Quest Diagnostics Incorporated (DGX) Earnings Call Transcript & Summary

All right. Hi, everyone. Good morning. Thanks again for joining us at this year's William Blair Growth Stock Conference. This morning, we're very pleased to have the team from Quest Diagnostics joining us here. We have the CEO, Jim Davis, from Investor Relations, Shawn Bevec here in the front row. Format for today will be a 30-minute presentation in this room, then we'll go to the breakout afterwards, which is in the Adler room on the second floor. And then for compliance, I am required to tell you that for a full list of research disclosures, please visit williamblair.com. And with that, I'll turn it over to Jim. Thanks, Jim.

All right. Good morning. Looks like Kevin Conroy left his Exact Sciences presentation here. So I give that back to you. All right. So consider this all your health update for the day. Okay. So fact things will cover. By the way, this is largely the presentation we used at Investor Day. So all of these pages are up on our website. So look, the questions we always get is the clinical lab market still strong. It is. It has remained strong. There was certainly escalated demand coming out of COVID. And I would tell you, the demand is still there. I think we've got a proven strategy to generate above-market growth in our key channels. We've been investing, as you know, we develop our own LDTs. We have our own R&D staff, 850 MDs and PhDs that develop tests and those investments are paying off. Our operational strategy, right, always designed to improve the quality of the things we do, enhance the customer experience, the customer being a physician, a patient, a payer and then driving productivity in a business like this. When you get paid $50 to do something, your costs are $43, driving productivity every day is incredibly important. Our long-term outlook, which we reaffirmed on our April earnings call, 4% to 5% revenue CAGR, 7% to 9% adjusted EPS. So our purpose statement, long before anybody started talking about creating a healthier world in Washington, D.C. This has been our statement for a long, long time working together to create a healthier world, one life at a time. How do we create a healthier world, look, we unlock answers, we unlock insights into what is going on inside your human body. Many times, when your health is going down, you may not see it in your physical appearance, weight gain, things like that, but you will see changes in your underlying biomarkers with changes in what you eat and how you exercise within weeks of changing those behaviors. So getting early insight as to what is going on in your human body, we think, is incredibly important. We touch upwards of 350,000 patients each and every day. So how we treat them, the care, compassion that our phlebotomist use when we touch those patients incredibly important. And again, continuous improvement in our industry. We do over 200 million transactions to the extent we can take $0.01 out of a process, there's $2 million of op profit added to our bottom line. For those of you who may not be as familiar with the company, we serve over 50% of the U.S. hospitals and physicians annually. We test over 1/3 of the U.S. adult population. So every 3 years, we'll see 50% of the U.S. adult population. It's safe to say that we know more about the health, the underlying health of the U.S. population than any other company in the United States. And we use that information, and I'll talk a little bit about that to help others make important decisions. 217 million requisitions in 2024, 2,000 patient service centers, 8,000 different patient access sites, 90% of the U.S. lives, 80 billion collection data points on I would say more than 1 data point for individual over the last 10 years, 55,000 employees. I mentioned 850-ish MD PhDs, 1,600 patents pending, and we are global. We have a large presence up in Canada. We got into Canada last year. We also have labs in Mexico. So the market, about $90 billion on the left-hand side, we break it up into 2 chunks, right? There's physician market, people that work outside of hospitals. You go to your doctor, he writes a lab order. That lab order comes to us, paid for by third party generally. So there's a physician market, and then there's a hospital market, a hospital -- all hospitals have to have labs. They're generally cost centers. A patient comes into the hospital, you need a laboratory for patients coming into the ED, patients in surgery, patients in the ICU unit. On the left-hand side, again, $58 billion market. We've got about 12% share, other independents about 42%. The segment of the market that we're really, really targeting is this 35%. It's the portion that is owned by health systems. So these aren't doctors in the hospital. These are doctors, for example, for Northwestern Medical Center here in Chicago, they sit outside the hospital. They are primary care, they are OB/GYN and they see patients and they do lab work. That lab work is generally sent into the hospital. It doesn't come to Quest or other independent labs. We want that work to come to us. Why? It's better for you, the patient, your co-pays co-deductibles