Quest Diagnostics Incorporated (DGX) Earnings Call Transcript & Summary

All right, everyone, thank you for continuing to join us in the health tech and services track. With me today, I have the whole Quest team. I've got Sam Samad. He is the CFO. And we also have Shawn Bevec, Head of IR. Thank you guys for joining.

Thank you for having us.

One of our most requested at the conference, so it should be a very interesting session. I bet you're going to get 1 million questions today on your guidance because there's a lot of moving pieces, and I've had a lot of questions from investors on it. Do we want to kick it off with just a refresh of the moving pieces?

Sure. Yes. So we guided to revenues of $9.35 billion to $9.45 billion, EPS of $8.60 to $8.90. And let's talk a little bit about the tailwinds and headwinds and some of the moving parts to your point, especially on EPS, I think, which is important for the audience to understand. But on the revenues, first of all, and on the tailwinds and also some of the things that are -- I think we see good momentum for. First of all, utilization, very strong in '23, we saw great volume growth. And our expectation this year is on base revenues to grow in the 3 -- almost 3.7% at the midpoint. And to the extent that there's more catch-up utilization, that's not included in our guidance, there could be potential lift as well from those numbers. The pricing environment continues to improve. We think that could be potentially also a tailwind. We've included in our guidance the assumption that pricing is modestly accretive in 2024. The mix, test mix, payer mix in our business, what we call the revenue per requisition is improving. That continues to be a tailwind as well. And then from an acquisition perspective, what we've baked in our guidance is roughly about 0.6% to 0.7% of lift from acquisitions. We don't include anything that's not announced in terms of acquisitions. So the impact that we've included in our guidance is really for acquisitions that are known that we've announced. And those are basically Lenco, which is an independent lab, NewYork-Presbyterian, which is acquisition that we did last year, but has carryover impact into '24, Steward Health Care, which is an acquisition that we did earlier this year, that has an impact this year as well. So those are the acquisitions that we've included, but there could be more depending on the pipeline.

Not so subtle.

And then from a -- if we look at a headwind perspective, things that you need to take into account that are factored into our guidance. Haystack, additional $0.20 of dilution. Last year, we bought the asset. We had half a year of dilution. So the additional $0.20 of dilution is really reflecting a full year of having the asset as part of Quest. We've got an interest expense headwind. We raised some capital last year, and this is the impact of it. And the reason we raised fixed debt last year in November is to fund some of the acquisitions, some of which, as I said, which are not included in our guide. The labor inflation market still not back to pre-pandemic levels. What I mean by that is or the labor inflation dynamic, that 3% to 4% that we've included in our guidance is still higher than it was pre-pandemic when it was closer to somewhere between 2% and 3%. And to the extent that, that improves, it could be upside. I don't necessarily think it will be worse than the 3% to 4% inflation, but that's still a cost that we're offsetting in our base. So those are the key dynamics that we -- and obviously, COVID is the last one.

Is that you're missing a big one.

Yes. Well, COVID $175 million year-over-year drop is still -- from '23 to '24 is still an impact, the negative impact.

I have so many people asked about this and just say, why are we still talking about COVID for this model? How did you have a $175 million of revenue still from that?

Yes. Well, I mean, we had $223 million in 2023, and we expect this year to be somewhere in that $50-ish million range. So that's the $175 million drop year-over-year. And yes, COVID is -- we expect by 2024, the end of '24 to be just another test in our portfolio, which is if you look at what we generate from some of the other respiratory tests, flu, otherwise, $40 million to $50 million is in that ballpark. So it's still a factor, unfortunately, for '24 because we still generated $223 million, a lot of that in Q1 of last year, so -- and then we had a steep drop off after that. And '24 is going to be a drop from '23.

But I've been thinking about the underlying dynamics? Was that more folks were still going in, in person, and getting the test? Or was there any relation to some of -- the hospital relationships you have that was driving this type of volume.

