Quest Diagnostics Incorporated (NYSE:DGX) Q3 2023 Earnings Call Transcript

Quest Diagnostics Incorporated (NYSE:DGX) Q3 2023 Earnings Call Transcript October 24, 2023

Quest Diagnostics Incorporated beats earnings expectations. Reported EPS is $2.22, expectations were $2.19.

Operator: Welcome to the Quest Diagnostics Third Quarter 2023 Conference Call. At the request of the company, this call is being recorded. The entire contents of the call, including the presentation and question-and-answer session that will follow, are the copyrighted property of Quest Diagnostics with all rights reserved. Any redistribution, retransmission or rebroadcast of this call in any form without the written consent of Quest Diagnostics is strictly prohibited. I would like to introduce Shawn Bevec, Vice President of Investor Relations for Quest Diagnostics. Go ahead, please.

Shawn Bevec: Thank you, and good morning. I’m joined by Jim Davis, our Chairman, Chief Executive Officer and President; and Sam Samad, our Chief Financial Officer. During this call, we may make forward-looking statements and will discuss non-GAAP measures. We provide a reconciliation of non-GAAP measures to comparable GAAP measures in the tables to our earnings press release. Actual results may differ materially from those projected. Risks and uncertainties that may affect Quest Diagnostics’ future results include, but are not limited to, those described in our most recent annual report on Form 10-K and subsequently filed quarterly reports on Form 10-Q and current reports on Form 8-K. For this call, references to reported EPS refer to reported diluted EPS and references to adjusted EPS refer to adjusted diluted EPS.

A doctor holding a clipboard talking to an elderly patient in a Medicare Advantage healthcare facility. Editorial photo for a financial news article. 8k. –ar 16:9

Any references to base business, testing, revenues or volumes refer to the performance of our business excluding COVID-19 testing. Growth rates associated with our long-term outlook projections, including total revenue growth, revenue growth from acquisitions, organic revenue growth and adjusted earnings growth are compound annual growth rates. Finally, revenue growth rates from acquisitions will be measured against our base business. Now here is Jim Davis.

Jim Davis: Thanks, Shawn, and good morning, everyone. We grew our base business nearly 5% in the third quarter, largely by driving growth in our physician and hospital channels. Our consumer channel also continued to produce solid base business revenue growth. In addition, we are pleased that we have now successfully completed negotiations for all our strategic health plan renewals that were scheduled for this year. These strength and collaborations will position us to build on growth opportunities going forward our Invigorate program is on track to deliver 3% annual productivity improvements and savings. In addition, the productivity of our base business improved sequentially and year-over-year. Given the strength of our business and a robust pipeline of professional lab services and M&A opportunities, we are well positioned for continued growth.

This morning, I’ll discuss highlights from the third quarter, then Sam will provide more details on our financial results and talk about our updated financial guidance for 2023. Now let’s turn to some of the highlights from the quarter. Our strategy is to drive growth by continuing to meet the evolving needs of our core customers, physicians, hospitals and consumers. We are enabling growth across our customer channels through advanced diagnostics with an intense focus on faster-growing clinical areas, including molecular genomics and oncology. In addition, acquisitions remain a key driver of our growth with an emphasis on accretive hospital outreach purchases as well as smaller independent labs. Finally, our strategy includes driving operational improvements across the business with strategic deployment of automation and AI to improve quality, efficiency and service.

Here are a few key updates on the progress we have made in these areas. In Physician Lab Services, we delivered mid-single-digit base business revenue growth driven by the strength in our cardiometabolic and general health and wellness testing. Our strong relationships with health plans were also a key driver in the quarter. As I mentioned earlier, we successfully completed negotiations for all our strategic health plan renewals that were scheduled for this year. Our success is a result of the clinical and economic value we deliver to health plans and their members. Today, more than 50% of the health of the health plan revenues are generated from these value-based contracts, which are fueling double-digit growth compared to our traditional health plan contracts.

Together with the health plans, we have a renewed focus on initiatives to reduce leakage to high-cost out-of-network labs. In addition, we are working together to redirect volume from high-cost labs to Quest. Importantly, this is good for both patients and employers which are paying for the majority of health care costs. In hospital lab services, base revenues grew high single digits in the quarter as we saw strength in hospital reference testing and continued progress with our most recent PLS relationships, including Northern Light Health, Lee Health and Tower Health. Our hospital strategy is to help health systems improve productivity and patient care by delivering innovative laboratory testing that is high quality, accessible and affordable.

