’re between 10% and 20%, we’re going to have a discussion. If you’re above 20%, we’re not going to do business with you.

“With this particular company, it was astronomical," he adds. "We cut all of our ties with them, (but) they got away with it for quite a while."

Patrick Burns, director of communications at Taxpayers Against Fraud, suggests that such a pattern likely reflects blatant - and rampant - deceit.

“It’s not an ‘error rate’ when it’s that high,” he declares. “It’s probably fraud. (And) ultimately, insurance companies just need to walk away.”

Abnormal Results

At this point, records show, Bio-Reference already faces long waits for lab payments that represent a tiny - and shrinking - fraction of the original list prices that the company assigns to its services.

Despite modest improvements touted by management, Bio-Reference ended its most recent quarter with a whopping 92 days' worth of sales outstanding (DSO) – a crucial metric used to gauge a company’s financial health – that dwarfs the numbers reported by other players in its group. In the end, of course, Bio-Reference will never collect all of the unpaid receivables that sit aging on its books. Last year, for example, Bio-Reference wound up writing off the equivalent of 13.6% of its annual sales as bad-debt expense for outstanding claims that would most likely remain that way.

In contrast, industry heavyweights Quest Diagnostics (NYSE:DGX) and Laboratory Corporation of America (NYSE:LH) reported much lower numbers in both of those important categories. Last quarter, as a matter of fact, their DSOs essentially came to half the total that Bio-Reference itself disclosed. Moreover, when those giant lab companies closed the books on their most recent fiscal year, they had written off an average of just 4.4% of their annual revenue (4% and 4.8% respectively) – or roughly one-third the percentage that Bio-Reference wrote off – as bad-debt expense for un-collectible bills.

As indicated above, Bio-Reference has also encountered yet another (if somewhat related) problem that keeps growing by the year. Specifically, corporate filings reveal, Bio-Reference has watched its official collection rate – or the difference between gross revenue (the sticker price for its services) and net revenue (the actual payment for those bills) – deteriorate as well. While health-related companies rarely receive full price for their services, due to hefty discounts or so-called “contractual adjustments” promised to insurers, Bio-Reference has seen that gulf widen to ever-amazing extremes.

Back in 2006, for example, Bio-Reference collected 29% of the cash that the company would have received if its customers had paid full price for its laboratory services. By 2010, however, that modest percentage had dwindled to just 18% instead.

Until the U.S. Securities and Exchange intervened, records indicate, Bio-Reference simply kept those numbers to itself. With the SEC repeatedly pressing Bio-Reference for concrete details about the revenue estimates contained in its last 10-K filing, however, the company finally released specific figures that exposed the full scope of that striking pattern. Bio-Reference then shed additional light on the situation by revealing that steeper pricing discounts had pushed its collection rate to new lows, while nevertheless attempting to downplay that erosion as “consistent with the current state of the economy” and ongoing reimbursement trends.

By the time that the SEC finally closed its review, when Bio-Reference followed up by filing an amendment to its original 10-K, the agency had literally spent months asking the company numerous questions about its financial statements. Moreover, even then, the SEC left the door open for potential action against Bio-Reference down the road.

Still, the SEC sounded downright gentle compared to some critics of the company. Bio-Reference competitors (along with some apparent insiders) have thrown particularly hard punches at the lab, both in statements toTheStreetSweeper and on posts in a popular chat room, by accusing the company of resorting to unethical and potentially illegal marketing practices in order to increase its business. Basically, as a group, those critics claim that Bio-Reference sales representatives often rely on glorified bribes – tempting healthcare providers with padded checks for their tiny lab rooms, free phlebotomists for their onsite lab services (presented as standard practice in an old internal contract), forgiven copayments for their cash-strapped patients and gift cards/event tickets for their office employees – because they face so much pressure to land new accounts.

By law, records indicate, any health-related company that receives payments from Medicare cannot reward doctors with gifts in exchange for business referrals. Even so, critics say, Bio-Reference offers questionable incentives to physicians all the time. For example, one veteran salesman claims, Bio-Reference has provided some doctors with iPads – popular devices obviously capable of far more than retrieving lab results – in order to further expand its growing client list.

“That’s a clear Stark (Act) violation,” says Forest Laboratories CEO Chris Riedel, who recently scored a gigantic reward for exposing rampant industry misconduct across his home state of California. “You can’t do that.”

Riedel should certainly know. He filed a whistleblower lawsuit against seven different labs - including both industry leaders - that triggered a major government investigation. Quest wound up paying $241 million to settle that case, the largest fine ever levied by the state of California under the False Claims Act, while LabCorp fielded a massive penalty as a result of that same probe.

