Quest Diagnostics Incorporated (DGX) Earnings Call Transcript & Summary

Welcome to the Morgan Stanley Healthcare Conference. I'm Erin Wright, Healthcare Services analyst at Morgan Stanley. We're happy to have Quest Diagnostics with us today, the Chief Financial Officer, Sam Samad, thank you so much for coming for important important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. And with that, we'll get started with our fireside chat. So I think we'll start out with the most recent quarter, if that works. So you raised 2026 guidance again to, I think it was 8.3% to 9.2% growth on top of the on top of the first quarter trend. So can you talk a little bit about the key drivers in the first half strength that led you to the guidance increase in those broader tailwinds, headwinds that you're contemplating in your guidance range for the second half.

Thank you for having us. Domain Chuck, who's my -- who's our new Head of Investor Relations. So I don't know if you've met her. She came to us from Merck. Now it's been what, 2 months. So welcome. So let's talk about 2026 and the guidance increase and the take-up that we had. Listen, first, I'd say very strong start or first half of the year. I mean we're seeing some really broad-based strength across utilization across revenue per requisition. We have these new partnerships that we established towards the end of last year with Corewell Health, which is a large health system in Michigan as well as Fresenius around performing testing for their dialysis business testing for the dialysis business. All of those things are giving us lift. In addition to our consumer business, which is really performing also very well. so almost 30% growth year-on-year. So all of those things, I would say, have given us confidence about the year, especially the strong utilization environment that we're in, that I do believe, by the way, is durable. Now as we think about the remainder of the year, I'd say we expect that strength to continue. In the first half of the year, we didn't see any impact -- material impact from the health care exchanges, the subsidies expiration, we were expecting with the disenrollment for that to start to have a bearing on revenue and volume growth. We haven't really seen it. We have seen this enrollment, but not really materially felt that impact. We do expect that to be felt in the second half of the year, whether that's the right assumption to be determined, but that's what we have baked into guidance. And so that's really one thing that we expect to have an impact in the second half of the year, if you're looking at growth rates second half versus first half. There's always the uncertainties or variable items like weather -- so far, weather has been good. We haven't seen much in terms of hurricanes, but that always has an impact on our business in terms of disruption usually what we do see in the latter part of -- well, in the summer months, et cetera, as we do see some more weather activity, but we haven't felt it yet. So Those, I think, are the key ingredients. But I'd leave you with strong -- very strong first half and confidence about the year.

Okay. And so that deceleration in the second half that's implied in guidance that is largely attributable to kind of your assumptions around like and enrollment dynamics.

Yes, that's really most of the implant.

And an element of weather conservative.

Right, exactly. And then the other one is the lapping of those Corewell and Fresenius partnerships, which helps our margin rate but an impact on revenue growth because those started in October of last year, and we're going to lap them in October of this year.

Great. That brings me to my next question, which is on margins for the year. So you are anticipating are expecting full year operating margin expansion. What does that mean? And how do you think about that into the second half?

We are expecting operating margin expansion for 2026. So I'll repeat that. We talked about it on our Q2 call. We still expect it. We're making really good progress on margin rate post this whole kind of period post COVID, where we've been working very actively on improving our productivity in the lab, margin rates, et cetera, and we are expecting margin rates to be up in 2026. If you're looking at Q2, for instance, Q2, we had a 40 basis point reduction in operating margin rate versus same period last year. It had a few things in it, what I would call not necessarily just one-timers, but things that impacted it the over Fresenius mix impacted margin rates by about 30 basis points. That's -- those are profitable relationships, but they are at least at this stage of the partnership to operating margin rate. No of our expenses, which is our multiyear transformation of order to cash was about a 20 basis point impact -- and then you have this thing we call supplemental deferred compensation impact, which is a net neutral EPS impact, but it impacts operating margin rate because it's really based on market performance across our deferred compensation plan. As we think about the full year, Erin, here are some things that improve, especially as we look at the next 6 months for the same or the second half. For the same reasons that I mentioned about core and Fresenius lapping those partnerships will improve the margin rate because they are dilutive to our overall margin rate at this point. But as of October, we lap them, so they're not a dilutive impact anymore. And then the partnerships themselves, both Corewell and Fresenius we are improving the profitability. We have some initial expenses, initial integration costs, especially with Fresenius with core well as is typical with collab relationships in our business, they always start out less profitable. And as we go further, we start to improve the productivity of those relationships. So as we exit the year, Corewell be approaching double digits or at double digits in terms of -- when I say double digits, I'm referring to approximately 10% margin rate. And Fresenius is definitely improving in terms of margin as well. So not only do we lap them, but we also are improving the margin rates of those relationships.