are going to be lower. It's better for the people paying for health care, your employers, and it's overall better for the health care system. But you need access to that, we'll talk about it. And then physicians, large independent groups own their own small little laboratories. They do this as a convenience sometimes or as a way to make money, but POLs, physician office labs are about 11% of the market. On the hospital side, again, $31 billion market growing 1% to 2%. What we get mostly from hospitals is work that is not done in the hospital lab. We call it reference work. They refer tests out because they don't have that capability. They could be low volume, highly complex or require a degree of medical specialization that the hospital doesn't have. They're not generally turnaround time sensitive. So they refer them out, we do the work, provide the results. We also have a business that runs hospital laboratories. We call that CoLab, and we'll talk more about that because it's been a significant driver of our growth. As I mentioned, we got into the Canadian market last year. We made an acquisition of a company called LifeLabs. They primarily operate in 2 providences Ontario and British Columbia is where we have labs, we do collections in Saskatchewan that then feed into those labs. Canada is a good market. 41 million people, actually, the underlying demographics, it's growing faster, population than U.S. a little bit older than the U.S. And LifeLabs is the largest independent lab in that country. As you may know, the payment model is different. You're dealing with one large payer called the Canadian government, although every Providence has their own slightly different payment methodology, but it's largely a capitated arrangement. So you know what your revenue is going to be, how much testing you're going to do and you want to do a little more testing than what you get paid for so that the next year, you get a little more money because you did a little more of the testing, okay? So there's a balance there. Again, operating in 2 provinces. Ontario, the biggest; British Columbia, third biggest. And so there's expansion opportunities available for us in Canada. Last year, we did close to $10 billion of revenue. We grew 6.7%. The physician channel represents the largest portion of where our work comes from. That's not who pays the bill. I'll talk about that on the right-hand side. It's where our work comes from. So ordered by physicians and generally paid for by somebody else. Hospitals represent about 20% of the revenue that comes into Quest and about 12% comes from employer channels, drug testing for employers, wellness events for employers, our consumer direct channel, which is the fastest growing segment and Quest right now is in that 12%, and we do work for life insurance companies. Who pays the bill. Everybody thinks that commercial health plans are our biggest payer. And in some respect, they are, but it's 27% of our revenue. Now you see above that, we have Medicare and Medicare Advantage and then Medicaid and Managed Medicaid. Obviously, Managed Medicaid and Medicare Advantage is administered by the commercial plans. So technically, you could say 13% of that 24% is coming through commercial plans, but the U.S. government is still paying for it, right? The U.S. government pays all the Aetnas, Humanas, Uniteds of the world to do that Medicare Advantage work. Okay? Does that make sense? Okay. So in total, commercial health plans, call it 40%, but 13% of it is government backed. Client bill is 35%. So 100% of hospitals, we bill the hospital. And the hospital is generally not billing a third party because there's a sick patient in a bed that get paid under a DRG formula. The Canadian government small last year only because we did the acquisition in August of last year. This year, it will be roughly 7% of our total revenue. And then patients most of that is co-pays, codeductibles. There is uninsured work in there, and then there's also our Quest Consumer Direct. So people that are paying out of pocket coming to us without going to a physician. Okay. some brief macro trends, right? The first macro trend is an older and sicker population, which I'll talk about innovations in the lab diagnostics, that's what drives growth. The development of new tests. So I'll talk about our new Alzheimer's blood-based test that is driving significant growth. That was a test, a blood-based PET test for the diagnosis of Alzheimer's did not exist 2 years ago. It exists. It over time, will largely replace PET CT as the primary diagnostic tool for the detection of Alzheimer's. Greater adoption of AI and automation, cutting through the lab industry. And then we're seeing a much bigger focus on consumer prevention and wellness, okay? And this is people paying out of their pocket mostly for tests that are not generally covered by commercial insurance. Let's go the other direction? Okay. So the U.S. population, look, you may have read the 67 page Make America Healthy report that was released last week. And I'm not going to make any political commentary, but it's hard to debate the statistics that were in the report. It's an accurate report in terms of describing the underlying health trends in this country, and they're not good. As I said, we've been testing over 1/3 of the U.S. adult population for the last 10 years. This wasn't news to us. We see this. 74% of adults live with the excess weight and obesity. In 1990, that number was 44%. So it has almost doubled from 1990 to 2025. 