So there's -- part of it is the PHE also. I mean back in Q1 when we had -- retailers were still offering the test like we had this relationship with CVS, where they were still doing the test and then in May, when the price got cut, the PHE ended, we went from $100 price to $50 price. But when the retailer stopped offering it like CVS, I'm referring to, then testing really went down. So in Q1, we had a big bolus of COVID testing in Q1 of '23. And then when the retailers stopped offering it because the PHE ended, we saw that really drop. And then it started to shift more into the hospital setting. So we started to see it more for us in our Professional Lab Services, PLS, setting.

When I think about the core business, ex Haystack and M&A and some of the COVID headwinds that we talked about. It does sound broadly like it's trending positively for everything besides labor. Is that a fair assumption?

It is a fair assumption, and labor is stabilizing.

So what do you think investors aren't appreciating about the business?

Well, let's talk a little bit about the revenue dynamics, first of all, because I think that's an important one. And I'll talk a bit about the investor aspect. And I don't think it's not appreciating. I think it's -- they want to see -- they kind of want to see more in this post-COVID stage. But on the revenue dynamics, there's a lot to unpack there, Stephanie, because we had 7% roughly revenue growth last year, a banner year for us, right? So really, really strong year from a revenue perspective, volumes were up 6.5%. When you look at it across the board, we believe that we gained share in the physician office space, in the reference space in hospitals and definitely in the PLS space. So across these 3 books of business, we gained share. But we also think of that 6.5% volume growth that we saw last year that about 1/3 of it was really what we call catch-up demand, utilization that was catch-up because of COVID, people deferred care, came back, did testing, and we saw that in '23. Our assumption in '24, again -- and this is, by the way, the numbers that I'm giving you are all base business growth. So that 7% and 6.5% is base revenue, base volume excludes the impact of the COVID.

It is an unheard of growth rate for the lab.

Exactly. Exactly. It's much higher. I mean, we used to be in the low single digit of growth. So that base business 7%, base volume 6.5% is way above the norm. If you look at '24, our guidance, as I said earlier, base revenue is somewhere the [ 3.5% to 3.6% ] range. And organically, it's about 3%, again, base. We're not assuming in our guidance the real significant impact from additional catch-up demand. We have assumed that basically the utilization catch-up has played itself out across 2023. To the extent that we still see additional utilization increases because of people that have deferred care coming back, there could be upside. So you asked me, what are investors not appreciating? I mean, again, I don't want to speak on behalf of investors, but I would say 2023 was a noisy year in the sense that it had a lot of moving parts. Our -- we did a lot of things around base margins to improve them. But that's not entirely visible because of the fact that we had a $1.2 billion drop from COVID, '22 to '23. It's hard to show margin appreciation across the business when you had a $1.2 billion revenue decrease. But our base margins that we don't necessarily report, we just report total margins, our base margins really improved markedly.

Now utilization has been a pretty hot topic for the start of the year. Would you then qualify what you have set out as maybe just some conservatism because you don't want to set too high of a bar given all the moving pieces?

I wouldn't say it's conservatism. I would say it's really setting the expectation, again, with that base revenue growth of 3.5% approximately of the things that we know, right, with -- basically that we can't assume additional catch-up utilization if we don't have the facts to support that because we saw a lot of that come back in '23. And again, we're assuming that, that's played out. The other part is -- and it's a smaller part, but it's worth discussing as well. We had a tough start to the year in January because of weather. The first 2 weeks were really tough from a weather perspective. And some of you maybe that are less familiar with Quest might say, well, how does 2 weeks of bad weather really impact this business? It does. You've got a lot of requisitions that get impacted by weather, when you have snow events, massive rain events on the West Coast, ice events in the South and they don't come back. Some of them do come back, some of them don't.

But you guys don't have snow days either. I mean your locations stay open.

They do stay open, but patients don't come back.

Exactly, so you have the same cost.

