Quest Diagnostics Incorporated (DGX) Earnings Call Transcript & Summary

Okay, we're going to kick it off. I'm Tycho Peterson from the life science team at Jefferies. It's my pleasure to introduce our next company, Quest Diagnostic. We are pleased to have Sam and Shawn with us today.

Maybe to kick it off, I was able to sit in on some of the group meetings. And I think 1 of the things you're talking a little bit about is some of the consumer initiations and applications. Maybe just talk a little bit about how you're thinking about some of these new initiatives, including the WHOOP partnership?

Yes. Sure, Tycho. And first of all, thanks for having us today and hosting us. The consumer health business that we have is something that we're really excited about. It's about a $250 -- or $2.5 billion market. And a while back, we said we can get to 10% of this market in terms of adoption. So almost $250 million. And we're well on our way to that. That business which is basically operated as a questhealth.com, where a patient can get on our website, order a test, get it fulfilled at a patient service center, get their blood drawn there and then get a result the next day. It's a really convenient offering to patients and 1 that's out of pocket, they pay for it directly. So seeing great adoption in that business. But on top of that, I think, to your point about wearables, we're also seeing now more interest in that wellness, preventive medicine aspect of getting not only your -- all your vitals on a wearable through the app and being able to track your sleep patterns, your health patterns, but also your lab testing. So we announced recently this partnership with WHOOP, which is a wearables provider that does this band that not only do you get all your vitals in the app, but you get also your blood testing. So it's basically an exclusive partnership with them where lab testing is provided by Quest. And I think there's a lot more opportunities in that regard in terms of other potential interesting things in that space. I think this focus on wellness is definitely opening up new opportunities for us.

And maybe 2 follow-ups there. You have a partnership with Function Health you've announced as well. Maybe just touch on how that's slightly different. And then also, how do you get paid on these? What are the economics?

Yes. So Function Health is a company that's operating again in this wellness space, it's a membership company. So basically, they've got thousands on the waiting list. But it's really been very popular recently with members and subscribers paying a certain fee per year and getting a panel, a very wide panel of testing. And again, we're the exclusive provider of lab testing for them. So patients who sign up for Function Health will get a panel once a year, they'll go and get it fulfilled with us, and they get a very comprehensive report. So slightly different in that regard. Again, it's out of pocket. It's not through our questhealth.com, it's through function health, but we perform all the testing for them. The economics, whether it's WHOOP or whether it's Function Health or whether it's any other partner that we deal with is really a price that's negotiated between us and that company. So they will pay us basically depending on the test. So it's a price that's negotiated. They'll pay us if -- they do 1 test a year for instance. They'll pass a certain fee. If it's 2 tests per year, they'll pay us a higher fee. So it's a direct -- it's what we call a direct client bill price that's negotiated between us and them.

And margins comparable to your kind of enterprise margins overall?

Yes, very much so. I mean with those providers or with those other companies, I would say it's comparable to our overall margins. If you're looking at questhealth.com, our direct consumer business. I would say the margins over time will be higher than our average margins because the testing prices are set by us. There's no limits in terms of reimbursed prices that we have to negotiate with the payers. And also on top of that, we have -- it's all out of pocket. It's all patient paid. It's all -- you put in your credit card and we bill you for that test. So there are no denials. There are no patient price concessions, bad debt that we have to chase from certain patients, are unable to collect on if there's copays or stuff in our usual business which is the third-party payer business.

Maybe we can shift over to oncology. You announced a partnership with Guardant last week for Shield 3-year network. Talk a little bit about the opportunity there? How you think about screening longer term? You obviously had the Galleri GRAIL partnership before that?