Yes. I want to go back to kind of the organic trends that you're seeing -- you have 4% to 5%, for instance, long-term revenue CAGR in your guidance, that implies about organic growth of about 3%. Over the longer term, you've been tracking well ahead of that. What are some of those key drivers? I mean, even excluding some of the dynamics around whether it's Corewell or Fresenius, your underlying trends here are still relatively strong, like break down what's really driving that?

The underlying rates are very strong. You're right. I mean we've had underlying volume growth, excluding those 2 partnerships of about 4%. And we've had the revenue per requisition in Q2 approaching 3%. It was 2.9%, excluding those partnerships. And I'm talking -- the value growth that I mentioned was organic volume growth, excluding those partnerships. I think there are a few key things here that factor into it. When I think about our physician channel where we call on physicians and they order tests for their patients in the physician office -- expanding guidelines favoring early screening. And it's not just cancer screening. It's brain health, it's cardiometabolic screening. We're definitely seeing a shift from acute treatment care to preventive care. So we are seeing high single-digit growth or utilization on the physician channel. If I think about our health system business, in the co-op side, we've talked about Corewell that's definitely driving it. But we also continue to see good traction in terms of onboarding new relationships on the collab side. If I think about another key channel in our business, which is consumer we're seeing pretty significant growth in consumer. That business is now annualizing to close to $300 million, and it's growing at about 30%. And we think it can grow over the next 3 to 5 years by north of 20%. So that's another driver. So when you look at all of these things, I think a lot of it is driving -- the key factors are similar. People owning their health, owning help outcomes, shifting more focus to preventive care from treatment care, and that's really helping our business. And I do think there's durability to that.

What do you see now across your hospital customer base and we get the question a lot in terms of bad debt exposure. But there's also just a swirling narrative of a potential slowdown in broader medical utilization trends. Are you seeing that at all?

We're not really seeing it. We're seeing typical utilization rates from our health systems customers. So we operate in health systems across I would say, 2 categories. One is reference business, where health systems reference certain testing to us, which is usually advanced diagnostics nonroutine testing that they don't perform themselves in their own labs. And then the other portion is the Co-Lab business, where we basically perform a key service for health systems and we run their hospital lab, they're inpatient lab. It's kind of a really a partnership. On the retro side, I mean, that is a competitive business. We compete with other players who perform that testing service for health systems. We're seeing mid-single-digit growth in that business. And traditionally, we have seen that same type of growth, maybe low to mid is what traditionally we've seen. And we're seeing kind of mid-single-digit growth there. On the Co-Lab side, setting aside Corewell, which was a big partnership that we had this year, listen, hospitals, I will not dispute the fact that they are feeling the pinch. They are struggling. They're definitely -- I mean, some of the coverage issues, the health exchanges, subsidies impacting patients, then having to perform work for uninsured patients. That is impacting them, but we perform an essential service there. When we run the hospital lab on the Co-Lab side, for instance, we usually give them -- provide savings for them. We provide 10% to 15% savings to perform that service for them to run the lab. And so that helps them in terms of managing their own cost structure as well.

Yes. I think that's a good point in terms of labs being a solutions provider kind of for a strained healthcare system. But how much of is it the growth that you're seeing improved access, for instance, it's Elevanceor otherwise? Or is there any way to parse out, for instance, like underlying market share gains where you're going into some of these physician relationships and really seeing some of that halo effect and reaching that tipping point in terms of the volume going to the low-cost, high-quality kind of provider across this industry.

