Quest Diagnostics Incorporated (DGX) Earnings Call Transcript & Summary

All right. Good morning, and welcome to the third day of the 2022 Jefferies Global Healthcare Conference. I'm Brian Tanquilut, I'm the health care services analyst here at Jefferies. And our next presenter is Quest Diagnostics, the leading laboratory provider in the U.S. Joining us today are the company's Chairman and CEO, Steve Rusckowski; company's CEO elect, Jim Davis; and the company's Head of IR, Shawn Bevec.

So I'll start, Steve. We were just talking on the sidelines about how 10 years ago, you hosted a sell-side event probably here in the same hotel. So as you look back, so much has changed and you've done so much at Quest. Maybe just a few reflections on your tenure there and where you see Quest today as you transition and pass the baton to Jim.

Sure. Well, thanks, Brian, for having us, and thanks, everyone, for being here today. Yes, it's amazing how fast 10 years ago. I remember that day, it was March of 2012. And I came in from the outside. And clearly, when you come in from the outside, you come in for a purpose, right? And we announced in the fall of 2012 transformational plan, and we called it still call it our quest. And so we've been marching against that plan, and we feel like we've made a lot of progress on a lot of different fronts. And first of all, I think today, if you think about Quest Diagnostics, you see that we're more than the world's largest lab. We're actually in the business of primary health with that diagnostic insight. And as we go forward, and Jim takes the reins for the company, you'll see more and more of the capabilities being brought to bear. And then secondly is, if you think about what we had to navigate in the course of the last 10 years. So when I joined, Brian, there was The Great Recession, okay? And there's questions around utilization and when that would recover. And then second is we had the Affordable Care Act, okay? Which was a significant question how funding would happen for laboratories. And then secondly is what's going to happen with insured lives and access points. And the next came PAMA, which was the biggest reset, if you will, on non-CMS prices that this industry has ever seen in the last 2.5 years, it was the pandemic, right? So over that 10-year period, we had a lot of disruption in our marketplace. But fortunately, where we are today is the company has never been stronger. We have strong relations with health plans. We have strong relations with all our customers. We have a brand that's never been stronger because of the visibility we have gained through the pandemic and because of the value we delivered. And also, we are now benefiting from an extension of the management team. Jim came in 9 years ago, and he's been part of this transformation of the company. So we now pass him the baton. So a very strong CEO and a very strong management team and now coupled with the hire of a brand-new CFO. So we're in very good shape going forward.

All right. So I guess I'll pass it on next to Jim. So as you look at the seat and you just announced a new CFO hire last night, what do you see are the opportunities? And how are you thinking about the strategy going forward as you take over?

Yes. So first, the strategy that we've put in place over the last 10 years is working. And while we'll look at the markets and the industry structure going forward, the strategy is working right now, but we'll continue to evolve the strategy. Obviously, as the markets change, customers change and technology changes. We have a really good health systems business today between our reference book of business, our PLS business, there's a $1.5 billion book of business that continues to grow. And if anything, we're even more bullish about our professional lab services business. You've seen the pressures that hospital and health systems are under, and I think that bodes well for us to come in and offer the kinds of assistance that many health systems need in terms of running their labs more efficiently and effectively. Second, our physician book of business continues to be strong. Third, we've talked about the build-out of our consumer-initiated testing business. We're really, really bullish about that. COVID has proven to us that consumers will come directly to us without a physician order. We can send a kit to your home. You can come into one of our patient service centers. We can swab you there. So COVID has really helped enhance our consumer brand and make consumers aware that they can come to us without a physician order to get laboratory testing. And then, Brian, we continue to build out our advanced diagnostics testing, and we will continue to invest in areas, cancer and genetics, where it makes sense, and we'll be there when the market continues to evolve. The final thing I'd say is our network access from a commercial standpoint, as Steve said, has never been better, but there's still opportunity to grow there, right? We've only been in network with UnitedHealthcare for about 3 years. We're about halfway to where we think we can be with United. There's still a lot of progress to be made with Anthem and even Horizon here in New Jersey.

Lots of things unpacked there. So it's hard to talk, and I'm trying to avoid this conversation, but it's hard to talk about labs without talking about COVID. And it feels like there is -- we're doing on-site testing here, right? And it feels like anecdotally, there's been an uptick in recent weeks. Maybe just anything you can share with us on that front? And I know your guidance has been more conservative than not on the COVID testing side so...