Yes. I would say we're working with broad-based many different companies in this space. We have an interest in early cancer screening and screening in general. And we're pretty agnostic in terms of partnering with other companies in cases where we have a gap in our testing until we stand up 1 of our tests, we're happy to partner. We're happy to in-license. We're happy to acquire. We look at different ways of partnering with different companies or standing up our own testing. But in the example that you provided, which is in the case of Shield, which Guardant just announced on their recent Investor Day, essentially, companies are recognizing the scale that Quest Diagnostics offers and the solutions that we offer. So they are going to be partnering with us for us to be promoting Shield to some of the primary care physicians that our commercial team calls on. We will basically get a promotion fee. We will get what we call an access fee when we essentially stand up the test with new physician practices and put it on our test list. And we will be also compensated through a blood draw fee when patients present at 1 of our patient service centers and they get their blood drawn for the test. We have similar partnerships with GRAIL for their gallery test in the pan cancer screening space. And as I said, we continue to have interest in the screening phase and eventually in the screening space. And eventually, we might stand up an early cancer, colorectal screening test ourselves. We have a partnership right now with a company called Universal DX, which is based in Spain that we intend to, at some point down the road, potentially launch a colorectal screening test with.

Anything you can say on how far down that path you are with Universal?

It's still early. We're doing clinical trial testing on their test right now, but it's still ways off before it makes it to market. So there's still some time.

And then I think you've noted screening and MRD have kind of different appeal to you. Talk a little bit about how your MRD strategy differs.

Yes. I mean, MRD, we wanted to be directly and acquire a test in the MRD space for 2 reasons. One is, first and foremost, it's a really attractive market with tons of growth potential. It's a market that we estimate today is about $1 billion in size. We think, not just us, but independent estimates, sell-side estimates, estimate that, that market could be $5 billion plus in 5 years, maybe even more. So we got into this MRD space because of the potential given the market growth, but also given the fact that we have natural synergies in that space. We have a pathology business, we call on oncologists. We've got $1 billion plus existing cancer business. We've got 2,000 patient service centers that collect blood from patients and do testing or at least process requisitions and send tests to our labs. So that was the appeal of MRD. Then the other reason is we saw this asset, Haystack Oncology that has a great test. And they started with research that they were doing in Germany. It's a company that was based in Baltimore. And we decided that given the profile of that test and given the appeal of the MRD market, this was a tremendous opportunity for us to get into this space.

And maybe just talk a little bit about the regulatory -- or sorry, the payer reimbursement pathway. You've got the 2 PLA codes. You're obviously working on Medicare reimbursement. Just talk a little bit about milestones we can track?

Yes, absolutely. I mean we see this path to -- we've already commercialized Haystack, but we see this path to growth resting on 3, what I call it essentially a 3-legged stool. One is commercial, and we've already ramped up commercial kind of promotion for this asset, for this test. The other one is evidence generation, and we're getting much more active on the evidence generation front, both for colorectal and other types of cancer. And the third you're asking about is reimbursement. And we're on the path to reimbursement now, and I'll talk a little bit about that. So right now, we're kind of in this case-by-case reimbursement through the MACs, the Medicare contractors, where every case we essentially have to submit a claim and get reimbursement. It's still not ideal in terms of the speed of reimbursement. But here's how things will work going forward. First of all, we applied for PLA codes from CMS. We received 2 PLA codes in June, 1 for baseline, which is when you first perform kind of the sequencing and doing a bespoke assay on the certain type of tumor for a patient and then 1 for the monitoring, which is the ongoing blood-based testing. So we've received those PLA codes. We expect to have a price attached to those PLA codes by the end of the year, I would say, close to somewhere around Thanksgiving. And then we really expect that by early 2026, as early as January to start getting reimbursement from Medicare. More than 50% of the patients that present for MRD having done a cancer surgery are in the Medicare age. So that's where most of the patients are. In terms of Medicare Advantage, we're doing a technical assessment or a technology assessment for the purpose of getting reimbursed by Medicare Advantage. The test received a breakthrough designation from the FDA recently. And so we think that's going to help the case for reimbursement as well. So I think we're making all -- taking all the steps that we need to take, and we really expect reimbursement, both from Medicare and Medicare Advantage by January '26.