We continue to manage a robust pipeline of professional lab services and hospital outreach acquisition opportunities. Health systems continue to face labor and cost pressures, which are prompting more of them to reach out to us for help with their lab strategy and in some cases, monetize their hospital outreach business. Our professional lab services can help manage hospitals labs, supply chain and workforce. We are also providing insights from our analytical solutions to guide hospitals to deliver the right test to the right patient at the right time. In addition, hospital outreach acquisitions enable health systems to focus their expertise and capital on the areas of their business that support patient care and drive growth. In Consumer Health, we generated solid base business revenue growth from our consumer-initiated testing channel in the quarter.

In addition, our consumer channel was again profitable this quarter. We attribute the strong performance to continuing demand for our expanded test menu, including STIs, comprehensive health and tuberculosis blood testing. Underpinning each of these key channels, physician, hospital and consumer is our advanced diagnostics. These highly innovative higher-growth test areas include molecular genomics and oncology as well as several other key areas. During the quarter, we grew revenues double digits in multiple clinical areas including neurology, women’s and reproductive health, cardiometabolic and infectious disease and immunology. We are particularly encouraged by growth in our Alzheimer’s disease portfolio, which features our AD-Detect blood testing services.

These innovative services use highly sensitive mass spectrometry technologies to provide insight into Alzheimer’s risk based on amyloid proteins and the APOE genetic risk marker. During the quarter, we saw strong demand for our Alzheimer’s cerebral spinal fluid panel as well, which helps providers identified levels of both amyloid and tau proteins as well as the APOE status. We also grew significantly in women’s and reproductive health, especially in non-invasive prenatal and carrier screening tests. During the quarter, the FDA granted breakthrough designation for our adeno-associated virus called AAV companion diagnostic, which we developed in collaboration with Sarepta Therapeutics for the Duchenne muscular dystrophy gene therapy. This FDA designation places us at the forefront of AAV test innovation in the growing area of cell and gene therapies and positions us to build collaborations with other biopharmaceutical companies.

Finally, the integration of Haystack Oncology remains on track. The acquisition positions us to enter the high-growth liquid biopsy area of minimal residual disease or MRD testing. We expect to launch our first MRD test in early 2024 from our Oncology Center of Excellence in Lewisville, Texas. Now turning to operational and productivity improvement. Our Invigorate program is well on its way to delivering our targeted 3% annual productivity improvements and savings. I’d like to share 3 examples of how we’re improving operations. First, we are deploying front-end automation to enhance specimen processing in our Pittsburgh and Dallas laboratories, which will improve quality and productivity. More sites are planned to receive front-end automation during 2024.

We are expanding the use of optical character recognition, or OCR, to scan in data from samples coming into our labs. By freeing up specimen processors from this manual data entry, we will improve our productivity of paper-based recs coming into all of our regional labs by 30%. Finally, we continue to optimize our real estate footprint. Post pandemic, we need less space for some of our call center and administrative functions. We’ve reduced our real estate footprint by nearly 250,000 square feet by consolidating functions into existing spaces. Before I hand it over to Sam, I’d like to offer our perspective on the rule recently proposed by the Food and Drug Administration that would regulate laboratory developed tests as medical devices. Lab developed tests are essential medical innovations that providers use to guide care for patients every day.

These services are highly regulated under federal legislation known as CLIA. In addition to the oversight by states, accredited bodies and Medicare as it makes coverage determinations. If enacted, the FDA’s proposed rule would impact patient care by compromising access, slowing diagnostic innovation and adding unnecessary cost to our health care system. We agree with the long-standing assertion of our trade association, ACLA, that the FDA does not have the statutory authority to unilaterally regulate LDTs under its existing medical device authority. Now I’ll turn it over to Sam to provide more details on our performance and our updated 2023 guidance.

Sam Samad: Quarter consolidated revenues were $2.3 billion, down 7.7% versus the prior year. Base business revenues grew 4.6% to $2.27 billion while COVID-19 testing revenues declined 92% to $26 million. Revenues for Diagnostic Information Services declined 7.9% compared to the prior year reflecting lower revenue from COVID-19 testing versus the third quarter of 2022, partially offset by growth in our base business. Total volume, measured by the number of requisitions, declined 0.5% versus the prior year, with acquisitions contributing 50 basis points to total volume. Total base testing volumes grew 5.7% versus the prior year. Revenue per requisition declined 7.2% versus the prior year, driven by lower COVID-19 molecular volume.

