Quest Diagnostics Incorporated (DGX) Earnings Call Transcript & Summary

Thanks, everyone, for joining us this afternoon. My name is Eric Coldwell. I'm the pharma services analyst -- we're good. We got it. Thank you so much. I appreciate it. It's -- I told Shawn and Sam, this is #9 for me today back to back. So I probably will misspeak and speak in tongues a little bit as well. But last but not least, on my side. So thank you, Quest Diagnostics for being here. It's such an interesting company on so many levels. And I've always been a fan of the company. It's just a pure play, an interesting story, good people, and it's fun to talk to you. So I'm looking forward to finally getting that lab update this week after a lot of other industries and sectors. Not a big formal opening. I don't think you're doing any slides...

No. We're not.

Good. So we'll jump right into Q&A. I don't know, Sam, if you'd like to make a couple of introductory comments. You've been here, what, now a year and...

A year and 2 months.

2 months.

Yes. A year and 2 months.

I mean you were...

Since July 11.

My dinner last year and...

Yes. Yes.

You were brand new at that point so...

Right after I started. No, listen, I'm really glad to be here and Shawn joining me here, our Head of IR. So I think we'll go and jump right into the questions, Eric, and thanks for hosting us. Really appreciate it.

Perfect. Thank you very much. Well, look, I told Shawn, I was going to start with speed Q&A. We'll just kind of get a few things right off the bat. First, just on the base business, look, I know how hard it is to do intra-quarter commentary, and it's only been a handful of weeks since you reported the last quarter. I mean, it seems like we leave one and go to the next one as quickly as we'd love. But overall market activity volumes, any kind of commentary that you're making or have been willing to make broadly as you've done some of this late 3Q conference circuit, I think it'd be great to get your latest update and where you were, where you are, where you're headed, what you're feeling right now is a good start.

Yes. So maybe staying high level, I mean, first half of the year, very strong volumes, very strong utilization. In Q2, we had volume growth of 7.4%. On the earnings call, we did talk about the fact that going into July, July, we were seeing that mid-single-digit growth in terms of volumes. I won't comment on anything beyond that in terms of volumes over the last 2 months or within Q3, except the comments that we made about July. But as we go into the second half, we -- based on our guidance, we do expect that growth at least the year-over-year growth to be lower than what we saw in the first half, driven by the fact of the same period compare in the first half of '22 was soft because COVID was still very much impacting base volume. So the year-over-year was aided in the first half of '23 by that. So -- but -- and in the second half of this year, another thing that's going to be affecting us from a year-over-year compare is the fact that we don't have the same activity of COVID multiplex test that we saw in the second half of last year. Otherwise, pleased with the volume momentum. A couple of things to note that have impacted us as a country recently, not just Quest, but we've seen a couple of hurricanes, Hurricane Hillary on the West Coast, we've seen Idalia in Florida. So those always have an impact as well. So just I'd be remiss if I didn't mention those.

It's funny. I don't even -- sometimes it doesn't even click, but every year, there's a blizzard or there's a hurricane that is something that can pop up from time to time.

Sure. Our business is impacted usually by those.

Yes. So something to pay attention to. The -- I don't want to put words in your mouth, and I don't want to press too hard on this, but one topic that is pretty relevant, and it's coming up more and more is COVID. And this question mark out there about whether the guidance that was established with ballpark COVID this year down pretty substantial amount. I mean last quarter was what down, Shawn, remind me, 80-something, the high 80s, mid-80s percent. Are we sure that the back half isn't going to come back as we're seeing these hospitalizations ticking up day after day, week after week, we're seeing more anecdotal evidence of people, we've had a couple of people had to leave the conference or not come to the conference in the first place that we're expected to meet here because of COVID. Two of my neighbors and my hometown have it right now. I mean, next door. So what -- what does that do for COVID testing volume? Is it all people just ignoring the testing? Or are they doing at home test? Are they going to their doctor's office? Or are you possibly seeing some recovery in the PCR?