Yes. So first, I'll say, we're definitely seeing market share gains in our space for us. We're definitely gaining share in the market. Some of it has been gaining access in those 4 new states with Elevance, which happened at the beginning of 2025. And the way to think about that is in the first year, when you gain access in a new state, and in our case, we gained access in 4 new states, you -- that's the bulk of your market share gains is in that first year. You'll get some in the second year, which is this year, and then it will start trailing off. The impact I would sort of cap it at about 5 basis points in terms of growth, Erin, from gaining access in those new states and the ability to win new businesses because now you have full access with all payers. But in addition to that, we're gaining market share through -- I think you alluded to it, redirection efforts we make with -- we partner with the payers on figuring out how we can redirect volume from high-cost labs, meaning health systems to labs which are high-quality labs like us that perform the work at much lower cost. We also have made acquisitions over the last 2, 3 years, fish and outreach acquisitions in states where we have really good access, but let's say, lower capture. So Ohio where we acquired the physician outreach business of Ohiro Health and University Hospital in Mesota, where we acquired the physician outreach business of Alina Health, those have driven market share gains as well because today, they're part of our organic growth but they're helping us in terms of growing volumes.

And just you mentioned during the most recent quarter that the last 3 weeks of July were consistent with what you were seeing in the second quarter. I guess any update on that front? And then you mentioned at the beginning your HICS expectations into the second half. So is that actually playing out like you thought?

Yes. So I won't talk much about what we're seeing in Q3, but I will give you a sense as to broad-based what we are -- the trends that we have been seeing. I mean, structurally, no change in our commentary about utilization, durable, strong and continue to see elevated utilization as we exited Q2 into July. And we feel confident about the guidance that we've given this year. In terms of health exchanges, -- so here's what's happened with the health exchanges just to give some background to the audience here, and I'll talk about the second half. What we saw was over 20% disenrollment in the exchanges when the subsidies were moved after the dust was settled, roughly 21% disenrolled on the exchanges. The impact to us in Q2, what we saw was basically an 8% reduction in requisitions. However, a 6% increase in tests. So basically, test per req actually went up. So -- what we are seeing there is, frankly, what we saw in Q2 was relatively a neutral impact. So no impact for us as a negative from the the people have this enrolled. So what it's telling you is the people that remain are more acute, high-acuity patients that require more care and more health care and the people that disenrolled were ones that really were very low, in some cases, non utilizers of health care. So we saw no impact in the first half. We set 30 basis points for the year. We saw no impact in the first half. We still have kept the 30 basis point assumption for the full year, which, by default, obviously means 60 basis points for the second half I would say that's what's in the guidance, but we haven't seen that so far.

Okay. All right. That's helpful. This brings me to my next question, which is about kind of test per rack and driving much of the revenue per rec rather than necessarily unit price. So how do we think about the incremental margin on that mix benefit?

Yes. The margin is definitely significantly higher because when you see higher test per rec, you're not having to incur a proportion of your same cost, as you know, you know our business well. If you're doing forecast per rec if you're doing 6 tests per rec, going to incur more reagent costs, you're going to incur some more material or supply cost, but you're not going to incur in most cases, more labor cost -- you're not going to incur if you're performing a drawer in 1 of our patient service center, a higher cost because you're performing a draw on a 6 test per rec or 4 test per rec. The cost of the draw is still the same. So it's definitely a higher drop-through.

But not something you can quantify it.

I wouldn't give a number, but it's -- let's just say it's a good step-up from our usual 35% to 40% drop-through that we get.

That's fair. On PAMA, I want to switch gears to PAMA. How are you thinking about the next set of data your peer competitor was out there still somewhat pointing to that $100 million in terms of in terms of their impact, do you anticipate it being drastically different this time around?

I don't. I mean -- but there's a lot of still uncertainty around it. I don't think it will be more than the $100 million. I think there's a 15% cap in the way that they've communicated this. So I don't expect it to be more than the 15% at worst case -- but then again, we have to see what the data collection brings. There's uncertainty still as to who participated in the data collection. Obviously, the results of the data collection, I can tell you, we participated. We submitted well before deadline. We think that we will get clarity maybe by beginning of October is currently the prevailing thought. There's going to need to be CBO scoring of also that data collection to see what the impact is on CMS budgets. I don't think the pre-billing assumption, I would say for us is that if -- obviously, it will depend on the data collection, but it shouldn't differ materially from the $100 million is at least what we're expecting. Now as I said before, we would offset a portion of it. It's not going to be the majority of the $100 million, but we will definitely offset a portion of it. So it's not going to be $100 million drop to us. But again, I caveat $100 million by saying it really depends on the data collection and based on the number of labs that participated.

Right. Would 30% mitigation sound about right to you?