Quest Diagnostics Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
July 20, 2022

There are 14 speakers on the call.

Operator

Good morning.

Speaker 1

Welcome to the Quest Diagnostics Second Quarter 2022 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. Now I'd like to introduce Sean Bevec, Vice President of Investor Relations for Quest Diagnostics.

Speaker 1

Go ahead, please.

Speaker 2

Thank you and good morning. I'm joined by Steve Ruszkowski, our Chairman, Chief Executive Officer and President Jim Davis, CEO-elect Mark Guinan, Chief Financial Officer and Sam Samad, our incoming Chief Financial Officer. During this call, we may make forward looking statements and will provide 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.

Speaker 2

Risks and uncertainties, including the impact of the COVID-nineteen pandemic that may affect Quest Diagnostics' future results include, but are not limited to, Those described in our most recent annual report on Form 10 ks and subsequently filed quarterly reports on Form 10 Q and current reports on Form 8 ks. The company continues to believe that the impact of the COVID-nineteen pandemic on future operating results, cash flows and or its financial condition will be primarily driven by The pandemic severity and duration, healthcare insurer, government and client payer reimbursement for COVID-nineteen molecular test, The pandemic's impact on the U. S. Healthcare system and the U. S.

Speaker 2

Economy and the timing, scope and effectiveness of federal, state and local governmental responses to the pandemic, including the impact of vaccination efforts, which are drivers beyond the company's knowledge and control. Before this call, references to reported EPS refer to Refer to the performance of our business excluding COVID-nineteen 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 Steve Ruskowske.

Speaker 3

Thanks, Sean, and thanks, everyone, for joining us today. We performed well in the quarter, growing our base business year over year, while increasing our share of COVID-nineteen molecular testing since March. As we have said before, we believe demand for COVID-nineteen blood testing is not going away anytime soon It will continue into 2023. Based on our overall performance in the quarter And our expectations for the remainder of 2022, we have raised our full year guidance. We also made very good progress on our leadership transition.

Speaker 3

Jim will give you an update and take you through our Q2 highlights, And then Mark will take you through our financial performance in more detail before we get into your questions. But before I turn it over to Jim, I'd like to say a few words about the Saving Access to Laboratory Services Act, Now called SALSA, the important new federal laboratory legislation recently introduced in Congress as well as the U. S. Court of Appeals for the DC Circuit's recent ruling on our trade association's PAMA lawsuit. We're grateful for the efforts of Senate and House members who introduced this legislation on both sides of the aisle.

Speaker 3

In our view, Salsa could fix PAMA permanently, setting the Medicare clinical lab fee schedule back on a In 2014, the intent of Congress when passing PAMA was to reform the Medicare clinical lab fee schedule a single national fee schedule based on private payer rates for the clinical laboratory services. Unfortunately, the first round of data collection failed to collect the data from large significant segments of the marketplace. The result was billions of Medicare cuts over 3 years with more on their way if Salsa is not passed. Our trade association is coordinating congressional meetings along with public advocacy efforts that involves collaboration with the provider and patient communities. Last week, The DC Circuit Court issued a decision in the PAMA lawsuit filed in 2017 by our trade association, ACLA.

Speaker 3

In short, the court sided with the ACLA and called the CMS' exclusion of hospital price data quote arbitrary and capricious. Importantly, this Case has been rejected for procedural reasons and this is the first opinion based on its merits. Unfortunately, the court is not requiring CMS to recalculate the flawed payment amounts. While disappointing, We believe this favorable ruling will give Congress additional strong grounds to finally fix PAMA's many flaws by passing SAUSA. Now, I'd like to turn it over to Jim Davis.

Speaker 4

Thanks, Steve. Our base business performed well despite softer utilization trends, which we believe impacted us and the rest of the healthcare industry. I'm proud of the efforts our team has made to grow our share of COVID-nineteen testing since the end of the Q1. We also ramped our investments to further accelerate growth in the areas of advanced diagnostics and direct to consumer testing. In the quarter, we announced the selection of our next CFO, Sam Samad.

Speaker 4

Sam joins us from Illumina, where he served as Chief Financial Officer for 5 plus years. As many of you know, he brings a depth of healthcare experience Sam, welcome to Quest Diagnostics. Thanks, Jim.

Speaker 2

It's an honor to join the Quest Diagnostics team. In previous roles, I had the opportunity to observe the many contributions Quest is making to healthcare. Since arriving less than 2 weeks ago, I've been impressed by the passion and dedication of everyone that I've met so far. I'd like to thank Mark Guinan for his partnership during this transition. I'm excited to be here.

Speaker 2

Jim, I'll turn it back to you.

Speaker 4

Thanks, Sam, and I look forward to working very closely with you. Now turning to our performance in the second quarter. Total revenues were 2,500,000,000 Cash provided by operations was $402,000,000 COVID-nineteen testing revenues $355,000,000 in the 2nd quarter, down approximately 31% from 2021 and 41% from the previous quarter. In July, with the spread of the BA. 4 and BA.

Speaker 4

5 variants, we continue to see the demand for COVID-nineteen molecular Testing consistent with the volumes we reported in June. Our positivity rate has increased since March and approximately 25% of the Tests we performed in the 1st 2 weeks of July were positive. We believe that the COVID-nineteen trend since March contributed to the softness we observed in the broader healthcare utilization. As you've seen, we're successfully We are executing a strategy to increase our share of COVID-nineteen molecular testing. A key element of our strategy is to increase the number of testing In addition to our CVS and Walmart relationships, we are now also collecting specimens at Rite Aid locations And the number of access points will continue to grow.

Speaker 4

Approximately half of our COVID-nineteen volume in the quarter came from retail channels. Quest is proud to have been selected by the CDC to participate in its Increasing Community Access to Testing or iCAD program for COVID-nineteen testing. Through this program, qualified uninsured individuals can In addition, we're pleased to be the provider of COVID-nineteen PCR We now have approximately 6,000 COVID-nineteen patient access testing sites through retail relationships as well as our own patient service centers. Through these efforts, we estimate that we are performing approximately 8% of COVID-nineteen molecular testing in the U. S, up from approximately 4% in March.