Although Riedel has personally witnessed no violations by Bio-Reference itself, which provides most of its regular clinical laboratory services to a few states on the opposite coast, he has long puzzled over the company’s mysterious ability to keep on gaining market share. After all, when Riedel initially launched Hunter Laboratories after successfully running other labs in the past, he found himself struggling to even penetrate a market that seemed driven almost entirely by illegal bribes and kickbacks when he decided to return. Unwilling to break the law himself, Riedel finally began gathering evidence against his rivals in a desperate attempt to level that treacherous playing field.

Despite the obstacles faced by Hunter Laboratories, however, Bio-Reference itself has somehow found a way to effectively compete – and ultimately succeed – in that same cutthroat business.

“They’ve had the most impressive success in the lab industry,” Riedel marvels. “I’d really like to know how Bio-Reference is doing this. I’ve been wondering about that for years.”

Growth Spurt

For starters, as Bio-Reference CEO Marc Grodman proudly bragged in May, the company budgets an outsized portion of its revenue for marketing - almost one-tenth - that’s “anywhere from two to three times” the percentage spent by some of its larger peers. Based on the record quarterly sales (up 25%) Bio-Reference reported that same day, when its stock hit an all-time high as well, that strategy – productive despite stalling demand for traditional lab services – looks like a resounding success.

After all, while Bio-Reference went on to announce a brand-new record for quarterly sales in late August, powerful Quest barely mustered any revenue gains during its most recent quarter at all. Bio-Reference handily outperformed LabCorp, too, which grew quarterly sales by a full 10% - topping profit estimates once again in the process - but still failed to even approach the 22% revenue increase that Bio-Reference achieved.

Moreover, unlike Bio-Reference, both Quest and LabCorp rely heavily on acquisitions to expand their market share. In fact, to some, Bio-Reference itself seems like an obvious candidate for one of those powerhouses to place at the top of their crowded shopping lists. Despite the buyout hopes that Bio-Reference keeps sparking (with LabCorp rumored as the likely buyer at last check), however, the company remains on its own – some 25 years after Barron's reported that it originally went public – even though, at first blush, it looks rather cheap.

With a market value of $560 million, Bio-Reference barely trades at a single time its prior-year sales in an industry that commands a multiple that’s about twice that size instead. Bio-Reference generates handsome profits, too, which rose by a solid 26% over the past 12 months – beating quarterly estimates three times during that period – and keep expanding by the year.

Curiously, however, Bio-Reference throws off little cash for a successful laboratory company. While Bio-Reference generated a total of $1.12 billion in revenue and almost $64 million in profits over the course of the past three fiscal years, the company somehow ended that period with just an extra $5.88 million in the bank. Excluding the $5 million that Bio-Reference borrowed last year, in fact, the company barely increased its cash balance – dwarfed by a debt load twice its size – throughout that period at all.

To some, Bio-Reference has always looked like damaged goods. As a young public company years ago, Barron’s reminded this May, Bio-Reference partnered with at least four shady investment firms whose leaders later wound up convicted of fraud. Moreover, news records show, Bio-Reference itself has been repeatedly linked to members of the criminal underworld. The company once relied on its ties to the Gambino crime family to secure a lucrative union contract in its home state of New Jersey, The Village Voice indicated years ago, and then reportedly went on to employ a suspected Gambino associate as an actual lab salesman until his indictment (and ultimate conviction) on fraud-related charges.

(TheStreetSweeper will take a much closer look at the criminals connected to Bio-Reference in an upcoming story.)

While growth-hungry investors may feel inclined to overlook that checkered past as ancient history, Bio-Reference itself still casually reminds the public that – in some important aspects – the company has never really changed its ways.

“We don’t forget those days,” Grodman allowed earlier this year. “They forged our corporate culture and character ...

“All this time, over the last quarter of a century, we still remain Bio-Reference,” he continued. “We’re still the same organization, the same management ... People change all the time. We don’t.”

In reality, much to the delight of Wall Street, Bio-Reference has actually evolved quite a bit over the years. Although Bio-Reference spent much of its history focused on the traditional lab business, primarily serving New York and other states in the northeast, the company has since branched out by doubling as a specialty laboratory that markets a variety of esoteric tests to healthcare providers all across the country.

Bio-Reference employs roughly 200 sales representatives, an enormous marketing staff for a laboratory of its size, with more than 70% of those reps assigned to sell nothing but esoteric tests. Notably, almost half of that massive Bio-Reference sales team works exclusively for the company’s young women’s health division.

“Their growth is in the women’s health area,” Riedel says automatically. “It is truly awe-inspiring what Marc Grodman has done, although some people question how the company is doing this.”