And I guess should we think about pricing similar to Signatera, the leading test in the market?

I think that's a good proxy. Is equivalent pricing to what's out there right now.

And then how about commercial? How should we think about time lines for commercial payers?

Yes, that's still a ways off. I think that's sort of the next phase, but I would probably say there's still some work to do before that happens, which is coverage by the third-party plans. But again, as I said, more than 50% are Medicare type of reimbursement. So that's the important part right now is to get Medicare and Medicare Advantage.

And I think you're tripling your sales force getting to kind of high 30s, 40 folks by the end of the year. Is that the right number in the long run? Your largest competitor has 150 reps?

Yes. I mean for us, so we've got, as you said, we're going to have roughly 40 by the end of the year or just shy of 40 dedicated Haystack reps. All they do is they call on Haystack. And then we're going to have roughly half of our oncology health system, general commercial sales force focus on Haystack. So 50% of their time is going to be Haystack. So between those 2, I think we're going to have about close to 60 FTEs focused on Haystack. Yes, we're not going to be at 150. That's not what we're aiming for. But I think with the focus that we will offer it with the FTEs that we have, with the evidence generation that we're looking to undertake with the broad reach that Quest has within the oncology space, and with the very, very attractive profile of the test with its low limits of detection, which we think are best in class right now, we're confident that we can succeed.

And how about for evidence generation beyond colorectal, how do we think about additional indications?

Yes. I mean we're focusing on a number of cancer indications. I think head and neck, breast, there's other types eventually lung as well. So all of those were going to be working, partnering with academic medical centers, oncology thought leaders, different thought leaders in this space to come up with more evidence on that front. So more to come.

I guess just rounding it out on oncology and then we'll hit on Alzheimer's. But how do you think about multicancer, that opportunity set, both in terms of partnering and going at it on your own?

Yes. I mean, I'd say right now, more our focus is in terms of standing up our own test is, I would say, early cancer screening with colorectal or with specific types of cancer. So when it comes to pan cancer, we're happy to partner right now as we are with GRAIL, but no specific focus to stand up our own test today.

And do you think that market goes pan cancer or will be narrower panels? How do you think about how broad you'll go?

Hard to say right now. I mean, listen, GRAIL has a really good test. Galleri has very, in my opinion, attractive sensitivity and specificity. But the reimbursement path is going to be challenging. So I think the more immediate appealing path for us is specific types of cancer.

Maybe just shifting over to Alzheimer's blood-based testing growing, I think, high double digits. You've talked about that doubling year-over-year. Just talk about adoption barriers, how confident are you that blood becomes a leading modality for treatment determination?

Yes. I mean listen, it's growing really fast, and it's -- the uptake has been exceeding our expectations in terms of blood-based testing for early onset dementia and Alzheimer's. I think obviously, the catalyst for some of that has been the availability of therapies. When you, as either a patient or a provider know that there's an option to slow down the progression of the disease, if you're somebody that's either presenting with symptoms or you have high-risk factors, getting them on an early screening blood-based test, which is way less expensive than imaging and a PET scan, way less invasive than CSF. I think is a really -- has really appealing -- has a very strong appeal and a lot of promise. So we're seeing the uptake really rise fast. I mean AD-Detect portfolio includes different tests with different analytes. We have 1 test that measures amyloid beta 42/40 and the higher the ratio, the lower the odds that you have or the lower the risk that you have early onset dementia. There's p-tau217, 181. And the reimbursement is attractive because the reimbursement is measured per analyte. So it's over $120 per analyte and you can get -- if you get a test that basically looks at 3 analytes, you can get a test that's being reimbursed at over $350. In terms of barriers, I mean, I'd say right now, it's not right now the guideline to say, based on a blood-based test, you're going to put a patient on therapy. Usually, a lot of providers, what they'll do is they'll default. If they get a positive test, they'll default to imaging and then put a patient on therapy. But if you're doing broad-based screening, it does save a lot of money and also, it's way easier to just do screening based on a blood-based test. If the answer is negative, then you as a patient can rest assured that maybe that you don't have Alzheimer's or you don't have early onset. But if the test is positive, then you'll default to an imaging test. So I think we'd like to see the guidelines continue to evolve where you can reflex from a blood-based test directly to therapy, but we're not quite there yet.