Speaker 4

Finally, the public health emergency was extended into October, which will help us maintain our current level of reimbursement. Based on these factors, we raised our COVID-nineteen revenue guidance for full year 2022 between $1,150,000,000 $1,301,000,000 Now turning to our base business. In the Q2, we continued to make progress executing our 2 point strategy to accelerate growth and drive operational excellence. Here are some highlights from the quarter. Our M and A funnel remains strong.

Speaker 4

We are in late stage discussions with several hospital health systems on the purchase of their laboratory outreach business. This is in addition to our normal conversations we have with C suite leaders on performing reference testing and providing professional lab services. While this pandemic paused some of these discussions, it has also created opportunities because of the financial and labor pressures many hospital health systems are facing. We continue to accelerate growth through health plan access. Excluding COVID-nineteen, health plan volumes and revenues grew faster than our overall base business in the quarter.

Speaker 4

Health plans continue to see the value of working with us. Over the last 2 years, we have renewed 12 national and large regional health plan contracts We expect more renewals with price increases this year. And we're proud to be selected as one of the UnitedHealth Care's preferred lab network providers for the 4th consecutive year, providing physicians and patients with improved access, quality and value. Finally, we're pleased to share today that we have renewed our strategic relationship with Florida Blue. Florida continues to be an important large and growing state for us.

Speaker 4

Earlier this month, the CMS transparency and coverage final rules became effective to help consumers know the cost of a covered item or service before receiving care. Beginning July 1, 2022, Group health plans and issuers of group or individual health insurance are required to post pricing information for covered items and services. As more pricing transparency requirements will go into effect in the next 2 years, we believe that pricing transparency favors Quest Diagnostics, which powers affordable care. We do this by offering clinical innovation, enabling better clinical outcomes through our quality, Speed and accuracy of test results improving the patient experience with accessible and easy to use patient resources and finally, reducing the cost of care. We continue to ramp our investments in advanced diagnostics capabilities.

Speaker 4

In the quarter, we saw growth from hematology, prenatal genetics and pharma services. We also introduced Quest AD Detect, Finally, last week, we launched a lab developed molecular test to aid in the detection of monkeypox. The test can differentiate monkeypox from other orthopoxviruses and we will be able to perform nearly 30,000 tests a week by the end of July. In addition, we can expand testing to other laboratories in our network to further increase capacity if needed. We continue to see growth in direct to consumer testing, thanks to our COVID-nineteen offerings and more importantly, our base business testing.

Speaker 4

Within the base business testing category, we saw strong growth from testosterone, comprehensive metabolic panels and Lyme disease. We're excited about upcoming improved digital experience, which we expect to debut later this year. We believe this improved experience will help us acquire, convert and retain more customers who visited QuestDirect digital platform. We expect to have much more to say about our improved digital experience before the end of this year. The second part of our 2 point strategy is to drive operational excellence.

Speaker 4

We remain focused on improving our operational quality, service and cost, thereby driving productivity gains. We have several initiatives underway to make this happen, focused on attracting and retaining our people, optimizing our network, Automating and digitizing our processes and getting paid for the work we do. Here are three examples. One, we're partnering with universities to help build our pipeline of expertise in medical technology, cytology and histology. We're also teaming up with a learning and development recruiting company to provide phlebotomy certifications to prescreen candidates in exchange for a 2 year commitment to work at Quest.

Speaker 4

2, our Schedule a Check-in initiative, which encourages patients to make appointments, Has now expanded to 1,000 of our patient service sites. In one area, which has implemented the program, we are seeing a 20% decrease in average wait times as well as an improvement in patient satisfaction. We're also building the payment process into the digital customer experience, which frees up our phlebotomists to focus on specimen collection, thereby increasing their capacity and improving the patient employee experience. 3, we continue to implement digital technology to provide end to end specimen tracking, including the arrival patterns that enable load leveling We're not immune to the current inflationary environment and are managing through rising fuel and labor costs. Like many However, these increased costs are in line with our expectations and are built into our guidance.

Speaker 4

We are In 2021, we launched our 1st formal materiality assessment to help identify the most significant ESG topics to the company and our stakeholders. Also to enhance the level of our ESG disclosures, we began reporting in accordance to our 50,000 colleagues who are making that vision a reality every day. Now Mark will provide more details on our performance and share more insights and our updated guidance for the remainder of 2022.

Operator

Thanks, Jim. In the second quarter, consolidated revenues $2,450,000,000 down 3.8 percent versus the prior year. Base business revenues grew 2.9% to $2,100,000,000 while COVID-nineteen testing revenues declined approximately 31% to $355,000,000 Revenues for Diagnostic Information Services declined 3.6% compared to the prior year. The decline reflected lower revenue from COVID-nineteen testing services versus the Q2 of 2021, partially offset by growth in our base testing revenue. Total volume measured by the number of acquisitions declined 1.4% versus the prior year.

Operator

Acquisitions contributed approximately 100 basis points to total line. Total base testing volumes increased approximately 2% versus the prior year. Excluding acquisitions, Total base testing volumes grew less than 1%. As we have seen in prior COVID surges, we experienced some softening of base testing volumes Beginning in April, as COVID-nineteen cases began to rise again throughout the spring, COVID-nineteen testing volumes were Stronger than expected during the Q2. Together with our JV partnership, Sonora Quest, we resulted approximately 3,700,000 Quest alone resulted roughly 3,500,000 molecular tests, down approximately 1,300,000 tests and 2,800,000 tests versus the prior year and Q1 respectively.

