Quest Diagnostics Incorporated (DGX) Earnings Call Transcript
May 29, 2024
Earnings Call Speaker Segments
Great. Good morning, everyone. Thank you for joining us for this session of the Leerink Healthcare Crossroads Conference. I'm Mike Cherny, the health care tech and distribution analyst. Much more importantly, though, we have the team from Quest Diagnostics. Jim Davis, Chairman, CEO and President. I always make sure I like to get everyone's titles in there. Shawn Bevec, who heads up IR and was a long ago former colleague of mine, so this is always a fun reunion. So tell the story after Jim...
I guess maybe just to kick off, and I don't know if you have anything from a Reg FD perspective, but obviously, you're coming off a really strong performance in the last quarter after a continued building volumes basis. As you think about where you sit right now, maybe using 1Q as an example, how is that being viewed from -- I'll start volume first in terms of underpinning the dynamics versus your long-term guidance that you've laid out?
Well, the volume we saw in Q1 was very strong. Let's just go to the revenue growth rate. The base revenue growth, just under 6%. Do we expect that to continue in the long term? Probably not, okay? So we certainly saw, continued to see in the first quarter higher utilization trends, utilization trends reported by the health plans, in particular, with respect to the Medicare Advantage population, just put it all together, as you know, there are shifts between the 2. But if you just look at the 2 together, that book of business was the fastest growing in our portfolio. So will that continue at that rate? Probably not. Now it wasn't just there, though. The commercial book of business was strong. Medicaid, managed Medicaid was still strong. We did see growth in the exchange plans. So maybe there was a bit of shift from Medicaid, Managed Medicaid into some of these exchange plans, but it's unusual. It's the strongest growth we've seen since I've been in the company.
Not a bad problem to have and nor is anyone expecting that level of elevated growth. But I think...
And so we're not changing our long-term guidance, right, mid-single-digit revenue growth with some acquisition built into that. And on the EPS side, we said higher single digits.
And when you think about that volume dynamics, I like the fact that you broke it down by market base and seeing those pockets of growth across the board. How do you think, especially as we see growth like in the exchanges and continued expansion of Medicare Advantage that moving pieces and the ability to drive lower cost settings of care, which you offer from a testing perspective, does it start to resonate -- this kind of a dumb question, but start resonating more and more in the market given that there are so many other cost overruns from [indiscernible] perspective, where it's almost like a encouraged level without having a preferred or forced dynamic...
Yes. So for straight Medicare, there's no difference in pricing. Medicare pays everybody the same rate. And we actually think that's a very prudent policy that the health plans should continue to move towards. When it comes to Medicare Advantage, what we get paid, us and our nearest competitor, is dramatically different than what health systems are getting paid, okay, along with our commercial book of business. Now I'll shout from every mountain top in this country that if your work is going into a hospital lab, you are paying significantly higher out-of-pocket expenses and your employer, that's covering your health care expenses, is paying 200% to 300% of Medicare rates. What we get paid by the commercial plans, as you know, is a number that has a decimal point in front of the Medicare rate, okay, 0-point something, okay? And so it is one of the biggest inconsistencies in health care today that ends up costing patients a lot more money, ends up costing employers a lot more money. And we'll continue to preach that gospel. And some of the commercial players -- commercial payers are starting to make some changes with that.
And I want to come back to the commercial pricing side, but I've never understood this philosophically. Hospitals, the vast majority of hospitals that you're competing with, lab is not a core solution for them. It's something they do when they need to. But there's still so many other things going outside the hospital that the efficiency created by you and your closest peer on the independent side is just so much stronger. And so as you think about that, you talked about you'll shout as loud as possible, what do you think are the pivot points that continue to evolve that further and further role of independent market where you have a large market share, but there's still a small fraction of the overall testing market?