Yes. Again, I mean, without commenting specifically on Q3, and I know this is a phenomenon of the last month or 2 in terms of some of the surge that we've seen. But we did about $160 million of business -- COVID PCR business in the first 2 quarters. We guided to $200 million for the year, so -- which implies $40 million in the second half. We feel that's a reasonable estimate in terms of what we think COVID will be for the year. Remember also the -- so a couple of dynamics, the site of testing has really changed for COVID as well. A lot of the testing is being done now in our PLS side of the business. So in health system, hospital testing sites, not in physician offices. I think where we see the testing, at least the PCR testing being done now is more in the hospital setting. And to your point, Eric, I think you mentioned it, which is there's a lot of antigen testing as well. If it's not -- if it's just run-of-the-mill testing, you want to find out if you have these symptoms are COVID or flu or something else, usually, you're doing an antigen type of test. So that's -- that dynamic that we were seeing before is not necessarily what we're seeing now in terms of PCR being the go-to.

So someone that shouldn't necessarily look at where, let's say, COVID-related hospitalizations or daily deaths were at the peak of 2Q. They trended down and now they're back 2 or above where they were at the peak of 2Q, but there's not necessarily going to be a direct correlation.

No, I wouldn't look at it that way.

Because of market shift in terms of appetite demand where this vaccine is, et cetera.

Exactly. Yes. I wouldn't look at it that way.

Okay. All right. Now here's another obligatory question, which probably is much less relevant to you, but it comes up in almost every session, has to. All of this chatter about GLP-1, any way shape or form are you being impacted by GLP-1s? That's a very open-ended question, but...

Yes. We're not at this point. It's an interesting question. It's very early to tell, but you can actually make an argument for either side. One is that it's going to actually be favorable to testing because we don't know what the long-term effects are for people on these drugs. Will they require annual monitoring, testing for that to be done because even though you're benefiting from some of the health benefits as a result of taking the drugs, but you -- let's say, a physician needs to monitor some other aspects of their health. The counterpoint would be people are healthier, they don't need to take as -- they don't need to do as many tests as they were doing before. Now having said this, in some cases, to get on the drug, you might need an A1c test to monitor whether you have type 2 diabetes or if you're prediabetic. And so that would require testing as well. So I guess I'm giving you a nonanswer, but it's still early days.

It's actually a helpful answer at times because it lets us know as expected were not to focus. And I just wanted to make sure there weren't as this market has really exploded in the last 2 quarters that something hasn't risen to a level of attention.

It hasn't.

That would change your perspective that we've...

Yes. No. I think on balance, as I said, it could be net neutral, could be a positive, but at this point, nothing has impacted us.

Last one on the speed around PAMA SALSA, latest and greatest thoughts PAMA coming back in '24, we kicking the can down the road again.

So likeliest option, most likely option would be PAMA getting -- the PAMA can getting kicked down the road. I think that's more likely than the other options, which is either SALSA. SALSA getting passed, and we know it was reintroduced to Congress this year or the other option, which is PAMA returns. But remember, the CBO scored the delay and kicking the PAMA can down the road as a positive for government budget. So I know that doesn't sound intuitive, but that's how the CBO scored it.

When you're talking about the government not intuitive is...

It's an expectation, right? So...

I want to get back into growth professional lab services, PLS, what your counterparty calls hospital lab management, HLM, same thing effectively. Market seems to really be taking off. We're seeing more and more deals. We're hearing more chatter. We're seeing third-party consultants and pundits talking about opportunities rising. What are -- would you agree? And if so, which I think you will, what are the 2, 3, 4 biggest drivers of this shift for hospitals opening up and saying, no mas, we're going to pass this on, we're going to let you do it?

Yes. I think the drivers are related. I mean, the key driver really is governments feeling the pressure of high cost of labor of just all these macro factors that are impacting all companies but impacting health systems in a disproportionately negative way. And then saying, "We need help, who better to help us than a Quest Diagnostics, taking on some of that work, that lab work taking on the end-to-end sort of operation of our lab and basically providing a great service and saving us that cost." So essentially, I think that's the key driver. The reason that it's really also factoring into hospitals thinking these days is lab work isn't as strategic for them as some other things that they look at in terms of things that they can profitize. So it's less of a priority for them. It's definitely a key competitive advantage for us. So back to your point, I think what you mentioned initially around the growth of this opportunity. Remember, we -- and I think this is what you're saying is we have expanded this opportunity from roughly $300 million pre-pandemic to now almost $600 million. We've doubled the PLS opportunity. So we're seeing great traction on this. Our hospital -- our health systems business grew very robustly in Q2, and we've got a great pipeline of these opportunities. So agreeing with everything you said.