Operator

Our July COVID-nineteen molecular Volumes have been consistent with the volumes we reported in June, averaging roughly 40,000 tests per day excluding Sonora Quest. Revenue per requisition declined 2.6% versus the prior year, driven primarily by lower COVID-nineteen molecular volume. Base business revenue per rec was up modestly. As we have highlighted in recent quarters, the pricing environment has improved With unit price reimbursement pressure of less than 50 basis points in the quarter, reported operating income in the Q2 was 388,000,000 or 15.8 percent of revenues compared to $533,000,000 or 20.9 percent of revenues last year. On an adjusted basis, operating income was $435,000,000 or 17.7 percent of revenues compared to $584,000,000 or 22.9 percent of revenues last year.

Operator

The year over year decline in adjusted operating income is primarily related to lower COVID-nineteen testing volume, A higher portion of COVID-nineteen molecular testing volume from nontraditional retail channels, which carry additional expenses and logistics costs, Investments to accelerate growth in our base business and slightly lower average reimbursement for COVID-nineteen molecular tests. In the quarter, Approximately half of our COVID-nineteen molecular volume came through our retail partners versus roughly a third last year. We expect the mix of COVID-nineteen molecular volumes through this channel to continue to grow in the 3rd quarter. Reported EPS was $1.96 in the quarter compared to $4.96 a year ago. Adjusted EPS was $2.36 compared to $3.18 last year.

Operator

Year to date cash provided by operations was $882,000,000 in 2022 versus $1,200,000,000 in the prior year period. Given the limited M and A activity, we repurchased $200,000,000 in stock during the Q2. Now turning to our updated guidance. Revenues are now expected to be between $9,500,000,000 $9,750,000,000 Base business revenues are expected to be between 8.35 $8,450,000,000 COVID-nineteen testing revenues are expected to be between $1,150,000,000 $1,300,000,000 Reported EPS expected to be in a range of $8.24 to $8.64 And adjusted EPS to be in a range of $9.55 to $9.95 Cash provided by operations is expected to be at least $1,700,000,000 and capital expenditures are expected to be approximately 400,000,000 Before concluding, I'll touch on some assumptions embedded in our updated 2022 guidance as well as some additional considerations. Our guidance assumes COVID-nineteen molecular volumes to average approximately 15,000 to 25,000 tests per day for the rest of the year.

Operator

As we look toward 2023, we continue to assume our COVID-nineteen molecular testing run rate In the second half of twenty twenty two continues into next year. Last week, the public health emergency was again extended another 90 days Through mid October, we assume average reimbursement for COVID-nineteen molecular testing to hold relatively steady through this period. While the public health emergency could be renewed beyond October, additional extensions are not captured in our guidance. As Jim noted earlier, we have successfully grown our share of COVID-nineteen molecular testing through our retail partners, which accounted for approximately 50% of our COVID-nineteen molecular volume in the Q2. As these retail partnerships continue to expand, We expect the mix through this channel to continue to grow throughout the remainder of the year.

Operator

We continue to incur incremental costs to serve this channel. As COVID-nineteen positivity rates remain in the double digits, our ability to pull specimens for COVID-nineteen molecular testing continues As a reminder, we are ramping investments to accelerate growth this year. We spent approximately $70,000,000 in the first half of the year and we expect these investments to continue to ramp in Q3 to support the launch of our new consumer site later this year. A portion of these stand up IT costs are temporary, but variable marketing costs will increase following the launch of the new site. We'll also be adding additional headcount this year to support our consumer offering as well as bioinformatics capabilities within Advanced Diagnostics.

Operator

I will now turn it back to Steve.

Speaker 3

Thanks, Mark. As many of you know, This will be Mark's last earnings call as he is retiring next week. Mark, you've been a key member of our leadership team as we have transformed Quest and accelerated its growth. I'm grateful for everything you've done for the company, Especially for the last two and a half years of the pandemic. I would miss your partnership and console as we Navigated many challenges over nearly a decade.

Speaker 3

I wish you and your family health and happiness As you approach the next chapter in your life. Thanks.

Operator

Thanks, Steve. Quest is a special place It has been an honor to serve as CFO for the last 9 years. Thanks to the analysts and investors on this call. I have enjoyed working with all of you. My family and I are excited for what lies ahead.

Speaker 3

Thanks, Mark. And to summarize, as Jim shared, we had another good quarter, Driven by our efforts to increase share of COVID-nineteen testing, while we believe our base business performed in line with The software utilization trends we're seeing in Healthcare. We have raised our full year guidance based on our performance in the quarter and our expectations for the remainder of 2022. Finally, we're grateful for the Senate and House members who introduced the Saving Access to Laboratory Services Act and fully support The passage of this important legislation. Now we'd be happy to take any of your questions.

Speaker 3

Operator?

Speaker 1

Thank you. We will now open it up to questions. At the request of the company, we ask that you please limit yourself to one question. Our first question comes from Brian Tanquilis with Jefferies. Your line is open.

Speaker 5

Hey, good morning guys. And Mark, congrats on the upcoming retirement and for all the help over the years.

Operator

So I

Speaker 5

guess just my question on the base business, I mean you called out some Softness, right? I mean, do you guys think that it's more COVID driven with the current mini surge that we're seeing? Or just any color you can share with us on that? And maybe, I guess, Steve, Taking it a little bit further, how are you thinking about the business today as we face a recession down the road in terms of the defensiveness the volumes and the business overall as we get past COVID? Thanks.

Speaker 3

Yes, sure. So thanks, Brian, for the question. So as we indicated, we We're a little softer in the Q2 where the base business than what we expected in the Q2. And we do believe there's a relationship, as we have said before, between pickup in COVID infections And the amount of people that are going into their physicians and to some extent what's happening with hospitals even though that's a Secondary slowdown, if at all. And the second part of your question is longer term With worries about a potential slowdown in our economy and approaching recession, What's our view on that?

Speaker 3

And we're taking a hard look at what happened over the last 10 to 15 years of our business. And Things did change quite a bit over the last decade, as you know. The first or the last recession, the big Great recession in 2008. We had, in parallel with that, the Affordable Care Act. We also had Changes with healthcare policy and we had PAMA, so there's a lot of other effects.