Yes. So health systems in general today, let's just talk about the outreach business, right? Forget about patients in the hospital side, okay? On the outreach side, health systems today still control 35%, 40% of the outreach market, okay? Meaning doctors outside of the hospital are sending work into the hospital. My brother-in-law is an OB/GYN who works for a major health system on the East Coast, okay? He sends all his work into the hospital because that's what his employer basically tells him to do. So now I think some of the more progressive, smarter health systems are waking up saying, "Do we really need to be in this outreach book of business?" They have a hospital lab, they need that lab to treat inpatient patients as well as people that come into the ED. But do they need to try to run it as a for-profit entity? I actually think when the CFOs of these health systems look at that book of business, probably isn't generating a lot of profit. Second is when you start to think about the rising cost of capital and you think about the investment needs and the core capabilities of a health system, this is what NewYork-Presbyterian did. NewYork-Presbyterian decided to get out of the outreach business. Why? They weren't making money on it, okay? But when you look at what are their core competencies, neurology, cardiology, women's health care and the investment requirements to stay competitive in their market, it just -- lab was not one of the top 5 investment priorities, okay? So they sold that book of business to us. And I think the more progressive hospitals are coming to that conclusion, especially knowing that this 200% to 300% premium that they're getting eventually is going to come down, okay? Market irrationalities, inconsistencies do have a way of working themselves out over time.
And that's a great example. And again, I will come back to commercial pricing, but the dynamics of the hospital outreach and acquisition market, I know an organization can only go as fast as the resource like you don't want 10% of the markets all come to you tomorrow and say, "Hey, we're for sale, buy us" because that has no other constraints. But as you think about the pace of the hospital outreach acquisitions that you've been doing, is the pace that you've been comfortable with? Is there a potential for acceleration? And I guess to that point, you mentioned NewYork-Presbyterian as one example, but what tends to be that decision point? Is it inbound on your part or outbound from them that allows these acquisitions taking place?
Well, I think from a strategic standpoint, we look at the markets around the country where we have great access from a payer standpoint, but very, very low market share, okay? And generally, these are going to be markets -- I'll give you one, Milwaukee, Wisconsin, my hometown. Very, very few independent doctors left there. Most of the physicians in that marketplace work for the Aurora. Now Aurora advocate in the merger with the North Carolina company or they work for [ Freighter ] or they work for one of the Ascension hospitals, okay? So our only way to break into that market is to do an outreach deal with one of those systems, okay? So strategically, we look around the country, and we've picked 4 or 5 markets where we think they're right for some type of transition. And we've got active -- a very healthy funnel, and I think you'll hear more from us this year. But those are the types of markets. We look for markets with great payer access, so we're in network with all the plans, and we have very low share because there's very few independent physicians left. So our only way into those markets is generally to try to partner with one of those health systems.
Shifting back to pricing, and certainly we'll bounce across a lot of these things, but you talked about the dynamics of commercial pricing and payer recognition. And from my perspective, this, to me, qualitatively, but you're also seeing show up in your results, feels like as positive a pricing environment as I can recall seeing in my various different years tracking following lab space. And so we're long past the days of exclusive payer relationships for the most part. How do you think about that strategic discussions that you're having every time now that you go into a pricing and negotiation contract recycling process with especially some of the large national commercial payers? And what are the push and pull that they're looking for to make sure that both sides get the best value possible?
Yes. So it starts with a discussion of, in any given marketplace, we try to point out, again, you're paying us some percentage of Medicare and you're paying these health systems 200% to 300% of Medicare. They then come to us and say, what can you do to help us redirect those requisitions from these high-priced institutions to us? And we have partnerships with all the payers that do that. Now having said that, if they want us to provide a great patient experience that we need to keep investing in the business. So cutting our rates is not going to be -- is not the recipe to us providing a great customer experience. So those patients actually come to us and don't go into the health system for the routine lab work. So it starts with that. It starts with a discussion of, here's the other rates in the marketplace, here's what you're paying us. We obviously have had very thoughtful discussions around rising labor costs and inflation in our business. This was a business that from 2013 to 2019 had, on average, a 2% salary, wages and benefit increase every year. We're able to offset that. But during the COVID period, it was touching 4% and 5% in some of those years. And this year, we've guided, we've said 3% to 4% wage inflation, wage benefit inflation, but it's still significantly higher than it was. So it's a combination of those things, right? They want to continue to invest in us to keep the requisition volume coming to our labs because, again, good for the patient, good for the employer, and good for them, where they're taking risk as well, right?