I wanted to jump into the pipeline and also how do you handle the resourcing, how much of this is rebadging versus needing to bring in your own talent, your own people. But if the demand picks up, do you get more finicky, more particular in the kind of opportunities that are out there? Or do you look at most deals and say, no, we can make this work?

I think for the most part, we can make this work. I think the bottleneck is usually more on the health system side than it is on our side because we've got the capacity to make this work. And health system deals are really not all kind of vanilla same deal. In some cases, it's a supply chain deal where basically we moved the purchases and the inputs or the cost of the supplies to our own procurement organization and then we can purchase on our rates, save the hospital a lot of money. More typically, it's end-to-end. So we're basically acquiring the labor, acquiring -- buying the instruments in that lab and really taking on the end-to-end soup to nuts operations of that lab. Very profitable business. It's dilutive from a margin rate perspective, but really accretive from a margin dollar and an ROIC perspective because there is no significant capital deployment attached to it.

Right. If you had to -- if you had to pick an over under relative to existing midrange, long-range plans, guidance, your long-term outlook, which obviously has a component of this embedded in it. There's always a thought of opportunity to grow this. Is this going to be a bigger driver than you historically might have thought?

No. I think we've sized it appropriately within our long-term guidance that we gave at Investor Day. So when we talked about the margin expansion, that 75 to 150 basis points of margin expansion, when we talked about the revenue growth, organic and M&A, it was effectively factored into these projections with the attractive nature of it being as it is now.

I'm going to shift over to advanced diagnostics and I sort of [indiscernible] this last week, and it's sort of funny because the company used to talk about gene-based and esoteric testing and now it's advanced diagnostics, but I'm never sure if those are exactly the same categories and same reference points as a jumping off spot from one terminology to the next. So feel free to jump in on that. But can you size your overall advanced diagnostics business today? I think there's this there's this debate on the Street about, one, you have some really big growth businesses, some don't grow as much. You have some that are mature and very profitable. Others are brand new and very -- fair, very big investment right now. And the Street is trying to get its head around where the rubber meets the road in terms of growth rate and opportunity versus investment and risk that some things may not work.

Yes. So let's kind of define those components because I know we've talked about some things maybe interchangeable, and we need to be more specific as to what those terms are. When we talk about esoteric, it's not necessarily just advanced diagnostics. It's bigger than that. Esoteric is anything, any test that's nonroutine. That's being done on a sophisticated instrument, but it's not just advanced diagnostics. When we talk about advanced diagnostics. We're really talking about those gene-based tests and these really novel tests that are sequencing based for instance. So to drill down on what those categories are, it could be hereditary genetics. It could be prenatal genetics, it could be oncology. It could be our pharma services business. It could be somatic areas as well within gene-based and it could be our genomic sequencing services that we do there. So that's what we call our advanced diagnostics. It's a subset of that gene-based an esoteric book of business that we talk about. So that category of advanced diagnostics is growing faster than our overall Quest book of business, and you would expect it to. It's higher growth areas. It's more novel, non-routine areas. It's also -- we haven't sized it exactly, Eric. It's, let's say, in the several hundred millions of dollars. I know that's not precise, but that's kind of the size of that book. And it's really exciting work. I mean Haystack fits into that category, and I'm sure we'll talk about it. But it's these really higher growth areas.

And the overall gene-based -- obviously, I knew part of the answer before I asked the question, but I wanted to frame the kind of question I get and gene-based and esoteric overall size on that is more in the $1 billion plus category today.

Yes, that's what we had talked about before. Yes.

Still in that ballpark...

Yes, we had talked about over $1 billion. Yes.

Yes. Okay. So Haystack, you brought it up, let's jump right to it. The acquisition took you into the minimal residual detection business -- disease business. So MRD. Early detection and residual cancer really interesting space, but it is a big investment. And you're trying to develop a product that's not yet commercialized, a solution that's not yet commercialized. With that acquisition, again, on one hand, I would speak with investors who focus more on the diagnostics companies and say, wow, really interesting, I love the growth potential, and you talk to more traditional reference lab investors who would say, where did my profit go? Where's my margin? Do I want to take this on? And so it's a bit of a storytelling that I think the company still is working through. It felt like on the most recent call you were or Jim was maybe saying, "Look, we're going to make investments, but don't think we're going to go overboard with these investments. They're still focused on returns and on margins." So I'd love to get your perspective on that and where your gut is on where the balance is between making a dilutive but potentially very promising acquisition like Haystack versus not just giving people their cash flow and their margin and moving on.