Speaker 3

And so, yes, we do believe there may be some impact in our business related to A slowdown in the economy and the recession. We do believe that we're so essential to the delivery of healthcare and the need for health Going forward, we believe that utilization will continue to be reasonable throughout any up and down In an economic cycle. So, but we're taking a look at it and we're seeing if there's any differences this time around. As you know, many people are saying this is an unusual set of circumstances, Given what's happened with healthcare and what's happened to the economy over the last 2 to 3 years. So Jim, anything you'd like to add to What we see with our base business?

Speaker 4

Yes. Steve, what I would add is, look, we're in close touch with the payers. And the payers have indicated to us and you saw UnitedHealthcare's announcement earlier this week that they saw softer utilization of healthcare services as well. In addition to that, we track a group of Quest accounts that we know are 100% loyal to us. We call it our same store sales analysis.

Speaker 4

And we noticed in the quarter that it was basically flat, those accounts that are 100% loyal. So The other thing we look at is just the mix of our business. And we noticed our general health and wellness panels grew at a Lower rate than some of our infectious disease, non COVID infectious disease and chronic care types of testing that we do. So Based on all that information, we come to the conclusion that the base was certainly softer this quarter. Thank you.

Speaker 1

Thank you for your question. Our next question is from A. J. Rice with Credit Suisse. Your line is open.

Speaker 6

Good morning. I want to offer my congratulations to Mark and best wishes and welcome aboard Sam. Look forward to working with you. Maybe I'll just pivot over to talk about margins. Obviously, within the base business, you've called out some inflationary Pressures seem like they've been manageable, but you also talked about the Invigorate savings and They're largely offsetting it.

Speaker 6

I wonder if you could just sort of comment on how you're viewing base business margins. And then I'm assuming also on COVID related testing, as long as the PHE is in place, that margin is stable. But has there been any reason To think that that has changed, we get the aggregate margin, but I'm wondering about the underlying trends there, if you could just comment on it and how much that Factored into your back half guidance outlook as well. Any changes?

Operator

Thanks, A. J, for the questions. Let me start with COVID. So as I mentioned in my prepared remarks, when you look at our COVID business, the good news was a lot more volume, a lot more revenue, a lot more dollars Of operating margin. However, with that also goes less pooling, a larger mix shift towards the retail outlets, which Have higher expenses.

Operator

And then we have had some slight erosion versus last year on average reimbursement, a couple of dollars, not anything super significant. So the margin percentage was less, but still its contribution to the bottom line from COVID was much higher. As we look into the back half at this point, We don't know where the positive rates are going to go, but we've not assumed a material change in the amount of pooling. We would expect To continue with the current mix or potentially grow that as a proportion of our total COVID volumes, So within the ranges, that's kind of how we're seeing the balance of the year play out on COVID. So if the positive rate And the positive we ran, I'm looking at Jim here, has been as high as we've seen through the pandemic.

Operator

Now a lot more people We are doing rapid antigen testing and so on. We believe that the cases are unreported, but we believe that the prevalence of COVID right now is extremely high. And so in the earlier answer that we provided to Brian around the base business, there has been a historical negative correlation between those. And we do believe that the base This has absolutely been impacted by the surge in COVID. We just aren't sure how long it will last.

Operator

On the base business, we've shared that as we built our plan and the ranges for 2022, we built in a higher SWB, salary with benefits assumption, that was in our guidance. And certainly that's something we control and that's really within expectations. We have a couple of $1,000,000,000 that we have long term contracts. And so really not exposed to inflation in a short window for that. But then we have some other costs where we don't have long term contracts and there are things everybody is familiar with and you've heard from other companies as well, things like fuel, things like Housekeeping, security, temporary labor.

Operator

And so those areas have been, a little more inflationary than we would have anticipated going into the year. The good news is those are in our results year to date. They're in our guidance. We're not expecting that to go away immediately. We certainly hope it's not long term inflation unlike If you have wage inflation, you generally expect it will continue.

Operator

If you add contractual inflation with your key suppliers around reagents and other things That might be longer term as well or certainly a couple of years. We don't know how long this spike is going to last, but I can tell you it's Probably like $0.05 to $0.08 a quarter in the first half and we're not expecting that to change. We hope it might, but in the guidance that we provided. So hopefully that's And A.

Speaker 3

J, just so it's clear, you all know that the Emergency Act has been extended and so we're assuming in our guidance that will be extended through October, Well, we're not assuming in our guidance that it extends past October until we have certainty around that, Okay. So that is the assumption and what we've just provided for guidance for the remainder of the year. I think since you asked A. J, Jim, why don't you comment a little bit about the opportunities we still see around Invigorate and you mentioned in our opening remarks The things we have changed, but once you chat a little bit about why we're still bullish on the prospects of improving Yes.

Speaker 4

So A. J, as we've talked in the past, there's still certainly a lot of opportunity around automation of manual Processes in the laboratory, I touched on in my comments around some of the automated check-in procedures. So we've long had appointment scheduling. What we've added recently is when a patient walks into the PSC without an appointment, you actually go to the check-in and if the weight room is You scheduled an appointment at that point. And what we've seen is it really does help productivity in the PSC as well as if the patient leaves, they may not come back to Quest.

Speaker 4

They make an appointment to come back in 2 hours or the next day. We feel like the patient retention is better. But automation, the use of artificial intelligence in terms of Readouts of manual curves and laboratories, all of that work continues. And then I tell you, the other thing that will help Continue to drive productivity is our work around retention of our employees. So our productivity, like all companies, we're seeing a much Higher increase in turnover.

Speaker 4

We feel like it is stabilized, albeit at a higher point. So as we now drive retention higher and turnover lower, That will certainly help our productivity efforts in the back half of the year.

Operator

I just want to add one thing about PCR in the back half. Steve talked about The potential for the PHE to not be extended, which at this point we're not assuming it does extend. But I want to remind people that the price drop It's not a full margin drop because when we get to beyond the PHE, first off, there's not absolute certainty, but most people would expect The positivity rate will be significantly lower. We can pull a lot more, so we can get some margin offset there, dollar wise. And then the second one is that the retail relationships that we have will change in the structure.