Actually, you have the same cost, but you don't have the volume impact. Now the second half of January, we actually saw a good rebound from those negative weather events. But as we set guidance for the year, it was also with the knowledge that January was a tough weather month. And we did size in our guidance a $0.05 to $0.07 impact -- negative impact from weather for '24.

I'm going to jump all the way to a question I wanted to ask at the end, but this just makes me think, you talk about how the 7% growth was very high. And that historically, your growth has always been more low single digit, [ which is a tradition ] thought of the business. But your long-term guidance doesn't say that. So help me bridge how you're getting to that mid- to high range.

Sure. Again, do I think the 7% is the norm going forward? No. As I said, there's some catch-up demand in that, the more normalized was probably from a volume perspective, closer to around 4%, somewhere around there. So let's bridge to long-term guidance. What we said back in our Investor Day last year and what we still stand behind is that we think this business can grow organically by approximately 3%, which, by the way, is where our guidance is for '24 and we think that inorganically from acquisitions, we can generate an additional almost 1.5% of growth from acquisitions, 1% to 2% is what we've said. So basically we think the long-term steady-state growth of this business over a certain period of years is, for the next 3 years, let's say, is about 4% to 5%, and we stand behind that. I think that's still very much attainable. We've got a very healthy acquisition pipeline that could support that as well to support that 1% to 2% growth. Now from a margin perspective, we said we can grow margins 75 to 150 basis points over the 3-year period from the '23 starting point or the '23 annual starting point, where we finished. And we still stand behind that. We think we can generate that margin appreciation of 75 to 150 basis points over the 3 years. So we still stand behind these projections. If you look at EPS, and I think since you're talking about long-term guidance, let me punctuate that a little bit. EPS this year, our guidance calls for about 0.5% at the midpoint growth in terms of EPS. If you back out things that don't repeat, right? So one is Haystack because eventually, Haystack is accretive. Next year, it's actually a bit of a tailwind because it's less dilutive. And in '26, we think it's breakeven to accretive. So that was -- if you back that out in '24, if you back out the impact of COVID, and I hope we don't have to talk about COVID after '24.

If we're here at the conference next year talking about it, I'm just [indiscernible] the questions.

Exactly, I wouldn't be talking about it. I'll promise you that. But if you back those 2 pieces out, our EPS growth this year would be closer to 8%. So again, I don't want to normalize things too much and keep going like detailing the moving parts, but it's important for you to realize that those 2 items, COVID, Haystack, if you back them out, EPS growth would have been 8% in '24. And so that's why we're still confident about the long-term guidance that we gave about high single-digit EPS growth.

So is the way to think of the bridge that EPS growth is, it's like a [indiscernible], like '24 just kind of.

Well, I think about it as -- look at it for the long term, look at it over the 3 years, and we still stand behind that. That's really the long-term guidance, I think, of high single-digit EPS, we're still confident with.

When I covered you guys back in the day, I remember that the hospital outsourcing business. And I'll give you it looks a little different at the time it didn't sound like it was the most attractive part of the world for what you were doing. And now it sounds like a very attractive part of the world. So talk to me about what changed?

Sure. Yes. And maybe a couple of facts to support or to at least level set, first of all, we started this business, we call it the PLS business, the Professional Lab Services business. We started it around 2015, 2016. And by 2019, right, before the pandemic, this became a $300 million business. So to your point, Stephanie, it wasn't as much of a factor back then. Now this business is about just excess of $700 million for us. So we've more than doubled it since 2019. As I said earlier, this business grew by 13% last year. The reason we're seeing traction on that business is think about it from a customer perspective. And by the way, these are not acquisitions. This is an outsourcing relationship that could be either a supply chain relationship or a full scale outsourcing of their inpatient lab. So basically saying, Quest, we want you to run this for us. Take on the employees, take on the supply chain and a full rebadging, do everything yourselves. And the reason is because hospitals are stretched. They're stretched from a labor standpoint, cost standpoint, and the lab business is not a strategic business for them. They know that we can do it with our scale more efficiently. And we can generate for them up to 20%, if not more, of savings as we run this lab business. So that's why it's picked up for us. That's why it's become much more, I would say, a big driving factor behind our growth.

