Quest Diagnostics Incorporated (DGX) Earnings Call Transcript & Summary

Good morning, and welcome to our second presentation from the Barclays Virtual HealthCare Conference. Really pleased to be joined this morning with Quest Diagnostics' CFO, Mark Guinan, as well as Head of Investor Relations, Shawn Bevec. And hoping to get through these questions over 25 minutes.

Just wanted to start, Mark, with the here and now. Obviously, the topic de jure has been the coronavirus. I was curious if you could weigh in just how you expect this to impact the business and demand for testing services and have you seen any increased testing rates so far related to the new test.

Right. Thanks for the question, Jack, and pleasure to be on the phone here. What we've shared publicly is that we started yesterday with specimens collected yesterday in California, at our Esoteric Lab in San Juan Capistrano. We'll be ramping up capacity. There's a validation process across multiple pieces of equipment and then across multiple sites. It's going to take us several weeks to maximize our capacity through that validation process across the 2 Esoteric sites and then some -- we do have some of that equipment we're using in some of our regional labs, and Steve shared yesterday in an interview that within several weeks, we expect to be able to do several tens of thousands of tests a week. Now we're all speculating. So I have no idea what demand will be. But based on the discussion that took place in D.C. last week with the Vice President and with Secretary Azar, the sense is that the demand could far outweigh capacity even with us and the other national lab and multiple regionals and hospitals all ramping up as quickly as possible that it is a race to increase capacity. So we're not in any way, sizing this, and saying, we think we're going to get x, and therefore, we're only going to create so much capacity. We're going to create as much capacity as we possibly can as quickly as we can. And then, obviously, monitor the incidence rate and see if we need to slow that down, but we're not at all being cautious. The next phase, Jack, would be likely, there are several IVD manufacturers who have suggested they have some kits that would be available as well. We're probably a couple of weeks away from those. If that ends up being accepted and validated, then the next step of capacity would be acquiring some of those kits in addition to the laboratory-developed tests that we've already put up and got approval for through emergency use. So that's kind of where we're at. We've shared a couple of instances already where we can't size this. We're not going to predict how much testing we're going to ultimately do. It's unpredictable. And that we do think there is potential for an offset on utilization because society seems to be changing behavior around certain things. We're not having this conference in person. That's a prime example. And so one could imagine that some people might choose to engage less with the health care infrastructure for concerns around catching something in the office and the waiting room from the doctor, et cetera. We don't know. And we've already had a couple of investor one-on-ones this morning. I've been asked certainly, we don't share mid-quarter updates. However, if there was anything material that we've seen a change in our business, we'd feel obligated to share something. And again, we don't know. So one thing you might think about is our average patient encounter, which is a requisition is the mid-$40 range. Certainly, the coronavirus reimbursement should at least cover that, if not be a little higher. And so you'd say a one-for-one swap would be about even. But we don't know how many people -- is it going to be one-for-one, [ one ] office visits replaced for a corona visit. And then the other question is mix. If people who don't engage are skewed toward healthy annual wellness check. Certainly, we do a lot of tests in those -- the whole battery of chemistries and lipids and blood count and so on, how are seniors going to react. Seniors consume more of our business. So are they going to be more or less likely to go to the doctor, one camp can say, hey, and for the smallest sniffle, they may rush in because, obviously, they don't want to get -- seriously, they only want to get in treatment quickly. And the other thing is they're the mostly at risk. So therefore, maybe they're going to be as cautious. We don't know. So all we can share is some of our thinking, but we can't quantify any at this point. We just want to acknowledge that. Like other industries, we think that there could be some potential for negative impact to our business if people change their behaviors. However, unlike many other industries, we also will do some testing specifically related to corona.

Yes, I think that's all fair. And I'm personally doing this call from New Jersey. I wish I were in Miami, but also not looking to take the train into New York at the moment. Next, I wanted, maybe just move over to some of your themes for the business like payer access. There was a big change, which took place across the industry in 2019. Just reflecting over your experience, what were you most pleased with? And what are you looking to do better moving forward?