52% of adults have prediabetes or type 2 diabetes. That was 20% in 1990, 79% increase in early onset cancers, okay? The fact that we're seeing colon cancers in people in their 30s and 40s has nothing to do with genetics. And I know Kevin was up here just earlier with the Cologuard. It's a great test. It detects colon cancer very early. But it'd be better if we prevented colon cancer of individuals in their 30s and 40s, and that's what we, as a country, need to work on. 2% to 12% increase in autoimmune disorders, you can see all the things on here, what's the net result we spend twice as much per capita of any other developed country in the world, and our outcomes are the worst of any country in the world of life expectancy. And it's been declining. You see our dip, which a lot of that occurred during COVID, but you don't see those same kinds of dips in other countries during COVID because they didn't have the same types of underlying chronic conditions. So our 3 primary groups that we go after, physicians, hospitals, expanding in some of these other high-growth areas that I'll talk about. First, with respect to hospitals. The #1 thing you got to do is you got to be in network, and we expanded our network access year-over-year. I'll talk about that. We're extending our geographic reach. Yes, we serve the entire U.S. population, but there are some regions of the country were much stronger than others becoming a partner of choice for large enterprise customers. So it's no secret that independent doctors are shrinking. They're working for bigger mega corporations, and I think we're well positioned to serve those big mega corporations on a national basis. On the hospital side, the reference business, as I said on the previous page, generally a 1% to 2% growth business. But our opportunity to manage hospital labs, where we go into hospitals, and it will allow the Quest employees inside the hospital. We own the assets. We own the supply chain, and it's really a third-party agreement where we're managing that hospital lab. That's an $800 million business in Quest Diagnostics that's grown 10% to 15%. And over the last 10 years. And then the 3 high-growth areas I'm going to talk about are consumer-initiated testing. We support life science partners so pharma and life science companies are a big customer of Quest Diagnostics. And then that mountain of data that I talked about, we monetize that data. We sell it to health plans. We sell it to pharmaceutical companies. We sell it to large primary physician groups to help them make good clinical decisions. So what is it that makes us unique? First, I talked a little bit upfront about our scale. Our broad access from the PSC and IOP, we spent over $1.2 billion a year, collecting blood and urine with over 15,000 phlebotomists, 2,000 retail settings where we collect that. It is a major strategic advantage. When you hear and see some of these new startup diagnostic companies that blood-based test, they call us and they say, "Can we leverage your phlebotomy network." There's no way that these small companies can do the kinds of blood collection and urine collection that we do. You also then need to move that to a laboratory. We have over 4,500 -- a fleet of 4,500 vehicles, 20 airplanes where we move specimens around the country every single day. Every single day, we're doing on the order of about 750,000 requisitions that come in. Clinical innovation. I'll talk about health plan access and then at the end of the day, we provide the best value in this marketplace. We are reimbursed at significantly lower rates for the same type of work that is done in hospital systems. It's good for you, the patient. It's good for your employer or it's good for the health plan if they're taking risk -- economic risk on those lives. So I mentioned access. We walked into 2024 with 2025, greater than 90% access to all lives, meaning we are in network with most of the U.S. health plans. The states that we gave a darker gray, Nevada, Colorado, test my geography here of Georgia and Virginia were Elevance. So we were not in network with those states with Elevance. As of January 1, we're now in network with those states with Elevance in those states and a plan in the Virginia area called Centerra. Centerra is a large health system, but they also have a health plan, and we're in network with them. Now as I mentioned, we carve up the country into the largest 50 MSAs. And where we're always focused is where our brand presence may not be that strong and where we think there's great growth potential. And that actually informs some of our acquisition, our hospital outreach work. So last year, we did transactions in Minneapolis, Columbus, Ohio, in Cleveland, Ohio. The common characteristics of those markets were, number one, we didn't have access to the physicians. Most