And along those lines, thinking about the wage dynamics, how is that spread across your business? How much of it is you, have a ton of science. I think that's one of the other things that maybe gets overlooked at times. It's just the sheer magnitude of PhDs you have on staff. So the bottom of staff, you have the people that work in labs. How is that spread out in terms of where you're seeing the areas of wage inflation? And how much of it is, I guess, excuse me, like replaceable versus people where the wage inflation is there because you need that scientific rigor and expertise within the organization?
Yes. So let's divide it into 2. I would say most of the wage inflation we saw from 2019 to 2023 was actually in these front-line positions. And I think, in general, in the country, it was folks phlebotomy, logistics, or specimen processing, but it was also retail workers. It was people working in fast food. It was people working in grocery stores and hotels. That's where the majority of the wage inflation was occurring in the country, and it was no different than us. We have actually very good stability on the very technical side of what we do, pathologists, MD PhDs, people that are developing some of our tests. More often than that, the things they kind of value is working from home. And so we've had very little turnover there. It's been in those other frontline roles you've seen less of the turnover.
And I guess that's a good segue to think about the more high technology side of your business. You talked about the pathologists or the MD PhD side. I think about it relative to the continued advancement of your esoteric testing portfolio, your specialty platforms. Maybe give us a kind of current state of the union on where you see your oncology franchise, some of your other franchises on the testing side? And how much of it is from consumer demand versus technological advancements, i.e., the ability to test for some of these conditions that didn't exist 3, 5 years ago?
Yes. So I think there's 3 that we would point out. First, in the cardiovascular space. If you guys -- if you go to your physicians, and the only thing they're ordering for you is a cholesterol panel of LDL and HDL, you're really missing -- you're probably going to the wrong primary care physician, okay? There's a lot of people that have very standard normal LDL levels and are dropping dead every day, okay? Why? Because it could be the nature, the characterization of those LDLs, the particle side, it could be inflammation within the coronaries that really contribute to this. So tests like Lp(a), test like MPO, tests like APOB are all becoming mainstay. And that's what's really -- we talked about this thing called rev per rack, right? There's price per test and then there's test per rack and test mix. So cardiovascular -- advanced cardiovascular testing is a really big growth area in Quest Diagnostics. On the brain health side, in particular, with Alzheimer's, 3 tests that are in our portfolio that 18 months ago were not in our portfolio. This AB-4240, which is looking at the early development of amyloid plaque on the brain, and then 2 very important protein markers, TAU-217, TAU-181 also in the portfolio, blood-based tests, right? These biomarkers were available in a CSF cerebral spinal taps, but painful, costly or patients were instantly put into a PET CT at $2,500 exam. So as these tests become more and more available and they are available, now it's about educating physicians, it's about establishing guidelines with both primary care and the neurology community, but all of that will continue to drive growth. And then on the cancer side, our MRD assay that came to us through our Haystack acquisition, we're in what we call our early experience program. We have 20 customers that are now sending us specimens on a daily, weekly basis. We'll continue to work out that workflow with those customers from order all the way to reporting, and we'll be in a position to launch that assay later this summer early this fall.
And along the Haystack side, at what point in time do you really get into the nitty gritty of the reimbursement discussions there and the pricing discussions? And how do you think about that versus other MRD tests there on the market? And the dynamics of potential for reference pricing versus the kind of working backwards and the proof point on appropriate reimbursement?
Yes. So I think there's a couple of things involved. One is to prove out that the assay is, at a minimum, equivalent to other assays in the market today. That should be no problem. Stay tuned. An important oncology conference coming up this weekend, okay? ASCO. Now once you have the medical evidence, how you pursue it first with one of the CMS organizations, whether it's MolDX whether it's Novitas we're thinking that through. We'll get through this early experience program, that will continue to generate enough evidence along with some of the publications that will be coming out. And then it's just a matter of approaching CMS through the organizations that actually pay for these tests and proving out the assets.