And I guess, can you talk to the strategy of having AD-Detect and then the Fujirebio partnership that you signed? And how does that work having different 2 different tests?

Yes. I mean the AD-Detect, again, with different types of AD-Detect depending on the analytes is an LDT, and that's the test that's widely used. The other test that we stood up with as a partnership is an FDA-approved test. So in cases where you need an FDA-approved test, that's the option that we could provide. But really, the main test that we're focused on is the LDT test.

And long term, do you get a sense that imaging is still going to be a big part of the market? Or how do you think about that evolving?

I mean hard to tell. I think it's going to be a while before imaging is not the go-to when you have a positive test, I think that's still the guideline right now. And I think physicians still feel that, that's the -- probably the better option is to go to imaging. But over time, as I said earlier, we hope that given the high sensitivity, the reliability and the high predictive power of some of these blood-based tests, we hope that, that's going to be sufficient to go to therapy from that.

Maybe we could just shift to the base business then. Utilization you've seen accelerating organic growth. You've kind of said we're beyond the post-COVID catch-up testing dynamic. But maybe just talk about the structural shift you're seeing in underlying utilization.

Yes. I mean utilization has been stronger than expected over the last number of quarters. I think coming out of COVID early '23 or so. We thought that there is some catch-up demand, catch-up utilization. If I was in a room like this and I asked for a show of hands as to who had done a physical in the last 2 years, I would probably have gotten just maybe in the single digits or low single digits of hand saying they have. And a lot of people had not done because they had basically just during the course of COVID, maybe had not done their physicals or not kept current on their testing. I think we're past that now. I think most people have gotten the catch-up care they need, having maybe left that behind during COVID. And I think what we're seeing is structural. We're seeing more structural demand and more structurally higher utilization. Now not -- we're not talking like 2 or 3 percentage points higher, but I do think we are seeing structurally higher utilization. Now what's driving that? Number 1 for us, and I don't want to gloss over this, but we are seeing a share shift that we are capturing in the market. We've done a lot of acquisitions in the physician outreach space buying up these physicians -- affiliated physician businesses that hospitals have and move them to Quest. So as opposed to these hospitals that have affiliated physicians getting the patients from these physicians, doing their testing in their hospital labs, what we're seeing is with the acquisition of these businesses is now we're doing the testing for them. So that's caused the higher utilization and definitely as a positive share shift for us. Other things, I mean, in addition to the usual stuff like a sicker, aging population. We're not getting any healthier, so that's driving utilization. I do think evolution of guidelines is favoring more testing, favoring more advanced diagnostics testing. So we are seeing more nonroutine advanced diagnostics testing. Listen, we talked about at length just now about AD-Detect and some of the blood-based screening. So this focus on early screening, whether it's cancer, whether it's Alzheimer's early screening is also driving more testing in general. Things that weren't available 2, 3 years ago. Therapies, availability of therapy is definitely driving more testing. So you put all those together, we are seeing a step up in utilization.

You talked about M&A being kind of part of the market share shift. Talk a little bit about that opportunity set going forward. Do you see this pace continuing? Or multiples changing? How do you think about M&A?