of the physicians in those markets are owned by large health systems. So when we buy that physician outreach book of business from a large hospital system, it instantly gives us access to that marketplace and we grow from there. So those are -- there's about 14 MSAs in the country that we have our eyes set on that are faster growing and our share is a little bit lower. As I mentioned earlier, independent physicians are kind of going away. Now you could say, hey, that's bad news for Quest Diagnostics because we're an independent lab that kind of grew up over 50 years serving independent physicians. It's not so bad, though, because where are those independent physicians going, they're largely going to large corporate entities. Things like Optum, Oak Street, MinuteClinic, Function Health, Summit, CityMD now owned by Walgreens. And we, as a company, are set up better to serve all of those large national entities who generally prefer to deal with 1 to 2 labs, have 1 IT system to work with their IT system. And so we have partnerships with all of these companies, which is why I highlighted those. Now health systems, again, we still work with health systems. So the fact that the physician works for the health system doesn't mean they can't use Quest Diagnostics. It's just in some cases, it can become a bit more challenging because the health system would like to do that lab work as well. Okay. Let's turn to hospitals. Coming out of COVID, no secret that wage inflation, supplies inflation was a big concern, workforce shortages, cost of capital. In many cases, we were taking on work during COVID, not just doing the COVID work for hospitals, but they had shortages of people to do things like cytology, histology, microbiology. So we are importing those large books of business from hospitals into Quest Diagnostics. Again, there's really 3 ways we work with hospitals. First, reference testing. Again, it's work that they've chosen not to do in the health system. And generally, they're not time-sensitive tests. They are capital-intensive tests, things like FISH-Flow, genetic types of testing. They're not going to stand up 1 million-plus Illumina sequencers in a hospital to do a very little amount of testing. So that work gets referred out to Quest Diagnostics. The second piece is -- and that's a $1.1 billion business today. The second piece is we call collaborative lab solutions. This is Quest Diagnostics inside the 4 walls of the hospital. Hackensack Meridian system in New Jersey, the largest health system in New Jersey. It's 16 different hospitals spread across the state. We run their hospital labs. It's Quest employees inside. We own the capital inside and it's our supply agreements. Generally, when we do that, we can bring the hospital somewhere between 10% to 15% savings. Why? Because nobody is buying reagents at a lower price than we are. And we can also leverage our large regional lab that sits in New Jersey. Not every test that is done in a hospital today needs to be done in 4 hours or less. So we shrink that menu down and we move those tests to our large regional lab which, in many cases, can be done at a 20% to 30% savings versus what they were running those tests for in the hospital. And then, as I mentioned, we work with health systems to monetize an asset called their physician outreach business. We did that with Presbyterian system. And as I mentioned, Ohio Health University Hospitals and a line of health up in Minneapolis. And I would tell you, the funnel is full of these types of opportunities. Okay. Let me touch on 3 really important growth segments within Quest. The first is our consumer channel. It's called quest health.com. You -- everyone in this room could go to that site, you can order upwards of 150 different tests. And you might say, well, why -- why would I go order those tests if I have insurance. And by the way, most of the people that come to our site, they have health insurance, but they're not using their health insurance. They may use FSA or HS dollars, but they're coming to us directly. Why would they do that? The first case is people want privacy. And the #1 types of tests, STDs, STIs if you're 18 to 26 years old and you're still on your parents' health plan, you're probably not going to order an STD test, right, because mom and dad are going to find out about that. Or just married people might not want their partner to know what they're getting tested for. So privacy seekers. The second one is we call watchful warriors. So these are people with chronic diseases but the health plans limit the number of tests they can get a year. So a diabetic who may want to check their A1c test once a quarter who may want to check insulin resistance, what they learn very quickly is if they go to a physician, spend $150 just to get a lab order, it's going to get denied if it's their third A1c test. So why not just come to questhealth.com order the A1c test, you get it at a better rate than you would anyways. So watchful warriors. And then look, 50% of the U.S. population does not get an annual physical. It's actually more like 55%, 60%. But they still -- there are some people that still want to understand