Yes. I think as you know, we publish once a month now, our COVID volumes and our most recent COVID report that I believe came out Tuesday, suggested that our month of May was in the low 40, and that's up from April. You read the same reports that we do. Reports suggest that there's a peak here in the Northeast and that we may be coming down off of that peak, but the wave continues to move westward. And so our data would suggest the same thing from both a positivity rate standpoint as well as the volume. So now what is unknown? And look, we've guided to $850 million to $1 billion for the year. There's still a lot of unknowns. We read this week, you read that BA.4, BA.5 is now here in the country. It's 13% of all new cases. It's not clear how patients that were infected with either Delta, earlier versions of Omicron or who've been vaccinated. It's just not clear how those group of people are going to react to the BA.4, BA.5. There's just not enough data out there. So at this point, our guidance remains the same. We'll see what happens with the spread of the 4, 5 variant and how people react to that.

So Brian, I think it's important for us to recall what we said in '21 at our Investor Day. And remember, '21, we said we don't believe COVID is going to go away, but it's going to decrease throughout '21, and then we reported '21, and we had about the same revenue in '21 we had in 2020. And here we are in '22, and we're saying that we believe that the number is going to come down, albeit though in the first half, we're probably doing more than what we indicated initially. But what we also continue to say as we get into '23, you need to think about COVID being a consistent part of our portfolio. And we see a world that that's going to be for the foreseeable future. It's going to be with us. And we actually be on the PCR testing that we do quite well, I believe there's a bigger opportunity in the whole field of protection management. How do you understand is at an individual between our serology test and see if we've had the virus and the spike protein testing and other test we go in this table for an individual assessing with a physician and what you should do next to manage your protection level, given your own set of characteristics as an individual. So that is a piece of our portfolio that people are thinking it might go away. We believe it's a good piece of our portfolio next year.

No, that makes a lot of sense. Shifting gears a little bit. Steve, you talked earlier about network access and the United business. So kind of halfway through -- running through the United book. But maybe just talking about the opportunities remaining for narrower network strategies across the different payer clients that you guys have?

Yes. So this country, and as a company, we've been entirely focused on the Affordable Care Act and what we talk about at Quest is powering affordable care. And so we talk about our alignment with what was referred to as the triple aim, great quality, great service, great patient experience at the same time with very competitive cost structures. And we've been driving against that. And so Jim deserves a lot of credit, given he's been in charge of the operations for this company for over 9 years -- is as we continue to get more and more productive as a company, we've improved our quality, we've improved our service performance. And hopefully, you've seen the improvement in that patient experience with many different investments we've made over the last decade. And so now when we come to the table with the plans and they're thinking about what they do to drive down variation, we're very centered on how do we bring more of our volume to the best providers. And that's the concept for lab network. And so that affords us an opportunity to work hand-in-hand with those plans of getting the right conclusion for that patient. At the same time, making sure that it can maybe leverage some of that experience for other categories of providers because this is not just about labs, but it's around radiology, it's around physical therapy. How do you have to tighten up that concept. And since we're very competitive, it affords us an opportunity now to raise prices. That's a big change. When I joined 10 years ago, we were dropping prices every contract period. Now what we've said is we've actually presented that we deserve more given what's happening with our cost structure, but also the value we deliver to the table. So that's a big change, Brian, that I think people need to realize as we go forward.

You touched on my next question, which is the rate opportunity here. So what are the -- those conversations right like -- because I know, Jim, we've talked about your ability -- how cost inflation is starting to hit you guys, but at the same time, you're trying to manage that. But broadly speaking in health care, there's a lot of discussion about payers, willingness or interest in having the discussions to raise rates and give rate increases to providers, right? So what are those discussions like with the payers. Yes.

Yes. So as Steve said, look, we always start the discussions with the value we bring to health care and the differential value we create versus health system leverage. And it's not just cost. We think there's turnaround time, quality, there's a lot of benefit to using the independent labs in our broad network, our broad test menu. Certainly, there's an added dimension today of labor costs and inflation that we can bring to the table. Obviously, most of our payers have similar -- some of the same jobs that we do, call center jobs. And so they see the same thing. And so we combine those 2 and make a pretty good case. And more often than not, it's leading to a change. As Steve said, every discussion was priced down, more of the discussions are priced up.

And then Jim, to follow up on this discussion. The last time you know, [ Matt ], we talked about your ability to address or manage costs, especially in this inflationary environment, right? So maybe if you can just walk us through how you're thinking about it, what the levers are that you're pulling. Just any opportunities left to bring the cost structure down.