Yes. Yes. Great question. So I want to kind of clarify some misperceptions here and bust some myths, so to speak, around Haystack and MRD in particular because I really believe strongly in this opportunity. There's a lot of potential growth and upside here. One is, hey, there's still a lot of R&D that needs to be done before this can be commercialized, et cetera. We expect to commercialize this test in early '24. That's what we said when we bought this asset, that's still the case. We expect to submit it for CMS reimbursement by the end of this year. That's still the expectation and to get reimbursement, the bar is that you can prove equivalents to another equivalent assay in the market. And so we think the bar is kind of a low hurdle to clear, and we think we will get CMS reimbursement for colorectal, which is the first indication. The point about it being an expensive asset to purchase. This is a market today, this MRD market, in oncology, which is in the few hundred millions right now. Our estimates, which I think are conservative because if you ask some of our peers, if you look at market data, it's actually well north of that. But our estimates, let's stick to ours, are that it could be a $3 billion market in 2028, well north of that 10 years from now. So...

Just for MRD?

Just for MRD. That's exactly right. Just for MRD. So getting a portion, a certain market share off of a market that's growing this fast, you don't need to do the math. I think it's pretty intuitive. The other part that you need to think about too is -- I think you started to allude to that is the point about some of our peers may be in this space, not making money, the peers that are operating in this space are not Quest Diagnostics. We already have the network. We have the footprint. We have the ability to draw blood at scale. We have the reference labs across the country. We have commercial presence that supports oncology today because we have $1 billion business in oncology today. Now some of the more mature aspects of oncology, not the MRD part or these emerging technologies. But still, we can find a lot of synergies in terms of the go-to-market focus and strategy. So again, I think there's a lot of opportunity here for Quest Diagnostics to extract significant margin in this space.

AD-Detect, really interesting opportunity here. I think this is one of those where you're gut checking is this as big as I think it might be with Alzheimer's and you've just launched a commercial over-the-counter consumer-initiated tests $399 a few months in, what, 2 months in now, I think something like that. There were some comments on the last call about this and how this market could in theory be opening up with some new approvals out there, but give us an update on that if you will and...

Sure. Sure. Yes. No, we're...

Is it $400 a test, are people buying this?

They are. They are. Now this test that we have, which is the AD-Detect blood-based test can be ordered by a physician or you can buy it through our CIT consumer-initiated testing platform online as a patient. Now you have to work with a third-party physician network to make sure that they monitor how the test is conducted, the outcomes from it, et cetera. So it's not like something you buy and you do and you're now trying to figure out what the results mean, you work with a third-party physician network. But it's a beta amyloid test. So it measures BA42, BA40, looks at the ratio. The lower the ratio is, the higher the likelihood that you have the signs or the early signs of Alzheimer's. Now remember, we have an Alzheimer's portfolio that includes blood-based and also cerebrospinal fluid based detection. So this is kind of the next step, which is to measure AB42 and AB40. As you said, it's a $399 price if you buy it through our consumer-initiated platform. It's definitely growing at a good clip. It's still, I wouldn't say material to our overall revenues, but it's definitely seeing some good healthy growth in terms of adoption.

The jumping off point for that question was consumer-initiated testing has over the last year been -- and maybe 2 years really been an area where we said, look, our underlying growth in performance or margin performance -- adjusted operating profit performance is better than what you're seeing we're making investments. And some of those were in the advanced diagnostics, somewhere in the consumer initiated testing. This is one of those tests. It's now launched. At the same time, it may be uncorrelated, you've said we expect consumer-initiated testing to turn profitable and to be less of an investment drag. So I'm trying to get a sense on how much of that is specific to let's say, one product or one new introduction versus something broader happening within the consumer initiated testing category.

Yes. It's not driven by one product. I mean one product helps and menu helps in the case of CIT, the more you can introduce different tests that have great interest for consumers, the more that you're going to be driving revenues and driving profitability. But just a couple of things on the CIT business overall. We have made some investments behind it. Some of those were, like, I would say, set up investments or start-up investments in order to introduced the platform, modernize platform, the website. Some of it was to get some recognition in terms of media, marketing, some broader marketing in terms of awareness for the site. Now we are more focused in terms of targeted -- getting eyeballs to the site and really making sure those eyeballs are clicking and buying a test. So we've become much more focused in terms of the investment now that we make. . We turned profitable on our CIT business in Q2. So we broke even, turned profitable. We expect it to be profitable in the second half of the year. So it's no longer dilutive to our overall book of business, and it's growing fast in terms of revenue, some of it because of tests like AD-Detect. But it's just overall, when you look at the options that are available, whether it's STD tests, whether it's general wellness tests like in terms of A1c testing, those are the things that are driving adoption.