Base business revenue per rec declined 0.4% due to growth in our PLS relationships and lower demand for respiratory panels, partially offset by an increase in unit price reimbursement and test mix. Positive unit price reimbursement was consistent with our expectations. Reported operating income in the third quarter was $342 million or 14.9% of revenues compared to $392 million or 15.8% of revenues last year. On an adjusted basis, operating income was $380 million or 16.6% of revenues compared to $423 million or 17% of revenues last year. The year-over-year decline in adjusted operating income is related primarily to lower COVID-19 testing revenues, wage increases and higher benefit costs, partially offset by growth in the base business, lower performance-based compensation and headcount reductions.

We continue to closely manage the cost of our corporate and support functions and our actions to reduce support costs by approximately $100 million this year remain on track. Reported EPS was $1.96 in the quarter compared to $2.17 a year ago. Adjusted EPS was $2.22 compared to $2.36 last year. Cash from operations year-to-date was $745 million versus $1.38 billion in the prior year period. The decline in operating cash flow was primarily related to lower operating income and timing of collections. Turning to our updated full year 2023 guidance. Revenues are now expected to be between $9.19 billion and $9.24 billion. Base business revenues are expected to be between $8.99 billion and $9.04 billion. COVID-19 testing revenues are expected to be approximately $200 million.

Reported EPS narrowed to be in a range of $7.61 to $7.71 and adjusted EPS narrowed to a range of $8.65 to $8.75 with the midpoint of $8.70, unchanged. Cash from operations is expected to be approximately $1.3 billion and capital expenditures are expected to be approximately $400 million. With that, I will now turn it back to Jim.

Jim Davis: Thanks, Sam. To summarize, we delivered solid base business revenue growth of nearly 5% in the quarter. We successfully completed negotiations for all of our strategic health plan relationships that were scheduled for this year. We also drove improved productivity in our base business as we have done throughout 2023. Finally, given the strength of our base business, combined with a robust pipeline of professional lab services and M&A opportunities, we are well positioned for continued growth ahead. And now we’d be happy to take your questions. Operator?

See also 10 Most Effective Methods of Birth Control and Biggest Brands In This Space and 20 Highest CPM YouTube Niches in 2023.

Q&A Session

Operator: [Operator Instructions] Our first question comes from Ann Hynes with Mizuho Securities.

Ann Hynes : Can you just comment on progress on what’s happening with the turnover? And do you still feel good about your 16.5% margin goal for 2023?

Jim Davis: Yes, the employee turnover, again, improved from Q2 to Q3. So we’re certainly seeing improvements as we’ve marched from Q1 to Q2 to Q3 and expect to see more improvements as we go to Q4. Having said that, we’re still not back to 2019 or pre-COVID levels. But we feel optimistic that as we go into next year, it will actually be a continued tailwind for us. Sam, do you want to comment on…

Sam Samad: Yes, sure. Ann, thanks for the question. So as you recall on the Q2 call, we talked about operating margin expectations being approximately 16.5%. As Jim mentioned, we’re seeing slight improvements in terms of turnover. We have made some investments and are going to be making some investments in terms of frontline phlebotomist in anticipation of volumes coming into the winter season here, but also the strong utilization that we’ve seen. And with regards to margins, we now expect to be slightly below the approximately 16.5% for the year. We’re making really good progress on all the cost initiatives and also the productivity improvement initiatives. Volumes have been strong, but we — especially in light of volumes, we have to make some targeted investments in terms of frontline staff and phlebotomist.

Jim Davis: Yes. Ann, let me just make one other comment on the margins. If you go back and start with Q1 of this year. In Q1, we were just slightly north of 15% and in that quarter, we did $120 million of COVID revenue. And as you know, the reimbursement was still at $100 that quarter. We go to the second quarter, and we improved our margins up to 16.7%, with COVID going from $120 million down to $41 million. And then the second quarter COVID was at a blended rate of, call it, $75. Now we go back into the third quarter and COVID is really insignificant in our results. It’s only 1% of our total revenue and the reimbursement on that small 1%, as you know, for the whole quarter was at $50. And we hit 16.6%, so basically in line with Q2, so we’re really proud of the productivity efforts and it’s really coming through in these numbers and the progress that the teams have made from Q1 to Q2 to Q3.