I do see it continuing. I mean we've called out in our long-term projections that we would expect to continue to drive 1% to 2% of top line growth from M&A. That equates to a deployment every year of about $0.5 billion of capital. Could we do more? Absolutely. If the conditions favor us doing more in the sense that there's attractive M&A that meets our criteria. Our criteria are simple. We look for EPS accretive M&A by year 1, and we look for a return on invested capital of 10% by year 3. If we find opportunities that meet those criteria, we'll do even more. But the baseline assumption is 1% to 2% revenue growth from M&A over the long term. We are definitely seeing those opportunities and a healthy pipeline. Our main focus is these hospital outreach acquisitions. That's our #1 priority because they're easy to integrate. They generate a 35% to 40% contribution margin after a few months of integration, so they're very profitable. Our #2 priority is independent labs. We did a large independent lab acquisition last year, which was in Canada. We bought the biggest lab in Canada called LifeLabs. We'll do more of that in the U.S., not necessarily broad international expansion, but we'll continue to do those independent lab acquisitions whether it's in the U.S. or any other opportunities that we find that are appealing. And then any other acquisitions that are capability building, although those are fewer and further between. And again, they need to meet our criteria. I think, Tycho, the 1 last thing I'd say about it is in terms of the availability of those targets. Hospitals are under a lot of pressure, as you know, I don't need to tell you this, but whether it's Medicaid challenges, whether it's reimbursement challenges, whether it's coming out of COVID and labor availability and specialized labor access, wage inflation, so they need our help. And more and more, they are deprioritizing the less strategic parts of their business, hence labs and focusing more on the more strategic parts like procedures, cardiovascular clinic or cath lab, other things that really make them more money. And so we are the beneficiary of that because they tend to look at us as either a lab insourcing provider or an acquirer of some of their outreach books of business.

And since you mentioned, how would you score the LifeLabs acquisitions growing mid-single digit. I think you just changed the reporting structure there, talk to that and then also the margin levers for that business going forward?

It's going really well. I mean just very briefly to kind of, again, remind you of why we did that acquisition, really large independent lab in Canada. It's the #1 player in the markets in the provinces that it plays in Ontario, British Columbia, Saskatchewan, which is a smaller market. Very stable payer, the provincial governments are the main payers. We usually see low single-digit price increases with -- when we renew those contracts with the payers and aging population of the G7 countries, I think, Canada is 1 of the faster-growing and also aging populations. So really good appeal economically and really good scale for that lab in Canada. And so it's been doing really well. It's exceeding the expectations that we have in the deal model when we first acquired it. We said it's going to be at our margin levels at some point over the next few years. I think it's exceeding those expectations. And one last thing I'll say about it is another part which is really appealing about LifeLabs is the potential for growth initiatives that are not funded by the government, but really patient-funded or patient paid. So physician-initiated testing that the patient directly pays for other growth initiatives in Canada that the government needs because they need somebody else to start footing the bill, so to speak. The governments are, as all governments are, are strapped for cash. And we're seeing good progress on those growth initiatives as well. So I think there's a potential to also grow other smaller things into bigger opportunities down the road.

Okay. I made it this far without asking about PAMA, but I'm going to ask about PAMA. And you've now got the recently submitted RESULTS Act. So maybe just talk about your opinion on the likelihood of a cut next year, it's a perennial overhang, obviously, and then different paths for how CBO scoring might shake out?