Operator

We know how that's going to work. And basically, the significant cost We're incurring right now to get that volume for the retail outlets will go away because it's only permitted under the PHE. It's complicated, but it will go away. So while the value per acquisition will drop to whatever price we end up with and people have talked about the CMS rate that was originally published and certainly that's potential Over time, that's not all a margin hit because there's some other costs that go away. So we still will make a decent Percentage margin, certainly fewer dollars per patient encounter, but I just want to make sure people are clear that COVID profitability doesn't fall completely off a cliff when the PHE goes away.

Operator

Okay, Greg.

Speaker 1

Thank you for your question. Our next question is from Jack Meehan with Nephron Research. Your line is open, sir.

Speaker 3

Hey, Jack. Good morning.

Speaker 7

Hey, Jack.

Speaker 8

Good morning. First, Sam, congrats. I think you're going to be a great fit at Quest. And Mark, of course, really enjoyed working together. But before you go, I do have more margin questions for you here.

Operator

When Nick's touched otherwise, Jack. Thanks.

Speaker 8

Of course. So specifically, can you just talk about what was the COVID Testing margin in the quarter or how did it compare to the overall margin? And I guess what I'm trying to get into is just like How much of the sequential step down in earnings might have been related to the margin impacts you've talked about?

Operator

Yes. So Jack, as you know, we don't provide specific margins on sub segments of our business. But what I can give you directionally is, I referred to Half of our volume coming from retail channels or non traditional channels and we talked about dollar wise what the incremental cost per counter is there. A year ago in the Q2, it was about a third of our volume. So you can see that's pretty significant.

Operator

In the Q2 last year, we did Quite a bit of pooling and that's varied in the interim quarters between that and now, but there was quite a bit of pooling last year because the positive rate had fallen to a fair low. I think many of us By June of last year, we're thinking this might have been behind us before Delta hit us. And this quarter, we expected in our plans to do Quite a bit of pulling, but in reality, it was not a large amount. So that should give you a little bit of idea. The other thing I did mention, a couple of dollars Erosion on the average reimbursement.

Operator

So I think you got all the pieces. I can provide a specific number, but that should help you understand. But I think the key thing is that the dollars we earned off COVID was much better than our plans. And that's and we expect it to continue And that's why we're raising guidance. So while the percentage was worse, the dollar bottom line was better.

Speaker 3

Yes, Jack, as you know, in Q1, We did about $600,000,000 worth of COVID and in the Q2 that we're talking about right now, it was roughly $350,000,000 So that was a material change in COVID. And as Mark has gone through, there's a lot more dynamics And what the margin is in COVID, but essentially that sequential compare and our margin drop is primarily related to the drop in COVID testing.

Speaker 8

Got it. If I can squeeze in one more on the core business, what are your expectations for Merit increases and SW and B this year,

Speaker 9

have that changed at all?

Speaker 3

Jim, do you want to take it?

Speaker 4

Yes. No, it hasn't changed at all, Jack. We said 3% to 4% for the year. We're still within that guidance. We've already provided the merit increase We do that annually in the April timeframe.

Speaker 4

So it's already in the Q2 numbers for sure.

Operator

So, yes, as Jim referenced, the vast majority of our increase has already taken place. Certainly like all other companies, we have some off cycle adjustments based on promotions and Other things, but most of the quote inflationary headwinds in SWB were recorded in the 2nd quarter. So you look sequentially, that's one of the drivers of margin reduction Q1 to Q2, that's been a historical event as well. That's not new. But we don't anticipate going forward to see significant inflation beyond kind of the run rate we were on in Q2.

Speaker 3

Jim and I actually in a couple of financial conferences try to dimensionalize what's going on with our wage bill. And we talked about of the 50,000 people that the most pressure we see is what are really our Real frontline people and they're primarily what we call specimen processors. When the specimens come into They do the sorting, it's a tough job, it's at night and we're paying them we think fairly and we've increased that for their hourly wages. And the second Couriers. And to give you an idea, because it is the area that we have the most pressure, roughly, it's about 10% to 11% of our Workforce, salary, okay.

Speaker 3

So and at the same time, it represents a larger percentage workforce count of the 50,000 people. So that's where we have the most pressure. So even if that number went up Considerably, you get an idea of the impact that would have on our margins, but that's where we see the most pressure.

Operator

Okay. Thank you.

Speaker 1

Thank you for your question. Our next question is from Patrick Donnelly with Citi. Your line is open.

Speaker 7

Great. Thanks for taking the questions guys. Sam, looking forward to continuing to work with you and Not to put you on the spot on your first call here, but I'm sure on the way in, as you know, there's a lot of questions as you've seen on this call already in terms of the margin And the margin profile going into kind of next year as we work our way through kind of the high margin COVID coming out, some of the expenses around DTC and retail, Wage inflation, I guess, when you came in and Mark, feel free to chime in obviously, but Sam, how did you get comfortable with that? It would just be Helpful maybe to hear your perspective on that as I'm sure it was a key consideration, something you dug into on your way in and I know investors are hyper focused on that Piece as well. So if you're willing, we'd love to hear your general thoughts on kind of how we work our way through the margin side as we kind of work our way into next year.

Speaker 2

Yes, Patrick, thanks for the welcome and I look forward to working with you and the rest of the folks on the call as well. Listen, it's really early days. I've been here in I'm in my 2nd week here. So all I can tell you is coming Obviously, we're in a challenging environment right now, but Quest has an incredible reputation with incredible people That really provide a significant value to healthcare. So I've been so far really impressed with the passion that I've seen, people here, the knowledge And the contributions that I think we can make in healthcare.

Speaker 2

So I'm going to punt a little bit on your question because it's really early days and really ask Mark to more comment on it, but I'm very excited about how we can work through these challenges. But it's really early days, Patrick. I'm in my 2nd week here. So I'll let maybe Mark talk about it more.