what's the underlying, what is my underlying health. You can get a very extensive wellness panel with Quest Diagnostics and really decipher, do I need to see a primary care physician or not based on your lab results. Now we also sell through channel partners. Have you heard of the company called Function Health. Function Health is a largely telehealth company. You pay $499 a year, you get 2 very extensive lab panels and all of that work is being done by Quest Diagnostics. The company was just recently valued in a recent raise at north of $2 billion. So we go direct, but we will also work with other channel partners and as you can imagine, there's some big, what I would call, consumer branded health care -- consumer branded companies now moving into health care and we will be opportunistic about those that we work with. Life Sciences, we generate close to $100 million in revenue from pharma life sciences companies doing Phase I, Phase IV decentralized clinical trials, we will also do mobile phlebotomy for people that are in clinical trials. So one of the worst things that can happen to a pharma company is to lose patients that are in a clinical trial because they didn't get their blood tested or didn't go see their physicians. So pharma pays us to go visit somebody's house to collect blood just to make sure that, that patient is staying in the clinical trial. And then close to a $50 million business in health care analytics. So it's monetizing data. Our #1 customer is pharma. When pharma wants to know people with a certain disease state across different ZIP codes in the U.S., we're able to provide them with that information. We can also tell them who their doctor was. Now the patient had to acknowledge when they got their blood test that we can use that information but we're happy to do that and it generates significant revenue at very good margins. The other piece I would tell you is health plans. As people move from 1 health plan to the other, especially in Medicare Advantage, the new payer wants to get all the old health records, okay? So grandma moved from Aetna to UnitedHealthcare, UnitedHealthcare calls us and says, "Can you give us the lab results for grandma over the last 10 years?" And we're happy to provide that data at the right price. The other way we look at this business is through the eyes of a clinical -- deep clinical lens. And what's generated significant growth in Quest Diagnostics over the last few years, is revenue margin from tests in each of these areas. Now in the first quarter, we reported modest volume growth, but we also said that our rev per rec was up over -- close to 3.3%. Now rev per rec is a bit complicated. What's in rev per rec. Well, one is price per test. We said price per test was relatively flat. So all of the growth in revenue per rec is coming from an increase in test per rec and it's coming from an increase in the types of tests that we're running, higher revenue types of tests. Where is it coming from? The first one we've laid out oncology. We're here this week in Chicago, it's at the very tail end of ASCO. I can tell you the #1 topic at ASCO was this thing called MRD, minimally residual disease. I'm sure you all know what that is. We've launched the test. We're making nice week-over-week steady progress. We also have a test called ISO PSA that is a reflex test for normal PSA test. PSA tests are incredibly sensitive but not highly specific. And so this is a reflex test. Most times, when a man gets a high PSA test, it's really not cancer. It's because of some underlying infection, yet often that high PSA test leads to a biopsy, okay? And so this is a higher level test that will help the clinician determine is a biopsy really required. In the cardiovascular space, if I could give you any clinical advice today, go get an Lp(a) test and go get an ApoB test. These are tests that are not widely covered by commercial payers because there's no therapy for Lp(a), but that doesn't matter. You should know your Lp(a) status. There's people with low LDL, high HDL that are dying every single day because of the lipoproteins that are in those red blood cells. So you ought to get those tests. And by the way, they are being adopted by these functional health medicine, these functional health gurus. Women's in reproductive health we are gaining market share in our QNatal noninvasive prenatal screening test, our QHerit test. By the way, the state of California has standardized on our noninvasive prenatal screening test in the state of California pace for all pregnant women. Brain health, our early detection of Alzheimer's. 2 types of things caused in Alzheimer's, the development of amyloid plaque, the development of these proteins, these tau proteins. We were the first to come up with this test called AB 4240. It detects, it's an LDT, it detects early onset of amyloid plaque in the brain. It is a necessary but not sufficient condition for the development of Alzheimer's, but the combination of LP -- of AB4240 plus these pTau biomarkers really give clinicians an earlier view of early onset Alzheimer's long before you would see it in a PET CT. And why is that important? Because these new