Sure. So we're very pleased with the access. We believe -- and of course, you need to check with the payers, but we believe that our message that the exclusive strategy was flawed and that all parties, certainly patients, but the payers, and certainly, the labs and those paying the bills are better off when you have both nationals because we both present tremendous value. And it's not a zero-sum game between us and our chief competitor, but it's about all that other lab work that's done generally by higher costs. And in some cases, labs that don't have the service cycle time and quality that we have is not helpful and, therefore, to give options and to partner with us and a subset of other providers who demonstrate that they have that positively differentiated quality and so on is what the payers should be doing. We believe that the performance thus far has demonstrated those that the share of the national labs, certainly together, certainly, the share of work going through United's preferred lend network has grown, that share has come somewhat, if not largely from higher-cost providers. So this is a win-win for everybody involved. And so that we believe, is a great opportunity to continue to gain momentum with this notion of partnering in the preferred lab network and expand that with other payers as well. So I'd say that's the positive. And then again, just sizing it. We said there's about $1 billion at our fair share and that it's going to take us multiple years, there's multiple layers of difficulty in converting network from the wireless to the multi-lab users to some lab of physician offices that may not have used this at all for a long time because we were out with some of the key payers. I'd say on that the tougher point probably horizon, it's been a bit slower. We were out of network for quite a while and there's a number of New Jersey offices where they're very, very highly concentrated horizon. And therefore, that's a little harder for us to break through. And then if you combine that, that UHC had a fairly large book of business. There are some offices where maybe we were in network for very few patients. So that's a little longer pot, which we knew and that's why we said this will be a multiyear opportunity. We're not going to get that whole $1 billion in the first year. So that's probably something that we expected and anticipated, but it's been a little harder than maybe we had speculated. So more work to be done there. We know we're going to ultimately be successful with our objective. We feel the strategy is playing out. We're happy with it, on track. But certainly, some things, as you suggested, have been a little easier or better. And then some things maybe were a little more difficult and that's -- we react and change our plans accordingly.

Yes, all fair. Next, just recently, with fourth quarter earnings, you announced some investments in genetics with Blueprint and then also in liquid biopsy. Maybe just talk a little bit more about what your ambitions are here in advanced testing? And there's a lot of start-ups that are burning a lot of cash in this category. Where does Quest want to compete versus some of those companies?

Yes, I appreciate it. So very, very different model, I would suggest, and you can make your own conclusions. But as Carrie shared at the last Investor Day, we have a very large advanced diagnostic business, it's probably larger than a lot of people appreciate, but we grow profitably. So unlike some other start-ups that you referenced, losing more money is not deemed to be a good thing for us. So we're very thoughtful around how much we invest and the returns and the amount of denials you get and so on and so forth. So we've also shared that typically when we launched advanced testing, whether it's a panel or what have you, we'll sit down with the payers, we'll consult -- our physicians will consult with their clinical specialists. And part of it, and I'd like to say most of it is around what do you think is appropriate testing. A part of it is, you asked about what are you going to pay for it? Because we're not going to just throw out there and do a 2,000 gene panel of which 90% of them are actionable or something like that. So we are -- we don't grow as fast as some of the other companies that are very visible. But quite frankly, it's because we make a conscious choice to ensure that we have a path towards profitability. When you look at Blueprint, specifically, and the liquid biopsy reference that we made. We've talked about multiple ways to gain access to technology or capability that we think is important for continued growth and presence of Quest. We said some of that will be organic, some of that will be through partnering, some of that will be through acquisition. Clearly, Blueprint, we thought made sense from an acquisition perspective and it brings to us some outstanding capabilities around bioinformatics that not only will be applied to the Blueprint book of business, which is pretty small but actually will be extended to the full Quest portfolio where we need that bioinformatics capability. It's going to make it faster and therefore, it's going to make it little expensive. It's going to enable us to be more competitive with our turnaround times and all sorts of things beyond just the cost of doing that work. We also talk about partnering. I'd say the liquid biopsy one is kind of in the middle. We've not acquired something, but we've made an investment in a company that has a very promising liquid biopsy technology. Because of accounting rules, we have to write down our investment as they incur their losses on a proportional basis. And then, as I shared, that clinical work will come to an endpoint within the foreseeable future. We haven't date stamped it exactly. And either we will have success and we would envision then launching a really exciting new liquid biopsy that could substantially change that particular treatment segment or Diagnostic segment or the program will be done and then we'll no longer continue to have expense incurred. So there's multiple ways we gain access. And these are just 2 examples. So that is our strategy. We do do some things organically. We do acquire some things and we do -- partnerships can come in all ways, shapes and forms. But we're going to do it responsibly and we're going to do it in a way that we clearly see a reasonable path to profitability.

