Quest Diagnostics Incorporated (DGX) Earnings Call Transcript & Summary

Going back briefly, we won't stick here the whole time, but I do want to keep hitting on this volume and your performance over the last several years. At the last IR Day, you highlighted -- you put up a map, you said 50 MSAs, you highlighted 14 where you were previously unexposed -- not unexposed, but underexposed low relative mix. And you were going to go after those. Is there an update on those 4 MSAs and how they've done?

I'll tell you with 3 of them, we went after, and it started with an acquisition of the outreach business. Our market share in Minneapolis, our market share in Cleveland, Ohio, our market share in Columbus, Ohio and the characteristics of those markets in Minneapolis, 3 very large health systems that own probably 80% to 85% of all the primary care docs. Cleveland, Ohio, dominated by 2 large health systems, university hospitals, Cleveland Clinic and Ohio -- Columbus, Ohio, largely driven by Ohio Health and then Ohio State health system. So we simply didn't have access. There's just not a lot of independent physicians in those markets. They're owned by the health systems. Health system physicians use health system laboratories. So we built relationships with 3 large health systems in each of those markets, and we purchased that book of business. And now we start to see growth rates well beyond what we purchased, okay? Because now we're in the market, you see Quest people, Quest logistics, Quest patient service centers, and we can grow the books of business from there. So those are ways you enter -- there are some geographies where it's structurally disadvantaged to the independent labs. And sometimes the only way in is to go and do a deal with a health system and then you grow it out from there.

I want to talk about your team, people -- a couple of people questions. So you had -- I would consider what I would say would be 2 larger changes or hires over the last several months, a new SVP, Chief Strategy and M&A Officer. Ben started in February. I know Dermot was retiring, but Ben has a bit of an interesting background, right? CDMO, some diagnostics, some specialty pharma. Obviously, great to get a health care guy, probably just a natural fit. But is there something more to read in terms of the nature of that hire what his background was in terms of how you're thinking about growing the company, the strategy, philosophy on what markets you're going after?

Yes, I wouldn't read too much into it. Ben was a seasoned strategy, M&A person. We loved -- he knew health care wasn't in our space per se on the service side. But he came from Danaher. Danaher, as you know, is a great company, very polished from an M&A standpoint, integration standpoint. I would even argue they bring lean processes to M&A transactions. So really, that's why we hired them. His experience, his strategy experience and a lot of respect for the work he did at Danaher.

And not -- you've already hit on this. So I don't want to beat a dead horse, but going back to that comment that M&A was a couple of hundred million versus a $1.5 billion target was a retirement and a transition part of being a little less? Or was it just, hey, we're so busy with Corewell and Fresenius and other things that...

It was more of the latter. Dermot is still with us in many ways as a consultant. So there's been a very smooth transition and no -- again, the funnel looks good. It's just -- some of these take time, and we're more discerning or very discerning.

And then on the Board, Tim Wentworth. So on one hand, interesting because your top competitor has probably 500 or 600 access points inside of the pharmacy that Tim most recently ran, but he also brings not only that retail and pharmacy experience, but also a deep insurance PBM background as well. What is Tim -- how is he helping you the most?

Yes. So first of all, we brought him on to the Board after he had completely left Walgreens. They broke the company up, as you know. We have a presence in CVS stores. Yes, nearest competitor more in Walgreens. I can tell you, though, while we value the presence in those settings, those settings are not what I would call the optimal settings to place patient service centers because you generally can -- they're small spaces, you can generally only have 2 draw rooms. And we prefer larger patient service centers where you have some scale. So we certainly didn't hire Tim to try to get us into Walgreens. He's just a genuine -- we like former CEOs that have been in health care. He's got great retail experience, great consumer experience. His payer experience is terrific. And Tim started out as an HR professional in his career, and that was a skill set that we wanted on the Board as well.