Operator: And our next call is David Westenberg with Piper Sandler.

David Westenberg : So just — thank you for the commentary on the FDA’s proposal on LDTs. I’m not sure if you can answer it yet because, I mean, right now, it’s still kind of maybe a little bit more hypothetical here. But how should we anticipate potential cost if it stands the way it is. I mean, is this about going back to the FDA with some of the more high-value tests? Or is this maybe about switching out to maybe IVD-cleared products. I mean how does this look for Quest and I get some of this is maybe theoretical right now because we don’t know what it’s going to look like in a month.

Jim Davis: Yes. I think your last statement is accurate. It’s largely theoretical at this point because we don’t know what it’s going to look like. And the FDA certainly opened this up to commentary and response back from industry and ACLA and other associations. Look, having said all that, LDTs are not the most significant part of our operations. In fact, it’s — on a volume basis, it’s less than 10% of what we do. And the 3 labs that we do are LDTs, most — the majority of our LDTs in are actually ISO certified. We do companion diagnostics, which is a regulated form of testing, right? You’re on label for a pharmaceutical drug, so it’s just not — it’s not a huge deal for us right now. Now having said all that, we’re going to work with our trade association. We don’t believe the rule makes sense. We don’t believe it’s fair. And we’ll continue to work to arrive at something that we do think is good for everyone.

Operator: And our next question comes from Lisa Gill with JP Morgan.

Lisa Gill: I’m just curious if you have an update as to how we should think about PAMA or SALSA going into 2024 given the current environment in DC.

James Davis : Well, you’re right, the current environment is a little uncertain at this point. But here’s what I would say. The current standstill in Congress, I think we’ll make what we call a comprehensive PAMA reform more difficult, right? So SALSA, I think, will be more difficult to get through this year. Having said all that, PAMA, a delay in the cuts of PAMA, again, went to the CBO. So this is a new analysis from the CBO updated versus last year. And again, the CBO scored a 1-year delay as a significant cost savings to the government. And again, the reasons for that is because if you continue to delay the PAMA cuts, you’re going to continue to delay a new data collection process. And we, our trade association and obviously, the CBO is convinced that a new data collection process will lead to higher rates.

So we feel good that the likelihood of a fourth PAMA delay will occur. But certainly, it has to be part of some broader health care package. And there’s a lot of things that will be in that health care package that are important to a lot of different constituencies. So we’re confident that something will get done there.

Operator: Our next question comes from Pito Chickering with Deutsche Bank.

Kieran Ryan: You’ve got Kieran Ryan on for Pito. Just looking at the sequential margin progression implied from 3Q to 4Q this year. It looks like it’s materially better than kind of what you averaged in that pre-COVID 2017 — 2019 range. So is that just really the tailwinds you have around CIT Invigorate better turnover and lower deferred comp just combining to drive better trends than normal. And I was just wondering, is there any offset there on some of these oil and commodity-related costs that we’ve seen step-up relatively recently?

Sam Samad: Yeah, Kiran, this is Sam. Thanks for the question. So I think some of the drivers that you would expect in Q4 are, you know, what we’ve been executing and seeing in Q3 and earlier in the year. I mean, Jim talked about the sequential improvement in operating margins despite the fact that COVID is coming down significantly. So what we would expect in Q4 is the following that helps our margins, which has been playing out so far over the course of the year. One is price. We continue to see a healthy positive environment around price and we, in fact, saw positive price in Q3, and we expect to see positive price in Q4. And that’s driven by all the work that we’re doing around the strategic plan, the third-party plan renewals and some of the value-based contracting that we’re doing there.

So definitely, the healthiest pricing environment that we’ve seen in a while. CIT, as you said, is a factor. It was dilutive in the first quarter. It turned profitable in the second quarter. It was profitable in the third, and we expect it to be profitable again in the fourth. We continue to do the cost — I mean, we see the benefit of the cost reductions in Q4. We talked about $100 million of annual impact of cost reductions on the SG&A line, and we expect to see that at least 1/3 of that be in Q4 as well because those savings started in Q2 and then we’re taking a lot of actions as well around improving productivity. Invigorate is one of them that you mentioned, but that’s also factoring into margin. So all of that is driving the better than pre-pandemic trends that you’ve talked about.