Operator

Yes. So Patrick, I appreciate the question. We know where people's heads are at right now around the business And

Speaker 7

that's where ours are as well.

Operator

So I can assure you we're spending a lot of time on that. We've spent a lot of time on that. There's a number of things that we generally control And then there's some things that are a little bit less in our control. So we do our best to forecast those things. We put together ranges And then we're I think and believe we're very transparent with you about how those things play out.

Operator

So you get a sense of, okay, well, what really is going on in the business. And because of that, I believe that generally we've not surprised people and we've given you delivered on your expectations, we've given you timely updates, we've given you interim information. And based on my time with Sam and I think the team here, I would expect that to continue. So you would expect that with my departure that We're not going to change the way we talk to you, the way we share, give all those updates. I think everybody appreciates what a great job Sean does No, they can call him anytime, any place and get him and he'll be as transparent as possible.

Operator

So really, I think what it comes down to is I believe we're focused on the right things. And also I believe we do our best job of being as transparent as possible around all those key drivers.

Speaker 7

Yes, that's helpful. I appreciate it guys. And then Steve, maybe a quick one. You've continued to talk about more constructive conversations with Some of the covering lives and payers. Can you just talk about, I guess, the kind of outlook on pricing?

Speaker 7

I mean, it seems As confident as you guys have sounded on that front in years. So maybe just talk about how you're feeling on the pricing side given some of those payer conversations?

Speaker 3

Yes. So thanks for the question. And we are very pleased with the progress we've made with all payers And where we are today versus when I started, which is over 10 years ago. We've got a network now that It's the strongest network that we've ever had. And I would say our relationship with All the significant payers national and regional is very strong and they are increasingly realizing that It's good for their membership and good for their competitiveness in the market to have us in network and we bring a lot of value.

Speaker 3

And so we're entirely focused on what we call Powering Affordable Care, which is consistent with what Jim Yes, it's driven in the company around making sure that we have great quality, great service and a great experience. And you heard earlier from Jim as we We continue to push on just working smarter and by working smarter, we're getting more productivity, but we're also going to have a better product. And payers understand that. And so as Jim mentioned, we have gotten some increases from the payers over the last Several negotiation rounds. We continue to believe that is something we're going to continue to push for because we do bring Lot of value in the marketplace and we're very competitive in the marketplace.

Speaker 3

And so if you look at the price effect that we saw in the quarter And what we have typically said in the past historically, remember historically we said you should plan at about 100 basis points versus the price effect. Well, in this quarter and the last quarter, we've actually saw less than that. And that's the best position we've been in. And I will share within that envelope, the commercial payer portion of it is significantly less than where we've been historically, But we still see pressure with price with our hospital business, with our client bill business and that's in that envelope as well. But on the commercial payer side, we're in

Operator

a very

Speaker 3

different And I'll share with you a part of Jim and I's my transition is Jim and I are going into the nationals and the regional Payers and we're talking about what we've done in the past and more importantly what we're doing in the future. We just had a meeting last week with one of the national payers And they see us as a much more significant player in the marketplace than what people think about us as, which is a laboratory. We're much more than lab. We actually help them improve the value of healthcare going forward. So much better placed than where we were in a good place right now.

Operator

And so what I will add is that we've really moved the needle on commercial. Over the last couple of years, we've talked about more pricing pressure in the client bill, which is as Steve referenced the hospital and then some cases where we contract directly with physicians. But instead of being a headwind On price, I will tell you that starting next year and going forward, I would expect the commercial growth to be at least neutral, not a tailwind. So we've moved it from a major headwind To be at least neutral and more likely positive. So, I wanted to dimensionalize a little more why you're hearing the positive common scores.

Operator

And it's in really recognition of what Steve said, which is our strategic value to them. We're not a commoditized provider of the laboratory result. There's so much more to How we're helping them and then these value based contracts that we've referenced were based on performance, we can earn a better payment for ourselves. And so because of that, We've really, really moved the environment and the relationships with the commercial payers.

Speaker 7

Great. Thank you, guys.

Speaker 1

Thank you so much for your question. Our next question is from Pito Chickering with Deutsche Bank. Your line is open.

Speaker 2

Hey, good morning guys. Thanks for taking my questions.

Speaker 10

Mark, it's a pleasure working with you over these years. And Sam, I look forward to working with you in the future. A quick two part on the inflation side. So the first one is a follow-up on that Pricing question that you just gave. Can you quantify what the better commercial rates are for 2023?

Speaker 10

Because you probably already locked us in this point versus 2022. And then follow-up on EJ's questions, just to make sure I understand that, you were seeing an additional $0.05 to $0.08 of inflationary pressures. Was that more or less than you expected? You guys gave guidance on the Q4 call. And then on previous calls, you talked about sort of the 2023 EPS of 8.50 So we add those inflationary pressures against that $850,000,000 or can you offset those with increased efficiency as well as this new recent COVID Our retail agreements you've done.

Operator

Thanks so much. Well, thanks for all the questions, Pito. I'll start with 2023. We've not locked down our plan and even if we did, we generally don't give specific guidance until our Q4 earnings call. And I'll leave it to Management team, I'll be leaving exactly when they decide to do that, but I'm not going to comment any specifics around 2023.

Operator

In terms of the amount of the increases, again, I'm not going to We don't have a planned lockdown, but we have enough contracts that are already set for next year and enough progress on some that are either, As we referenced like Florida Blue or some others that are getting close to being locked down, for renewal that I have confidence to say what I said, Which is that it's not going to be a headwind next year for us on a price perspective. So just

Speaker 3

to add to that, so what you're hearing from Yes, we hear your comments about inflation and yes, we have inflationary pressure and yes, we're managing that. But what you're also hearing from us is we're in a better price position than we've been in. You need to think about that too and thinking about The prospect of what we're going to do in 2023, we're not going to provide guidance, but we still feel confident with what we shared at Investor Day in 2021 around the prospects of what we're going to do going forward. Yes.