So on the 2 big partnerships, which are arguably getting -- one of them in particular, should be the next year should have a lot of margin enhancement in it. But talk about Corewell and Fresenius. Corewell entering into low single-digit margin, working up to low double digits. Fresenius starting out very strong. I think you've made some positive comments on where that is today. Any change in your outlook on time line to getting to those margin profiles? Any certain circumstances over the next year, opening the Michigan lab with Corewell? Does that cause any kind of a gyration in profitability even if it's a quarter or 2 phasing difference? Is there -- I know we're going to move on to the next deal eventually, but these are the ones in the moment...

So just to remind everyone, Corewell Health, very large health system in Michigan, 21 hospitals, adding about $250 million of revenue. So this year, we're just running the Corewell laboratories inside those 21 hospitals. Why is the margin rate low when you initially start these things? Because we have to, over time, bring Quest equipment with our preferred suppliers, Quest reagents, and that's how we bring them savings. That's how we accrue better margins is when we use the relationships that we have established from a supply base standpoint to bring the supply base savings. So you don't change out all the equipment overnight. That takes time. It's a 3-year pathway to do that. Next year, all the work from an outreach perspective that flows into those 21 laboratories will now flow into one central lab that we're building with Corewell is a joint venture in Southfield, Michigan. When you do that, you're taking a lot of work out of the hospital labs, moving into one central lab and you get scale economies, benefits from that. We put our Michigan book of business in there, the legacy Quest business, and now you have a substantial laboratory that is now going to compete for all other work in the state of Michigan. It will be the largest laboratory in the state, and we're damn proud to be partnered with Corewell, and we'll have a commercial team, logistics team. It will be like a stand-alone business. Fresenius, $100 million book of business. By the fourth quarter of this year, it will start to achieve the average margin rate in the company. It's been improving each quarter. And next year should be accretive to the average margin rate of the company.

Got a question from the audience on sticking with deals, partnership deals, which could include M&A, of course, but may just be coming in to help with management in those facilities. What are the largest challenges that the health systems are facing today? And how do you differentiate yourself when you're going after that business? How do you differentiate yourself versus your arguably one competitor that can compete everywhere, maybe a couple of others who could do some deals in some regions. But how do you differentiate? What is -- when a customer says, I want to outsource or I want to sell my outreach business, et cetera, how are you differentiating in that conversation?

Yes. So let me just first touch on the structural changes, some of the things that health systems. Look, their environment is obviously tougher because of the changes in Medicaid and the changes in the exchange plan. So to the extent these health systems are serving more of a Medicaid population have more exchange lives, it certainly creates a more difficult operating environment for that. Laboratory is one area. It's a substantial expense within a health system. And to the extent an independent lab can come in and bring our scale, our economies, our procurement synergies, we can generally save them 15% in terms of running their hospitals. Why are some of them in addition to us running the labs, some of them sell their outreach book of business, could be a couple of things. One, they come to the conclusion that they're really not making money on it, just probably getting paid higher rates, but still not making money on it. Two is they see the writing on the wall in terms of health plans starting to bring their rates down and not paying 200% of Medicare, 300% of Medicare. And three is sometimes they just need the capital, okay? They need the capital infusion. Having said that, New York Presby right here in town, they sold us their outreach book of business. And honestly, for them, it was more a judgment of where is their next dollar of capital best spent, neurosurgery, cardiology, oncology. And at the end of the day, the returns in these other areas were stronger. And they said, we don't need to be in the outreach business. So what differentiates us? Look, in some cases, it can be, honestly, location, proximity to a nearest central lab. Where you have -- where we have a large central lab in New Jersey, Hackensack Meridian has hospitals all around that. It makes moving that work from the hospitals into our core lab really, really simple. So proximity matters. Some of the other service elements can be around data, helping the health systems manage utilization, especially on the inpatient side. Remember, inpatient lab work, you don't get paid for it. It's part of the DRG. To the extent you can help physicians reduce the utilization of the lab work, it actually brings savings beyond just our supply cost savings. So we think we're very, very good at helping health systems manage utilization. We think our service levels are very good. We think our people's skills when we run our patient service centers, and we think our MyQuest application and the -- some of the AI things that we've added to that are differentiating.