Yes, all good. Next, I want to turn to PAMA. There's been some hope with the LAB act for beyond 2021 related to the rate outlook. I was wondering if you could just talk about what you're lobbying for here related to the rate methodology process? And as it pertains to 2021 itself, maybe just walk us through your thinking around what the rate impact could be there?

Yes. So on the current year 2020, which is the third year of the original collection data, that would get us further along. We shared -- you kind of go from 100 to 90, although we didn't start at 100% of NLA year 1 because some of the max were already below it. That's why 2018, amongst some -- a couple of other reasons we shared, wasn't as large a cut as we incurred last year and as we guided to this year. And then, you've still got another year in 2021 because you go from 100 to 90, 90 kind of to 81, 81 to 73. And then, you've got that stub to get into the mid-60s, based on the 2017 data collection. Now we've shared -- we think that's way too low. We've gone through all the examples how we're over-indexed, the national labs are way over-indexed. And that if you look at Medicare, for example, claims, the 2 naturals represent a little over 20% of the volume, but we're well over half the data in the current PAMA calculation. So we have enough information as a trade association. And certainly, as Quest we've looked at that we are highly confident that rate is too low. If you truly do what Congress intended, which is collect a market rate, the weighted median. And so we feel that there are other ways to collect the data or establish that price that would get a more accurate reflection of the market price, which is what Congress said they intended, and obviously, we think that it will be higher than the current calculation. So what we didn't want to have happened was we didn't want the data, collect it again with the same flawed methodology. And even though they changed a little bit the definition of applicable lab, which may have added some hospitals. We -- it was clear that there was not enough of a change that it would get to what we felt was a fair and accurate outcome of the calculation. So we felt, even though it wasn't fixing it per se, to not allow them collect the data again and have somebody say, well, why don't we just play this out and then any sort of fix can be after this. We said, no, don't do it a second time. If you're going to collect the data, do it in a better fashion. Obviously, we've shared our view as a trade associate with MedPAC and just 2 examples. You could do statistical sampling. You could get it from the payers. Either one of those would give you a much better estimate than the way that they went about it the first time and that they intended to do the second time. So that's our objective. And of course, that's in parallel to the litigation that's going on as well where we'd like to get it fixed in that fashion. I cannot tell you that -- I cannot tell you the time frame. Will MedPAC actually get the recommendation complete in 18 months that were given? Don't know. What -- how will CMS react if MedPAC has a methodology? How long will it take them to execute? How long would it take for them to reset the prices? So all of that is uncertain. That's why we continue to say, we're planning for the worst and the worst is the current calculation continuing. And then, therefore, if anything gets fixed either through MedPAC's recommendation and a better process or through the litigation, then that would be upside.

Yes, all fair. And one quick follow-up. Really, you mentioned the litigation. I'm not sure if you know offhand what the next update we should be expecting related to that is?

Yes. So it's really up to the judge, the briefs have been filed. So whether the judge has a hearing or makes the decision based on the briefs, we don't know. What we have said is that we're optimistic that we will hear something this year. But beyond that, we really don't know any more around the time line.

Okay, that's fair. Maybe turning to the commercial piece, I wanted to come back to something you talked about earlier related to United Health Preferred Lab network. Continuing to see payers strengthen incentives around that, just -- have you seen any benefit yet to start since it was implemented? And what are some of the initiatives you're putting in place to drive awareness of the PLN?