Yes. So first on the labor inflation side, I think it's important to understand the construct of our labor force. About 50,000 people, about 10,000 of them are what we call professional staff, IT, finance, HR. And I think you can all assess what the inflation rate is of those kinds of physicians. IT can be a little higher. The rest are fairly stable. If we then look at the other 40,000 employees in the company, 12,000 phlebotomists, about 4,500 couriers. We've got 7,000 processors doing specimen processing, and then the rest, medical technologists, supervisors and things like that. So phlebotomy is really a very unique market, right? It's either health systems or independent labs that higher phlebotomists. Generally high school trained, you can increase the labor pool pretty quickly. And we run our own training schools. We work with community colleges, technical colleges. It's a 3- to 6-month training period. So your ability to increase the supply is actually not so difficult. Now the 2 -- and medical technologists, again, they're either going to work in health system labs or independent labs. So that's fairly stable. It's the specimen processors and logistics people that they're not health care-specific people, right? And they can move between industries. And that's where we see the highest turnover. But keep in mind, the wage rates in those areas, all in annually somewhere between $40,000 and $50,000. So I've given the numbers of people in that group. I've given you sort of the wage rates even if it was 5%, 6%, you can calculate the overall impact on our payroll. We're still very comfortable with the 3% wage inflation that we gave this year.

No, that makes a lot of sense. Maybe shifting gears a little bit. Steve, there's a lot of discussion, obviously, in the market about value-based care. And I think people tend to forget that you actually have a capitation business already in place. So how are you thinking about the opportunities in value-based care and how Quest is positioning to maybe gain a good size share in that market?

So when we talk about value-based care, you have to define it. So this industry when I joined it, had a portion of the portfolio for a portion of the business tied to capitated rates. And it's a little bit of an outside portion of our negotiations with plans. And frankly, it's still there, but it hasn't grown considerably. But I would say there's 2 other elements, Brian, that we think about. One is what we're just talking about is how do we work with plants in a different way to bring value to the table. And when we bring value to the table, we have shared interest. They do better because they're bringing out lower quality, better priced offerings through their membership, and we benefit by gaining share, right? And so the UnitedHealthcare lab network is a good example of that. We shared that we have about 30% of our plans that we would describe as more value-based contracting versus just a fee-for-service on contract relationship. And we want to move that to 50%, okay, a larger percentage. And why is it greater than 50%, we have hundreds of contracts throughout the United States. And so we're really focused on the bigger ones, the nationals and some of the big regions. And then the last piece of value-based contracting is we really get into the business of more population now where we're starting to think about smart diagnostics could change the whole outcome for that patient, okay? There's nothing more expensive than a bad diagnosis. And there's nothing better than a good diagnosis, right? And so we have a role to play in that value chain of delivery of care. And when we work with integrated delivery systems and work with physicians, they might be taking risk for a population, we have a role to play in that equation as well.

And the only other thing I'd add -- capitation is not value-based care. Capitation for us is a very small percentage of our business, and we're not inclined to increase it. It was basically setting up an all-you-can-eat the bet. It's the capitative rate, physicians order what they want, when they want. We're willing to take risk as physician takes risk on group of patients. As Steve said, again, population centered. But the other way to do this is when we define care pathways. In other words, here's a set -- here's a lab panel that you run on these types of patients under these types of scenarios, then we can assess that risk much better and price it appropriately and actually make money on these.

No, that makes a lot of sense. I appreciate the clarification there. I guess, Jim, shifting gears here again. You talked a little bit about the PLS and the hospital opportunity there. As we get out of COVID or COVID becomes more endemic and the hospitals are fighting fires over the COVID -- on the COVID side every day. Are the discussions accelerating on the M&A front or just the outsourcing side of things. Yes, if you can talk about some of that.

Yes. So 3 ways we work with health systems. One, which has been a traditional way. There's tests that they can't do in their own lab, and we do that work for them. We call that reference testing. The second way is our professional lab services business where we go in and help the health systems run their laboratories. And whether we take on all the people, whether it's some of the people, the management team, we run the assets, we'll put the equipment in there as needed. The third opportunity is around outreach. And these are health systems that come to the conclusion that it's no longer either profitable or strategic for them to be in that outreach business. So I think all 3 opportunities coming out of COVID are increasing. As you know, some health systems have exited COVID in a worse financial position than they went into it. And they are looking and they have wage inflation and labor issues that are more pronounced than what we're seeing. So it's a perfect opportunity for us to go in and have the discussions with the management team around ways we can help them run their laboratories more effectively and efficiently. And then on the outreach side, look, if you're going to be in the outreach business, it requires sustained investment. You have to keep upgrading your lab technology. You have to add more salespeople, PSCs outside of the hospital. And if you're in a constrained investment environment, it's probably not the area of your health system where you're going to invest. And so I would tell you that the opportunity list of outreach deals has been increasing and, hopefully, in the back half of this year, we'll have some more to report there.