Operator

And so I was going to continue that. What you're hearing from us is It's happening now, Pito. And the $0.58 is more inflation than we would have anticipated. However, other things have changed as well. Most notably, we did a lot more COVID, so we delivered a lot more earnings.

Operator

So just like we don't expect the high level of COVID and we could be wrong to expect and continue into 2023. Also, we'd be really disappointed if the inflation we're seeing in the non contracted areas were to carry to 2023. But even if it does, We've got multiple pieces that are moving, including a better pricing environment in the commercial book. So in no way, shape or form are we saying that when you put all these together that 850 or in that range is not something we're still confident in. Thanks so much.

Operator

Yes.

Speaker 1

Thank you for your question. Our next question is from Ricky Goldwasser with Morgan Stanley. Your line is open.

Speaker 11

Yes. Hi, good morning. And Mark wishing you best of luck in the future and really enjoyed working with you. So thank you for All the color always and your patience. In terms of the question, I just want to go back To the utilization environment, I mean, you gave some color there, but what we're hearing from the managed care companies is that Softness that they're seeing is in ER visits and in inpatient admissions.

Speaker 11

We shouldn't really have an impact on lab Testing, right, it's more outside the four walls of the hospitals. So can you maybe give us some color on where are you seeing softness in utilization by geography and maybe By end market, I. E. What type of test? And how do you think about it, right?

Speaker 11

Sort of 2.5 years into the pandemic, What's structural in the soft in the software utilization versus, transitional in your view?

Operator

If I can just start quickly and then I'll pass it on to Jim. So Ricky, our source is not just seeing their medical wash ratios, But I'd point to 2 things in addition to what Jim talked about earlier, which is our same store sales as we call it. So one is we actually get data From the payers, okay, in total. So we know how many patient encounters they had for laboratory work. We know what our volume was and we can see that the good news is we continue to gain share in those commercial books.

Operator

However, we continue to see their total volume has been down certainly in the Q2. So it's Payer data that's being provided by them to us that is the basis for our confidence to say that utilization has dipped in our space. The other one is I'd point to the XIPAN data, which is based on billings of other independent labs. And if you look at that, that certainly suggests that utilization is down. So Well, you may be hearing it's emergency room and inpatient.

Operator

The data that we have and the best data we have also suggests that the market in which we Nate is also depressed in the Q2.

Speaker 3

And the second part is remember COVID and we're 2 years into it and every time COVID Infections go up, our base business comes down some. And if you think about a physician and what they need to do to run their offices, As you know, a large portion of our business is through physicians in their offices. If there's callouts of their staff or if their patients are They see their appointments because they are now infected, it affects volume. So there's no question there is a correlation. And the good news for us Because when that happens, our COVID business goes up, right?

Speaker 3

So Jim, why don't you

Operator

just walk

Speaker 7

us through the

Speaker 4

line now? Yes. Ricky, the last thing I'd say is we're not immune to Hospital, the inpatient work, remember, we get $1,000,000,000 a year in reference work. We have another $500,000,000 in PLS. So when inpatient and outpatient procedures are down, that certainly does affect our business on the health system hospital side.

Speaker 4

On the physician office side, again, we closely look at a set of accounts spread across the country that we know are 100% loyal to Quest, And we measure that we call it same store sales. Again, our general health and wellness panels from a mix standpoint were certainly lower than Some of our chronic disease panels in the quarter. And then the last thing, geographic mix, We've talked and it hasn't changed dramatically that our book of business in New York City is down still low to mid double digits. On the other hand, we see incredibly strong growth in the southern part of the country, in the southeast portion as well as the southwest and Parts of the West. So, if there's been a population migration out of New York City Into the Southeast and we're certainly seeing some of that in our business.

Speaker 7

Operator, next question.

Speaker 1

Thank you. Our next question is from Derik DeDurin with Bank of America. Your line is open.

Operator

Hey, Derik. Hey,

Speaker 9

Derek. Hi, good morning. This is John on for Derek. And thanks for all the colors and thanks for Putting out the initiatives because you knew we're going to ask. But in addition to that and In addition to the price increases you're expecting and the plan to clamp down the employee turnover, How should we think about the incremental spend in 2023?

Speaker 9

Are you thinking about ramping these down to offset the inflationary pressure? And on PAMA, could you just remind us what your expectations are in 2023, especially if nothing else happens on the legislative front?

Speaker 4

Yes. So in terms of 2023, as Mark said, there's a lot of moving parts at this point. We're committed to investments in Advanced Diagnostics. We're committed to investments in our consumer direct, consumer initiated testing business. Obviously, we can modulate those things if we see inflation getting worse.

Speaker 4

But at this point, We can't give you any further guidance than what we've given you around us. We're committed to advanced diagnostics, committed to our clinical and our consumer direct consumer initiated testing business.

Speaker 3

Yes. So just to add to that because we've commented on this before, it's important you think about this As you think about 2023, we started to make investments in 2020 to accelerate growth Yes, but we had already invested into accelerate growth. So think about 2020 2021 and now we're into 2022. And we obviously We would not make investments unless we thought there would be a return. And so therefore, you have heard from us, you're seeing growth rates In Advanced Diagnostics that have come up, you've heard about us feeling good about our consumer initiated testing, growing faster than We have seen growing in the past.

Speaker 3

And as you think about 2023, you should Think about the improvements you're going to see in those two businesses in relationship with investment in what we invested. And so therefore, you should not think about this as headwinds, but you should really think about it as tailwinds Because we will get a return on those investments we made over the last several years.

Speaker 4

Jim? Yes. You asked about Pam and we've said that, it's In our 2023 guidance outlook that we provided at this point and we've said it's about a $90,000,000

Speaker 9

Headwind.

Operator

So only thing I would add is that, to Steve's point, when you ask It's ramping down. I think there's 2 ways to think of investments. 1 is what's the P and L in that impact and one is the level of spend. So we at Investor Day talked Growing our direct consumer business to $500,000,000 by 2025. That is still our intention.