Outside the competitive laboratory industry, some doctors have voiced concerns about Bio-Reference and its rapidly expanding women’s health division as well. They worry about GenPap in particular, portraying the test as an overpriced – and oversold – screening tool that seems extremely redundant, typically unnecessary and occasionally dangerous to boot.

For starters, they say, GenPap screens for different variations of a disease or infection that will be treated with the same medication regardless of the specific organism identified as its cause. Moreover, they say, GenPap usually catches the same common ailments uncovered by traditional tests - which cost a fraction of the price - except in a few rare cases. Finally, they add, GenPap also detects harmless bacteria that should not be treated at all.

Although doctors can technically order individual tests on Bio-Reference requisition forms (since Medicare cracked down on broad “panel" screens years ago), critics say, physicians usually feel too rushed to spend the extra time required to comb through those forms and do so. As a result, they say, doctors frequently choose the easiest option - with the full encouragement of Bio-Reference salesmen - and order the full-blown panel instead.

Since Bio-Reference has long refused to quantify the amount of revenue derived from even its women’s health division, despite multiple requests to do so, the number of GenPath tests conducted by the lab remains a total mystery. Hit with pointed questions about excessive testing on female patients earlier this year, however, Bio-Reference automatically rushed to downplay that possibility. The CEO indicated that Bio-Reference carefully polices its lab orders and actually intervenes, when it senses that an OB/GYN might be performing unnecessary tests, despite the business that it might sacrifice in the process.

To some veteran laboratory salesmen, however, that claim sounds downright ludicrous.

“Nobody in the industry is going to go back to a physician and say, ‘You’re ordering too many tests,’” one of them declares. “It’s just not going to happen ...

“In the lab world, it’s all about incremental testing,” he adds. “It costs pennies to run more tests, so you make a lot of money there.”

Secret Formula

Bio-Reference certainly tests for an awful lot of organisms – some of them quite curious – with its GenPap panel screen.

Take hemophillis ducreyi, for example, the bacteria responsible for a sexually transmitted disease known as chancroid. While still prevalent in some third-world countries, primarily those located in poor regions of Africa, chancroid looks almost nonexistent here in the United States.

“Chancroid is extremely rare,” Dr. Siegle confirms. “I’ve seen one case in 31 years, and that patient had an African connection …

“There is direct testing for a disorder like chancroid in the rare event that this disease is suspected. (But) routine screening for this would not be cost-effective or an approach that I would teach any of my residents” in the OB/GYN field.

In 2007, the year before BRLI introduced its new GenPap test and began screening for that disease, the Centers for Disease Control identified just 23 reported cases of chancroid across the entire country. In 2009, the most recent year for which such statistics are available, the CDC still found only 28 reported cases of chancroid – despite the availability of a new test that could specifically detect a disease that may have simply gone overlooked or misdiagnosed in the past – and, in 41 states (including BRLI’s core territories of New York and New Jersey), no reported cases of that disease at all.

In contrast, the CDC found more than 1 million cases of chlamydia and 300,000 cases of gonorrhea reported throughout the U.S. during those same one-year periods. Notably, Bio-Reference critics insist, both of those conditions – like most common disorders seen by gynecologists in this country -- can be easily detected by standard tests, costing much less than GenPap itself, that have been used on female patients for years.

“We have all of those same technologies, but not combined into the same testing packages that Bio-Reference offers,” says one veteran laboratory operator. “We don’t do that. It’s not required. It’s not necessary. And it’s probably not good medicine.”

For now, at least, Bio-Reference can still depend on GenPap and other pricey esoteric tests to deliver the kind of rapid growth that Wall Street has always craved. However, critics suspect, at some point – potentially soon – those bright results are bound to fade.

“It’s a gamble,” says a veteran industry salesman who has marketed specialty lab tests himself. “Right now, I think these guys are still winning …

“But if they’re reporting great sales numbers, I would want an audit,” he concludes. “Nobody is kicking ass and taking names in this industry.”

* Important Disclosure: Prior to the publication of this article, TheStreetSweeper (through its members) established a short position in BRLI with the intention of profiting on declines in the share price. Since Sept. 27, TheStreetSweeper has sold a total of 97,183 shares of BRLI stock short at an average price of $19.64 a share. It covered 15,450 shares at $17.82 a share on Nov. 1 and another 29,284 shares at $17.66 a share on Nov. 2, reducing its short position in the stock to 52,449 shares. Going forward, TheStreetSweeper may choose to further adjust the size of this investment and will fully disclose the details of any future transactions in BRLI as those trades occur.

As a matter of policy, TheStreetSweeper prohibits members of its editorial team from taking financial positions in the companies they cover. To contact Melissa Davis, the editor of this website and the author of this story, please send an email to