Yes, I've heard of ASCO. People show up. And then just sticking again, different type of technology, but broad-based technology discussion is the whole advancement of point of care diagnostics. There's always been this, is this an opportunity? Is this a threat? Like how do you see where we sit right now in terms of product availability, and what it means to the efficiency that will happen in your patient service centers and some of your on-site hospitals? And where the opportunities sit in terms of driving more value to your patients, and therefore, to Quest?
Yes. So there's a role for point-of-care tests today, right? On the respiratory side, there's a lot of good tests that right at the point of care that can help the clinician distinguish between Flu A, RSV, COVID and appropriately treat right at that point of care. Where we've seen some evolution is on the molecular side, so little point-of-care test that can do -- that are miniature PCRs, if you will. We saw a rise of those during COVID. One of them apparently is just going away. I think it's Q that...
I saw that, yes.
So is there potential use of these devices? Look, I think you always have to consider the cost of doing the test right at the point of care, the throughput that you can achieve and whether the test is going to be covered, okay? Now if you take -- there's some small devices out there that will do on-site STD testing, but they're certainly not going to have the throughput. Maybe these devices can do 1 test every 30 minutes, every 45 minutes. So if there's a patient that wants an STD test and wants to know the answer in 45 minutes, there's a market that's there for it. And are there people that are willing to pay a premium to know right then and there as opposed to finding out the next morning, it probably is. Now we can also deploy these point-of-care devices into our 2,100 patient service centers. So if we think there's an opportunity, we can buy the devices, we can deploy them in our patient service centers to take advantage of that. But generally, they're not going to be anywhere close from a cost position to what we can achieve in these large-scale laboratories that we operate. And I certainly doubt that the commercial payers are going to pay more for a point-of-care test unless there's some health care economic value that says treating that patient at noon today versus 9:00 tomorrow morning when we have the result back makes a substantial difference in the outcome of that patient's health.
Sticking on the more high science-y side, but maybe for the different pivot, the LDT rule that was released. I know there was a kind of bated breath waiting for figuring out what the rule will look like. And the read of it to me seems very advantageous to companies like yourselves that have broad-based scalability, the ability to prove out your tests. Obviously, a lot of work in New York in the past with -- in terms of regulatory environment. Now a few weeks past the release of the rule, where do you -- maybe give us an update where you see the various different puts and takes of the LDT rule and how it factors into your long-term evolution on lab developed tests?
Yes. So let me start with, look, I think it's unfortunate that the FDA took this unilateral position that we still believe, our trade association believes, goes well beyond the authority that Congress vested in the FDA. And agencies are only set up to do what Congress has authorized them to do, okay? So still great debate on that, and we'll see how that gets straightened out in the long run. Having said that, the rule is in place, and we're going to comply with the rule. Now today, as you know, we are regulated under what we call CLIA guidelines. CLIA guidelines is a very stringent set of regulations and guidelines that we operate our labs under. There is this thing we call 21 CFR Part 820 is focused both on the operations end, which CLIA has established today. There's really nothing we need to do differently on the operating of our laboratories. But 21 CFR spells out that it's different from CLIA is the upfront portion around the design and development of LDTs. Now we have rigorous processes in place today, but it's -- there's further things we will have to do in the design and development of our LDTs in terms of what we call design controls. And so we're starting down the pathway. We will comply. In addition, now, it's a 4-year time frame. There are certain things we have to have up and running within 12 months. One is called a complaint handling unit, which is just a -- we track our complaints today, but it's just a more systemic formal way of tracking complaints that come into the company. And once the complaints come in, you track the complaints, you open up caps, all the things we do today, but it's just a more formalized process for doing that and documenting and showing the FDA that you're doing those things.
Yes. And I probably should start with the fact that this seems like this is something that should have been addressed through legislation versus regulation. But sitting here with where we sit now, it does feel like this is not something that's meaningfully disruptive to the way that you would invest in lab developed test evolution from a cost perspective, from a capital perspective.
We believe we have very robust processes in place in the company today. When we develop LDTs, our validation processes, our verification processes, we think, are very robust. Having said that, there's a set of regulations. There's a set of documentation. There's formal approval processes that will be put in place. So if it's a de novo LDT or it's predicated on somebody else, there still has to be a formal submission to the FDA. That takes time, that takes money to do that. But that portion of the process won't officially kick off for 3-plus years.