And that wasn't always the case, right? I remember hospitals used to view this as a source of margin.

They did, yes. But I think progressively, as you talk, especially whether it's academic medical centers, other health systems, they will tell you they've got a list of priorities and maybe COVID has played into it, and lab isn't in the top 5. It's a distant, I would say, probably 7th, 8th on that priority list. Yes, they can make margin from it, but they'd much rather focus their resources on the things that drive more profitability for them, procedures, patient care, other things that they do.

Who's going to say, looking in the rearview mirror, is this maybe a benefit of just PAMA looming every year?

Well, PAMA has changed a lot of things. And I'd hate...

But PAMA hasn't changed.

Yes. Well, PAMA hasn't changed, right? But maybe part of it is the dynamic with PAMA. I'm not sure.

So as long as we're talking about some different regulatory things going on, we do have a final action date coming up, right, for these LDTs, talk to me.

Yes. So a lot to unpack here. There's a lot of moving parts. So these [ reqs ], which could come as early as April of this year. I would -- the simple way to look at it is there's 5 stages to it. The first stage is basically medical device reporting. So having the labs stand up medical device reporting. The second stage is really introducing quality systems and more rigor. The third stage is good medical practice, good general medical practices. The fourth stage, which really is -- gets us into late '27, that's an important milestone here, which is really the approval or the requirement for the approval of high-risk LDTs. So that's 3.5 years out from when the [ reqs ] first take place. And then the fifth and final stage is the approval of the medium risk and low-risk LDTs. So those are kind of the 5 stages. For us, the impact is looking at the third stage -- or the fourth stage I should say, which is end of '27.

I guess contentious, right?

Yes, where you have to look at -- if you have high-risk LDTs in the market, you have to get them approved by that deadline, which is, at this point, we think it's end of 2027. Now a lot of moving parts here. Is there a grandfathering that's going to be introduced for LDTs currently on the market? We don't know. The [ reqs ] currently don't specify that, but it could happen. Is that period of 3.5 years, by which time you have to get these high-risk LDTs approved? Is that going to be longer? We don't know. But by the time the final [ reqs ] get introduced, we'll see what that looks like. What's the impact for us? I would say the impact for us, first of all, is that roughly 5% of our requisitions are impacted. What we consider in that category of high-risk LDTs. It's a little bit more than 5% of our revenues because usually, these tests carry a bit more value to them. There will be some cost. I think there's been some cost estimates that have been floated out. I'd say they are too high, but there will be some costs that we'll have to incur, just like others will have to incur those costs. Other labs will have to do same thing, other lab providers, I mean. The one thing I think that some people don't quite realize though is that for smaller labs, the ones that don't have the scale that we have, including many hospital labs and academic medical centers, they're not going to be able to stand up all of these capabilities. We already have a lot of rigor with our CLIA labs, we do validation. And we already do a lot of this. Now we will still have to incur costs. I'm not saying we don't, but some of these other...

Do you have the scale to offset it?

We have the scale, we'll absorb it when we find out what exactly the requirements imply in terms of cost. But the other smaller providers, including hospitals, might have to send a lot more reference our way because they don't have the capability to get these LDTs validated and approved. Now again, there's a lot of speculation here based on what we know and don't know. So I think we'll get more clarity when the [ reqs ] get introduced.

Given the amount of regulation that has maybe gone and look very disruptive to the labs business model, have you thought of maybe involving lobbyists or getting more involved in a way where things like PAMA don't come up or this doesn't come up, which would be very destructive to the vast majority of your competitors?