therapeutics that are coming along, they will work best at the earliest stages. They're not going to work with advanced amyloid plaque covering or pTau bundles covering the brain. We recently got reimbursement for these tests, the AB4240 test is about $180 and I can tell you the adoption of this test is just really starting to take off. Primary care physicians are using this test to determine should a patient get referred to a neurologist or not. And the #1 problem with Alzheimer's disease today is getting a referral into a neurologist, okay? So if a primary care physician can run a test to determine who really needs to get referred and who doesn't, it will be a huge help to the overall health system. Autoimmune disorders, whether it's Crohn's, rheumatoid arthritis, lupus, we're seeing big growth in those diseases. It's largely related to lifestyle conditions. We have a test again that can give primary care physicians a very, very good sense of what is the underlying autoimmune disorder so they can make the right referral, whether it's out to a rheumatoid arthritis specialist, whether it's to a gastroenterologist or to a kidney specialist, it's a test that provides them a higher degree of certainty. Just a few minutes on the operations side of our business. As you know, we are a people-intense organization, 55,000 people. I mentioned 14,000, 15,000 phlebotomists, 4,500 logistics. About 40,000 of those people, by the way, went to work every single day during COVID, right? There wasn't much work from home in Quest Diagnostics. So we depend on people and minimizing our turnover, ensuring that we have high rates of retention is paramount to driving productivity in keeping our patients happy. Technology, I would tell you, automation and AI, we're at the very early stages in the laboratory industry. I'll talk a bit about that and then process Lean, Kaizen, every single day, every aspect of our operations. We benchmark the collection of blood, the transport of blood, the processing of blood, our billing operations, every one of those operations is benchmarked across operations within Quest Diagnostics. And to the extent we have outside data to always drive best-in-class solutions. Our goal is always to drive about 3% annual variable cost productivity. Why? Well, with 55,000 people, if you pay them 3% every more, you need to offset that inflation to keep your margin rate improving. Our pricing as we've been saying, has been relatively flat for the last 3 years. We've been getting price with health plans, but losing a bit of price on the hospital side of our business. Some beautiful animation here. I would tell you, 5 years ago, robotics was just not in the lab industry. And we, as a company, brought in -- there were some traditional robotics suppliers to our industry, but we worked hard to bring in some nontraditional suppliers, companies like FANUC, companies like ABB, companies like Rockwell Automation and they are helping us each and every day. So I just show some things here that robots are doing in our lab, automated specimen processing, automated specimen preparation, mobile co-bots moving specimens around our laboratory. If you haven't been in a modern day laboratory, I can assure you it's not filled with beakers and it's a very different look and feel. Much of this is automated. Once we get a specimen into the lab, it's rarely touched by human hands anymore. Okay. A bit on the financials. Our revenue growth from 2019 to 2024, notice I took out those COVID years. We did have higher revenue. But take COVID out because there really wasn't much COVID in '24, generated 5% compound annual growth, 6% CAGR on EPS. The guidance we've given for the year, 10.78% at the midpoint. By the way, that matches our high point in 2021 when we had a lot of the COVID revenue so we should actually beat that. And then midpoint of our guidance, $9.68. The assumptions we've made are there on the right, all of these, again, up on our website. Cash deployment, like our #1 goal is to return the majority of our free cash flow to shareholders, either through dividends or share repurchase. We generated from 2015 on, over $15.4 billion of cash what we've deployed is in excess of that because we borrowed some money, took up our debt to fund the LifeLabs acquisition. We invested $8.5 billion of that, $3.6 million into capital expenditures to continue to grow and improve our network. $4.9 billion for M&A and then we returned over $9.1 billion of cash to our shareholders over that time period. Finally, just a little bit on actions we did. We'll talk more about it in our Q&A section. Generally, we're looking at 1% to 2% growth from M&A each year. Last year was an incredibly big year, mostly because of the LifeLabs acquisition that we did. Finally, as I started out with our long-term guidance, 4% to 5% revenue growth, we're improving operating margin each year, 75 to 150 basis points over that period. 7% to 9% CAGR on EPS and we chatted about free cash flow. So that's the summary. We like the company. I hope you liked the company, steady growth, reliable, safe, and go get your Lp(a) and ApoB tests done. Okay. Thank you for your time and attention.