Okay. And then sticking on regulations that kind of annoy all of us. It feels like every day, we're waiting to see if PAMA gets kicked down the road another year. Obviously, we have the SALSA framework in place that would solve a lot of these annual re-ups. As you think about the moving pieces here, how do you get -- when do you get visibility into the puts and takes on some of these pricing changes given that you still have to plan the organization for what could be a 1-year meaningful enough reset, but still something that would impact the overall organization?
Yes. So our trade association, I would say, 2 primary objectives this year. One is figuring out a path forward on our pricing with CMS. The second is obviously the FDA issue that you just talked about. I think the likelihood for another PAMA delay is very, very high. First, the telehealth bill just passed. They need a way to fund that. It's already been discussed that the funding mechanism to support telehealth could come from another 1-year push on PAMA. Why? Because the CBO recently scored preliminary scoring of north of $2 billion of savings if they delay the cuts one more year. Counterintuitive, but obviously, the delay in cuts means delay in a new data collection process. Everybody believes that, that new data collection process will show that Medicare is underpaying the commercial labs with respect to when you put it in the construct of the entire outreach book of business. So we would like a longer-term solution called SALSA. We continue to work that through both the House and Senate subcommittees that will ultimately hopefully come to a resolution. But our -- the likelihood of that getting done this year in a presidential election year is probably not that high, certainly less than 50%. So we think the likelihood of another PAMA cut is very high. Last year, we found out relatively early, right? I think it was...
In November.
In November, end of November, and that's ample time as you think about budgeting for 2025. Would we like to know by September? We sure would. It just makes planning for next year a lot easier.
Yes. Unfortunately, I don't think SALSA is part of anyone's campaign strategies this year.
I haven't heard it mentioned too many times.
In the last few minutes, I want to make sure we touched a little bit more on M&A. You touched on Haystack, which was most recent larger deal that you've done. You have a frequent pipeline of hospital outreach works, other targeted work. As you think about balancing a range of M&A with a strong cash flow generation profile, what are the puts and takes that goes into the balance of capability versus ROI versus dilution taking on? Because it's not a single we're only looking at purple widgets and find the best purple widgets for the best price. There's a lot more factors that go into how you've done -- mostly successfully done M&A. So in this current environment, how are you thinking about balancing all those pieces on the...
Still priority #1 is to grow our core business, existing capabilities and extend those capabilities. And as I mentioned on the hospital outreach, we're thoughtful and methodical about it. We look again at markets where we have low market share. When I say markets, these are -- you look at the biggest MSAs across the country. We look at where our share position is low and start having discussions with health systems in those markets. So the funnel of opportunities is certainly there. I think you'll hear more from us. We committed 1% to 2% of our growth will come through M&A, and we still feel good about that. So that is still priority #1. These tuck-in deals are good. They're accretive. The ROICs tend to be attractive. The 3 we've done most recently, NewYork-Presbyterian was just over a year ago. Lenco was a small regional lab in Brooklyn. The lab gets shut. All of that work just comes into our Clifton laboratory, so good economics there. And then, as you know, we just bought the pathology laboratory. It hasn't closed. It's announced. We'll close second week of June here. The pathology laboratory that PathAI ended up buying 2 years ago, right? PathAI is an AI-based digital pathology company that develops algorithms to look at digital images, go back 3 or 4 years, and they thought they needed to be in the laboratory business, right, doing real pathology work. They bought a lab in Memphis, Tennessee, and decided after 3 years, that's probably not what they need to be doing, okay? So those are regional tuck-in labs. Again, good ROICs, accretive in the first 12 months and always positive NPVs. Where there's gaps in our portfolio, we will address those. But in general, we've certainly looked to our own R&D capabilities first. And if we're convinced, like Haystack, right, we know Natera will likely do $550 million to $600 million of MRD sales this year. There is a market that is there right now, and we want to participate in that market. So this was our quickest and best way to execute to get into that market.
Got it. We're out of time. Jim, Sean, thank you so much for being here. Really appreciate it. Thanks, everyone.
Yes. Appreciate it. Thanks.
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