Operator

So as you can imagine, over the next several years, including 2023, We're expecting significant revenue growth. And in order to drive that revenue growth, we need to spend more. However, the good news is that A lot of 2020 2021 was pre revenue, pre contribution margin. And as we go ahead, we would expect the net impact To actually be less and to be less of a headwind. So really we're going to be investing less on the bottom line, but spending more money to That business.

Operator

Got you. That

Speaker 9

makes sense. Thank

Operator

you. Thank

Speaker 1

Thank you for your question. Our next question is from Matt Larew with William Blair. Your line is open.

Speaker 3

Hi, Matt.

Speaker 12

Hi, this is actually Madelyn Mollman on for Matt Larew. Just going off of the previous question for your investments into the base business, I know previously you've given a number around $160,000,000 for this year. Do you anticipate it's still being about that? Has inflation driven that cost higher? Any color you have there?

Speaker 12

And then my other question, just speaking to your investments in Advanced Diagnostics. You mentioned that you were ahead of schedule for your anticipated 8% growth. Is that still the case?

Operator

Sure. So let me take part of it and I'm sure either Steve or Jim will jump in. So first off, inflation really hasn't It impacted the level of investment in any material way. And we're on track to spend about what we told you previously. As I referenced a minute ago, we haven't put our final plans together.

Operator

But at this point, I would expect we're going to spend more Next year. And we're going to spend more in marketing, but we're going to spend a lot less and not much at all in the IT platform creation. So it's really going to be Tied a very high variable cost and highly tied to revenue growth and we'll monitor as Jim says and I'm sure Sam and will be all over us to make sure we're making the progress and to make sure we don't get the spending ahead of ourselves. But if we do what we expect to do and we need to do to get to $500,000,000 by 2025, The spending will continue to go up. The only other dimension I want to mention here is because when we talk about investments in the base business, There's a little nuance here.

Operator

Advanced Diagnostics absolutely is the base business, but really this consumer business is new. So Well, a lot of the work we do is similar to what we've done historically in our case business. It's really a new business category or opportunity. And some of it may cannibalize what would have otherwise come through our traditional channels, but we do believe that a lot of it is actually incremental To the overall amount of volume that we perform, Jim or Steve you want to?

Speaker 3

Yes. So as you know, we don't generally give Numbers every quarter about different segments of our business and advanced diagnostics, we generally give you an annual update and we'll do that again. But We keep on indicating that we believe we are making progress of getting to a higher level of growth as we indicated in our Investor Day in 2021 and we feel good about the So we gave you a number in the beginning of the year. And the same is true about our consumer initiated testing. We periodically gave you an update to show that we're making progress.

Speaker 3

So We're feeling good about the investments made, the returns we'll get. And again, you should see more returns in our 2023 guidance the expectations around that because we believe they still remain to be good opportunities.

Speaker 2

And just to clarify, the target that outlined at the Investor Day for the direct to consumer business was $250,000,000 by 2025. My apologies.

Speaker 12

Great. Thank you so much.

Speaker 1

Thank you for your question. Our last question will come from Rachel Vassendal with JPMorgan. Your line is open.

Speaker 13

Hi, Ty. Thanks for taking the questions. So can you spend a minute talking about the monkeypox market? You flagged in your prepared remarks that Quest was One of the 5 labs that was selected by the CDC to expand testing capacity and you guys are going to have roughly 30,000 testing capacity for a week. So can you just walk us through the market opportunity there and then is this contemplated in the guidance at all?

Speaker 3

Jim will handle that.

Speaker 4

Yes. So at this point, it's hard to anticipate what the market opportunity has been Or will be. I can tell you, our testing volumes at this point are modest. If we've done 500, 600 tests that would be on the high side. However, it is growing and we do see growth.

Speaker 4

We've only had the Approved for New York State, we expect that to happen within the next week or 2. I'm sure you're reading that that is where the major outbreak is in New York City. So we would Back to participate in that market, but most of our volume at this point is coming actually off of the West Coast. And so we'll keep you updated on what we're seeing.

Speaker 12

Great. And then in light of

Speaker 13

the current environment, can you just walk us through some additional color on how you're considering use of cash between share repurchases, dividends and then M and A? Thanks.

Operator

Sure. So we're going to continue with what we've done. And what that is, is that Between the dividend and we've already gotten there this year with the share repurchases to deliver a majority of our free cash flow to our shareholders. And with a $1,700,000,000 guidance and $400,000,000 of capital, says at least $650,000,000 between the dividend and share repurchases, we've already covered that. As we also shared, we'd rather do M and A than share repurchases because we have some very rigorous financial parameters around the deals that we do.

Operator

And so it's really going to be situational quarter by quarter, it may be different. Jim referenced that we have a deep pipeline and actually also Commented that we have some negotiations that are well advanced. So I think we'd all be very disappointed if we didn't execute some deals before the end of the year. Don't know the exact timing of those, but certainly as I said, I'd rather spend more on M and A. And I know Steve would and you'll hear from Sam and Jim as they take over the reins their view, but I wouldn't expect it to materially change.

Operator

So really no change to what we've done in the past. And at this point, no specific plans for cash deployment because we're really it's really dependent on that progression of the M and A.

Speaker 3

Okay. So thank you everyone. And again, thank you, Mark, for your time here at Quest. We're going to miss you We wish you well. So thanks everyone for joining the call.

Speaker 3

We appreciate all your questions and support and we'll see you in our travels. Have a good day.

Speaker 1

Thank you for participating in the Quest Diagnostics Second Quarter 2022 Conference Call. A transcript of prepared remarks on this call will be posted later today on Quest Diagnostics' website at www.questdiagnostics .com. A replay of the call may be accessed online at www.questdiagnostics.com /investor or by phone at 888-five 66-0439 for domestic callers or 203-369-3045 for international callers. Telephone replays will be available from 10:30 am Eastern Time on July 21, 2022 until midnight Eastern Time, August 4th 2022. Have a great day.

Speaker 1

Goodbye.

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Earnings Conference Call
Quest Diagnostics Q2 2022
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