I actually hate asking the PAMA question at the end of a great session, but I'll be left out of the room if I don't. So we're sitting here a few months away from having an answer one way or the other. There's still -- we can get a delay. Technically, we could get Results Act passed by the end of the year. I personally feel like that's going to be pretty tough. I want your perspective on that. But I think the other part, which is a bit different this year than the past is that CBO recently -- not only are we doing a new data run and we're waiting on those answers possibly in the next, who knows, 20 days or so, we could possibly be getting some answers, how many hospitals participated, et cetera. But what's different this year is that unlike prior delays that were implemented, almost effectively another version of Doc Fix that lasted forever, we had PAMA delayed 6 times here. CBO actually scored enacting or coming back to PAMA as a budget saver for '27 and beyond as opposed to a budget cost. So a lot of stuff to throw at you with 2.5 minutes left, but where do we sit on this? What is the real gut feeling on what's going to happen and when we're going to know -- actually have some better answers.

Yes. So there's a lot of balls in the air right now with respect to PAMA. The things that we do know is a data collection process was conducted. We have no idea how many labs reported. Remember, last time when the data collection process occurred in 2016, less than 1% of all eligible labs sent data in. We know we sent data in. We know our nearest competitor did and a few other labs. So it largely became a price profile established by less than 1% of all the labs. The data collection process has stopped. CMS has said end of September, early October, they would give a view of the data. We hope that they'll provide the number of labs that reported. I can tell you if it's anything less than 95%, 90% of all the labs, we're going to throw the challenge flag, and we're prepared to do that. Our trade association is prepared to do that because it's a volume-weighted median calculation. So to the extent that you're throwing out a lot of hospital labs that we know are priced at 200% to 300% of Medicare, it simply won't be fair, okay? And so we're prepared -- we'll see what comes back, but we're going to be prepared. At the same time, we are pushing hard and furious for the Results Act. We think it is a fair approach. We think it's the right way to collect the data. It simplifies the data collection process, and it will provide a more accurate view of market-based pricing. We've got 130 cosponsors. It's bipartisan. Now the problem, Congress basically leaves town at the end of this week. They go back, they campaign. They come back into session post-election in November. So a lot to get done between that date and the end of the year. I do believe there'll be some type of health care package. In the past, delays have been part of that health care package. We're going to push hard to get results as part of that package. It's gone through energy and House Energy and Commerce. They had a hearing on it. It was a very positive hearing. The bill sits in Senate Finance. It sits in the other House Ways and Means. They have a view of that as well. And so we're going to continue to push hard. Congress doesn't want to have to keep dealing with the structural flaws that are part of PAMA today. They would like a long-term fix just like we would. I can't give you a probability on what will happen here. I don't think a delay is the highest probability.

All right. We've just hit time, but I have to squeeze this in. Your competitor had an Investor Day a week ago. They came out and said, we really don't know, but $100 million, give or take, is our best guess on where we should start with a potential gross and net headwind, pretax headwind. And we would hope to offset some of that if PAMA came into effect. Are you comfortable even putting a number out there when you don't know how many hospitals reported, you haven't seen the data yet.

Well, what we do know is there's a max cap of 15%. So worst-case scenario, it's about 8% of our revenue. And by the way, it has been falling, okay? I know it's always said 8%, but if you look at -- we don't give the decimal point. But I think we all know lives are shifting from Medicare into Medicare Advantage plans. When I came into the business, it was 65% Medicare, 35% Medicare Advantage. Today, it's less than 50% Medicare and more than 50% Medicare Advantage. So lives can -- that book of business has not grown substantially. It's grown a lot less than our normal business because lives are shifting. So the max exposure, if every test went down by 15%, I don't think that would happen. But if every single test went down by 15%, max exposure, 8% of $12 billion times 15%, you get something a little north of $100 million, okay? So -- but that's kind of the worst case sizing of it, and we're going to push hard for a fair and equitable solution.

Really appreciate your time today.

Yes. Thank you, Eric.

Thank you so much. Everyone, please join me in thanking Jim and great story here.