That's good to hear. You mentioned earlier something about the direct-to-consumer push, right? And how are you thinking about the growth of that business in terms of maybe the menu for testing and the uptake that we're going to see -- because it kind of requires a shift in the mindset of the patient as well, right? Like you said, you can get a test without a doctor. So how are you thinking about driving that shift in the patient perspective?

Yes. So first, we've said we think this can be a $250 million business by 2025. We still feel really good about that estimate. Second, as I've said, COVID has helped us build brand awareness with consumers that you don't have to go to a physician to get a lab order. Now we also know there's some established segments that are out there that are growing every day. The first group we would call watchful warriors. These are people with chronic conditions, it could be cancer, diabetes, hepatitis. And more often than not, the payers will only pay for x number of tests per year. So they may pay for a diabetic for 2 A1C tests a year. But these are patients that want to know once a month. So why go to a physician, pay $100 to see a doctor only for them to write a lab order that's going to get denied by a payer. And you're going to have to pay for it out of pocket anyway. So just get online, order the test, come to us. And we're seeing that group of patients grow. The second is people that value privacy. They don't want to go to the doctor and admit that they may have something. This could be an STD. They don't want insurance to know because sometimes insurance sends a letter in the mail or to your e-mail and others can find out. So there's people that value privacy. And that's a big -- it continues to be a big growing segment. But there's other segments out there. There's young millennials who never -- who just don't have a regular physician and they know they can get a panel we call Blueprint for Wellness that really assesses head-to-toe what's going on inside their body. And if at that point, you get a result that says, "I need to see a doctor, "we can help set you up with a physician. So we feel really, really good about this business.

And then layering on to that, one of the other areas you mentioned earlier was advanced diagnostics. So what are the opportunities that you see in advanced diagnostics? Is it still oncology or just any areas of focus that investors need to be thinking about.

Yes. So certainly, cancer and genetics continues to be an area of focus. We have a very strong cancer business today around diagnosis, our pathology business. We obviously do screening for HPV, we do paps. We do PSA, we do FIT. So cancer is a big substantial business within Quest Diagnostics today. But it's growing on the ends -- what I call the ends of the cancer spectrum. Certainly, on the screening side, we're well aware of assays that others are working on. But there's not really a market for that today. And when I say a market, there's not coding, there's not coverage, there's not pain, okay? And Quest Diagnostics will be there when there is coding, coverage and pain, whether it's the early side or the mid side, we will be there. On the post diagnosis side, that's where there is some excitement, right, around treatment selection, treatment monitoring and then recurrence. And we -- increasingly, we are playing there. We are actually working with Illumina on -- in an assay that they call the TSO 500, which is an assay that looks for cancer mutations and then helps with therapy selection, therapy monitoring. So I can assure you we'll be there as the market continues to play out. But look, there's other advanced diagnostics. We're putting R&D dollars in microbiome gut testing, a strong linkage with cardiovascular markers. We recently introduced an Alzheimer's plasma-based assay. It's early. We're still doing our own clinical trials to prove out the efficacy of that versus PET-CT versus a CSF type of test. So advanced diagnostics cuts across the board. And outside of cancer and genetics, there's -- yes, there's other opportunities that we continue to pursue.

I appreciate that. Steve, since we're running out of time here, last question for you since you alluded to this in your earlier remarks. So as we think about a potential economic slowdown here, how are you thinking about -- you were there when Quest was dealing with some of the volume challenges, right? So how are you thinking about the difference maybe this time around versus when you came in, in 2012?

Yes. So Brian, first of all, when we had The Great Recession in 2008, there were some utilization downturns for the first time in my career in health care. And we thought it would come back at some point. What I did say is after that, we have the Affordable Care Act, right? So we now have a larger percentage of the American population with insurance or some options for insurance. And so therefore, that uninsured pool is a smaller percentage than what we have. And I think the durability of access in terms of insurance coverage is better than where we were last time around. And so when people have insurance, it's good for the business. And so therefore, I think we have more protection against the possibility of that.

I appreciate that. Well, guys, thank you so much. Really appreciate it. Jim, good luck. Steve, congrats. Good luck as well.

Thanks, Brian.

Thank you, Brian.