Right. Well, we work through ACLA, right? I mean ACLA is the lobbying body here. We work through the industry association, and we're very active in terms of educating the FDA, educating members of Congress, educating our constituents about what this means. But again, as I said, this is across the broad spectrum of the market, it's not just impacting us. And I think, again, if there's a silver lining here, it just means the scale providers are the ones that probably can navigate through this? And I wouldn't say in an easy way, but easier than the vast majority of others.

With that in mind, during what may be a very contentious election year, what is stopping SALSA?

So PAMA, you mentioned PAMA earlier. PAMA, we think right now has been delayed 4 times. We think it'll probably get delayed again in '25.

There are risk that's a lot later because it has to be after the election.

Is there a risk that it gets implemented later or delayed later?

It usually is like a November timeframe.

Yes, I mean, listen, last year, we got certainty on that in November. Could it be a bit later than that, maybe, but I think because of the noise around the election. But remember, the -- both SALSA and -- SALSA specifically was a bipartisan bill. So I don't think it's really impacted that much by the election. But could the noise of the election delay PAMA certainty, potentially. But I think the odds are, we think that PAMA gets delayed another year. Now going back to your question around SALSA. First of all, again, bipartisan bill, there's support from both sides of the house, but it has a cost to it. So back to why hasn't it been implemented as law? Why hasn't it replaced PAMA? The CBO has scored SALSA as a cost. And the reason they scored SALSA as a cost is because they expect with SALSA when a new fee schedule comes out, which now the earliest it can come out is 2029, prices will go up because the data collection method was flawed in the way that PAMA was done. So this new fee schedule, which is going to mean price increases, which is going to mean higher cost to the government. That's what's delayed SALSA. Now on the other hand, for PAMA, the reason it's been delayed now, at least last year and potentially coming year.

You've got to do something if you want to implement it, right?

Well, exactly. But also what it means is that PAMA -- the CBO has scored it as a savings to the government. So I know that's counterintuitive. But again, because they believe with the new fee schedule, pricing will increase. So let's keep delaying. Let's keep kicking that can down the road. So -- and the CBO scored that as a $600 million positive.

Can they cancel each other out?

Not really. I don't think it works that way.

The other big change in your business, I do want to touch on, we only have a few minutes left, is the value-based part of your business. And that's grown pretty meaningfully. It's 50% of the hospital business now, how did it get there? And what's the high end of what it could be?

Sure. Yes. So the value-based contracts that we work with payers on. It's in the health plan portion of our business. So about 50% today of our health plan volumes go through what we call value-based contracts. If you go back some time back, it was about 30%. It's grown to about 50% today. The reason it's grown so much. The reason it's important, first of all, is it has helped us preserve and actually increase pricing with payers. So incredibly important to our relationships with payers. Why has it happened? It's because simply put, we work on value-based incentives with payers, shared incentives, guaranteed savings, where we're shifting work and volume from high-priced out-of-network labs in certain cases or just higher-cost labs to our labs, which are arguably better quality, lower cost. And so we're moving that work and saving the payers a lot of money in the process. On top of that...

It is no longer contentious, the relationship, [ now you're ] working together.

Well, exactly, it's getting us on a same level platform in terms of having a good partnership and collaboration with the payers, their shared incentives on both sides. And in some cases, we give them savings guarantees and other incentives. In other cases, we have incentives for us if we achieve certain savings. Now we've been able to also, with our outreach acquisitions, reduce cost to the payers because they're reimbursing costs basically on Quest fee schedule now, which is much lower than what they were reimbursing for the hospitals. So that's another factor that has helped us pivot to that new relationship on value-based contract. Now you asked me what could it get to? Definitely above 50%. We still see a runway here, which is, by the way, allowing us to have price increases on average with the payers every year. Could it get to 100%? No. I mean we've got a long tail of smaller payers that you're not going to -- it's not worth the effort to do value-based contracts with really small payers, but we can get to significantly north of 50%.

Well, I look forward to seeing the rest at the [indiscernible] Thank you, guys, so much for coming.

Thank you.