Yes. So I think there's a couple of aspects to the PLN. I think the one that we've talked a lot about and probably you're referencing is the planned benefit design, which is being rolled out in a stage fashion by United that started last fall with 11 states. And they're smaller employer fully insured book, they expanded it more broadly at the beginning of the year. Amongst the smaller employers, they've made a statement that they're going to roll it out to the larger employer based on the fully insured and then they're going to start marketing it to the self-insured or sponsored plans. So most of that benefit that we anticipate is still in front of us. What we have benefited from is a couple of things. One is just being able to go in and you could imagine going to a physician office and you say, I've been telling you for years that I'm a better lab than the lab you're using. I understand you're probably having any sort of objective means of which to compare and contrast. You've now got the country's largest payers, saying, we're one of the 5 best labs based on quality and service and the tools we have and access. So maybe it's time for you to try us. So that certainly is helpful. And then some of the work that United has done for all of the PLN members, including us, around giving us list of physicians who are prescribing a lot of lab work out of network, we go in, we call in the physician, explain to them why it's not in the best interest of their patients to do that. And then United, in conjunction, sends letters to the physician office, telling them why they shouldn't be doing that. That has actually been very helpful for us in gaining share and saving money for United, and obviously, for their members. So that's an early success story even before you have planned benefit design. We've also shared that one of the elements, the preferred lab network is what we call an M&A benefit. It's where -- instead of historically, where when we buy hospital outreach, the minute we start doing the work, it immediately goes to our contractual pricing. Huge windfall to the payers and everybody else. We discussed, hey, this is a great thing for you and for your members. You want us to do more of this. Why don't you help us, allow us to share in some of that savings to really align our incentives? And so we've now got in place, not just with United's PLN, but this is an element of the PLN that we have with other payers, pretty much all the large payers, we have some sort of incentive in place where we will do M&A. They have a number of rex coming into them on a regular basis at a price that was negotiated with the hospital. We stepped down that rate over a period of time and kind of sharing that benefit. So there's a lot of things going on with the PLN that are all good, good for everybody involved other than the high-cost labs that are losing the work. But a lot of the planned benefit design where we said, this is really a powerful one, hey, zero out of pocket, no cost to your patient, no call from the patient complaining about their bill, even that the bill's legitimate. Doc -- whoever is ordering the labs, plus better value and this is not we bought our way into this, but the payer is doing this because we're better quality, better service. We've got these great tools. All these reasons why we're aligning the sun, the moon, the stars here, a lot of that is still in front of us.

And Jack, one of the things that I would add to all of that is that's just one thing that United is doing. Think about some of the other things that they've talked about, whether it'd be the new out-of-network approval process that physicians need to go through if they want to use an out-of-network lab that makes it more cumbersome to -- for them to do that. That started in August of last year. And then just more recently in February, United announced in a policy bulletin that they would like hospitals who are serving nonhospital patients, so basically an outreach program to recontract at independent lab rates. So yet another issue for outreach programs that should help drive volume to better value. So there's a number of things that United is, and will be doing that really benefits us in all of the preferred lab network members.

Makes sense. I wanted to maybe turn next to capital deployment. Obviously, there's been a lot of these industry pressures. They are pretty substantial on the nonhigh-quality, low-cost labs out there. Just wondering what you're seeing in terms of the deal environment. And also, given some of the volatility in the markets, has that changed the environment at all recently for deals?

Yes. So a couple of questions there. I'll try to make sure I address them all. So first off, no, I haven't seen any change, any sort of volatility in the market. I had a call with some debt investors the other day and they want to know when the interest rates drop, like would that somehow be a big impetus for new deals. I mean, no, I mean, these deals take a long time to negotiate. There's certainly nothing that I can point to that would say anything has changed. People are stepping away from the table because of concerns of XYZ or for that matter, try and accelerate things. I mean it's -- it just has its own pace. We're happy to announce these deals in the first quarter. And as we shared, we've got a deep pipeline and a number of these deals have been often on or discussed for quite a long period. Memorial, we said it was on and off for over 4 years for various reasons. So it's not as if we ever have a period of time where there's not a lot of discussions going on, but I really don't think anything in the environment has changed dramatically. It's really just when these deals come to their endpoint in a transaction. '18, obviously, we had a lot of them. '19, we had fewer, but as we said, if we thought that 200 basis point CAGR was at risk, we'd feel an obligation to say something and we certainly don't. And hopefully, the 2 deals we got completed earlier this year gives people some proof points to feel confident in that. And when you look at the industry, some of the smallest players, we would never buy them anyways for a lot of reasons. One is a deal takes almost as much work regardless of scale. So just spend the time on something like that, we probably would choose not to. The second thing is that a lot of them are not attractive in terms of the way they've conducted their business and whether we would conduct our business the same way. What platform are they on? So would there be any sort of synergies, if we acquired an independent lab or a POL for that matter? So a lot of that we feel the headwinds are likely to put them under pressure. And I doubt they're going to find any -- many buyers and maybe some private equity, but I'm guessing that a lot of the larger labs like us would look at them and say, yes, that's a difficult transaction. So our M&A is going to be focused on hospital outreach, it's going to be focused on where we can find executable regional lab and then there's going to be some capability acquisitions like proof point, but not a lot of the ones are feeling the most pain, the smaller subscale, independent labs or the POLs. Those are not like the M&A targets for us.

Great. Okay. With that, I think we're right at the closing time for the presentation. Mark, Shawn. Thank you again for joining us and appreciate everybody dialing in the new format.

Thanks, Jack. I appreciate it.

Thanks, Jack. Bye.

Ba-bye.