One of the bigger headwinds that you've also highlighted and it's not uncommon. We're seeing this still in many pockets. It's the labor situation. hiring the right people, retaining them what they expect in terms of compensation challenges for the broader economy, of course. I'd love to get an update if you can on where you are with retention. And how you're feeling about the labor market in the moment?

Sure. Yes, improving in terms of retention, but not quite to the level that we'd like to see it. I mean it's per our expectations. It's not a headwind for us in the sense that it's worse than we expected, but it's not better than we expected either. But here's a little bit of history on it, at least 6 months history. In pre-pandemic -- so more than 6 months, but pre-pandemic, it was sitting roughly at around -- turnover was sitting roughly at around 15%, maybe slightly below that. In Q4, the heights of kind of the -- when the pandemic effects were hitting us and people had so many choices in terms of where to go and jobs were really available at higher wage rates. It got up to about 28%. Q1, we brought it down to like just over 20%. We were expecting Q2 to be better than the low 20%, but it wasn't better. We kind of held steady at that. So that's when I say it was kind of the absence of a positive -- it didn't really hurt us in terms of as much what our financial expectations were, but it didn't help either. So now as we look forward, we are starting to see signs that the labor market is definitely -- I mean, we all know this. It's not great. So people have less of a choice as to where to go. Companies aren't necessarily giving these 15% wage increases and sign-on bonuses, et cetera, so people have less options, which means turnover is improving. So we see signs that it's starting to stabilize. We've had about a 4% wage increase year-over-year this year, which is about 1% higher than what we had traditionally seen pre-pandemic. That's about a $40 million cost to us. So it's not something to sneeze at.

Okay. Respiratory panels. Look, it's another one of those very tactical, very short-term type of questions, but I probably should have wrapped it into the COVID question in upfront because I think my gut is the answer is going to be the same, but you did cite on the last call that there would be about 100 basis points headwind from expectation of lower respiratory panels. And based on your earlier commentary around COVID, I would think the quick answer here is that nothing has -- nothing has changed.

Nothing has changed. You're right. I think that's embedded in our guidance that there's a 1 percentage point headwind in the second half.

And I do want to -- for the audience, I do want to mention, I have no idea where our iPad went. So if you've sent me a question, I can't read it. Raise your hand. I mean, we'll make this active if anybody does want to jump in. The unit pricing is one of the better topics in this industry. Maybe the best. I don't know, Shawn, the best we've ever seen, certainly in a very, very long time for people who are tracking every nuance day to day, give us a quick landscape of where you were, where you are and where you expect to be in the second half? And then, why is the second half happening the way it should be happening?

Yes. So where we were at least over the last previous 5 years or so, I mean, we were seeing price compression in our business. In '23, for the first time, setting aside even the draw fee benefit that we saw in 2023, the Medicare CMS reimbursement of draw fees that helped us. Setting that aside, we are seeing positive price appreciation across our business for the first time. Reason for that being...

Across the business or in total?

In total.

[indiscernible] there's still pockets.

That's right. That's a good clarification. So -- and I was going to get to sort of the breakdown of that. Value-based contracting and health plans is helping drive price appreciation. Our ability to redirect volumes, avoid leakage for the health plans, give them shared savings guarantees, them participating in that is helping us drive price appreciation in that part of the business. The health systems part is showing price compression, but it's being offset overall. We've also taken some price increases across our services businesses that are helping. To go back to your last part of the question around '23, I mean, we are seeing price appreciation in the first half. It will improve even in the second half versus that because of a few dynamics. One is some price increases with certain renewals that we're seeing across health plans. The other reason is some of the service business increases, price increases that we've taken will show up in the second half. Some a little bit related to the draw fee reimbursement and just the volumes that are going through the government part of the business. In the second half, it's more than the first half. So we see disproportionately higher benefit in the second half. So that's why pricing is improving even in the second half versus the first.

Fantastic. Folks, please join me in thanking Sam and Shawn for the presentation today.

Thank you.