Yes. So PAMA, just a reminder for everyone, it's kind of what's the law right now, which is this protecting access to Medicare Act, which was based on 2017 data that frankly, was flawed data, because it was only data representative of 1 part of the sample population, which was the independent labs. When that data was compiled the health systems never even submitted pricing data. Since then, it's been delayed 5 years in a row. So '21 all the way to this year, PAMA has been delayed every year. There's an expectation that it could be delayed again next. That's a possibility. If it doesn't, then PAMA is back in effect starting in 2026. We have, to your point, submitted this with the help of ACLA, which is the industry body, proposed this RESULTS Act legislation. If this goes through, and we can talk a little bit about whether -- what are the odds of it going through. But if this goes through, it basically freezes the pricing that's in place today for the next 3 years. So there would be no other price changes until at least 2029. There would be another data collection process that gets done by a third party that's an independent third party. There's a company that's been proposed called FAIR Health. That would be a much more representative dataset that's collected that represents all of the pricing from the different providers, not just the independent labs. And when that 2029 pricing change takes effect, it could either be a price increase for us or it could be a price decrease, depending on the data. But if it's a price decrease, the RESULTS Act caps the price reduction to no more than 5%. So we think it's a very positive potential legislation. Now you need both sides of the house. There is bipartisan support, by the way. Bipartisan -- I mean both sides of the house have said PAMA's is flawed, something needs to change. But it's the will and the actual execution are two different things. I mean I know we have challenges right now in Congress. So can we get something passed? That's the big question. And it needs to be passed as part of a broader legislation. It's not going to happen just as one specific act. So that's where we are. I mean, the odds, hard to tell. Honestly, Tycho, I can't handicap it right now. I think there's a chance that it gets delayed 1 more year that meaning PAMA. There's a chance it comes back. There's a chance that the RESULTS Acts passes -- it's a bit of a tough one. It's not going to be easy to get the results active pass. CBO scoring, we don't have CBO scoring of the RESULTS Act yet. So I think that's the next step, which is the CBO has to score what is the benefit or cost of a PAMA delay? What's the benefit or cost of the RESULTS Act passing. So we're awaiting that.

Maybe just in the closing 1.5 minutes here. If you could just touch on pricing, revenue per requisition continues to move in the right direction. Just talk a little bit about how you're thinking about the pricing environment?

Yes. That's another part of our business that's really been a positive catalyst. I think, it's the revenue per requisition which is driven by 3 or 4 key things that drive it. Number 1 test per req. If you look back to pre-COVID, the number of tests per req were somewhere in the high 3s, 3.8, 3.9. Today, the number of test per req that we're seeing. So every requisition that a physician orders is now somewhere in the 4.2, 4.3. So almost half a test more, which goes back to your question about utilization, what are the things driving it? Well, part of it is the availability of more tests, et cetera, which is creating a more dense req. Number 2 is payer mix. We're seeing more mix of Medicare business, Medicare Advantage business. Medicare is our highest reimbursement, it's our highest priced tests. So as we see more Medicare business driven by aging population, et cetera, it's helping our payer mix as well. Number 3 is test mix. We're seeing more advanced diagnostics, high-growth tests that are more high-value tests that are also helping in terms of revenue growth. And number 4 is pricing. Pricing pre-pandemic, setting aside PAMA, from the third-party payers, we were seeing usually a price erosion every year. And now our pricing has stabilized. We've been able to work on value-based incentives with the payers, which are helping us to stabilize our pricing. So I think we're definitely seeing a benefit in terms of more price stability with the third-party payers as well.

Maybe I know we're out of time. One last 1 before we wrap just Medicaid risk with Big Beautiful Bill. I know that's a little bit further out, but it's 8% of revenues. How do you think about that?

Yes. It's 8% of revenue. I mean, first of all, we don't think there'll be a material impact anywhere in the next 2 years, number one. I think these cuts will probably start to show up in '28 and beyond. I think what's been estimated is that 10% of Medicaid participants could eventually lose coverage, but that's over the next 10 years. So there's a glide path. The impact is not that material for us, frankly, Tycho. I mean we've estimated if the exchange subsidies don't renew. And if Medicaid cuts take place as we see them today and the One Big Beautiful Bill that by 2028, it could be an impact of about 50 to 60 basis points on our revenue, so in 3 years. Frankly, it's a manageable impact. Listen, the last time there was Medicaid cuts which was in the redetermination coming out of COVID, 25 million people lost Medicaid coverage, but actually, we didn't see an impact on utilization. So there are some people that actually can opt for employer coverage, et cetera. There are other means for getting coverage. So not too concerned about it. We minimize it. It's a big issue, but not too concerned about it for Quest specifically.

Great. We got to wrap. Thanks, Sam. Thank you, Shawn.

All right.