Quest Diagnostics Q3 2022 Earnings Call Transcript

Quartr
Provided by Quartr
October 20, 2022

There are 12 speakers on the call.

Operator

Welcome to the Quest Diagnostics Third 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 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.

Operator

Go ahead, please.

Speaker 1

Thank you, and good morning. I'm joined by Steve Ruszkowski, our Chairman, Chief Executive Officer and President Jim Davis, CEO-elect 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.

Speaker 1

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 and 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 pandemic's severity and duration healthcare insurer, government and client payer reimbursement for COVID-nineteen molecular tests The pandemic's impact on the U. S. Healthcare system and the U. S.

Speaker 1

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. For this call, References to reported EPS refer to reported diluted EPS and references to adjusted EPS refer to adjusted diluted EPS. Any references to base business, testing revenues or volumes 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.

Speaker 1

Now here is Steve Ruszkowski.

Speaker 2

Thanks, Sean, and thanks, everyone, for joining us today. While we had a Strong third quarter. We drove 5% growth in the base business despite the impact of Hurricane Ian, And we delivered strong earnings despite inflationary pressures and investments in growth areas. Based on our performance, we have raised our outlook for the remainder of 2022. We also made very good progress on our leadership transition, adding management depth and expertise to help us grow in important areas.

Speaker 2

As you know, Jim will assume the responsibilities of CEO and President on November 1, And I will remain as Executive Chairman. Before I turn it over to Jim, I'd like to say a few words about Savings Access to Laboratory Services Act, SALSA. If enacted, SALSA would fix PAMA And put the Medicare Clinical Laboratory Fee Schedule back on a sustainable path. Based on the efforts of our trade association, support for Salsa has broadened and continues to strengthen. As you know, we are currently planning for a Medicare fee schedule reduction under PAMA of $80,000,000 to $90,000,000 in 2023 if Congress does not intervene again this year.

Speaker 2

However, the work we are doing is aimed at reducing or postponing that burden. And fortunately, Congress has already acted 3 times to stop further cuts from going into place. It is therefore very important that we continue to build support for the enactment of Salsa when Congress returns to Washington after the election. As I transition to the Executive Chairman, I will remain actively engaged on this issue, working with a CLA and other stakeholders. Now I would like to turn it over to Jim Davis.

Speaker 3

Thanks, Steve. On behalf of our 50,000 Quest colleagues, I would like to thank you for your leadership Quest Diagnostics over the last 10 years. You turned around a company that was struggling and built shareholder value and transformed Quest into a trusted healthcare partner with a strong foundation for future growth. I'm personally grateful for all the help and guidance and friendship that you shared during the transition. Thanks, Steve.

Speaker 3

Turning to our results. Our base business grew year over year in the Q3 with performance rebounding in August September from the softer volume trends that we saw earlier in the year. In fact, before Hurricane Ian hit in September, we were seeing some of the highest base testing volumes we have ever experienced. I'd like to thank our employees for their incredible efforts to restore our labs and PSCs For our patients and customers in the wake of Hurricane Ian, while also enduring personal loss of their homes and belongings. I'm also grateful to our employees outside of the impacted areas who've stepped up to provide financial support to our colleagues in need.

Speaker 3

As many of you are aware, Florida is an important state for us. During the quarter, we grew the base business revenues and continue to invest in advanced diagnostics and consumer initiated testing. To help offset inflationary pressures, we have continued to pursue our operational excellence strategy and have been closely managing our cost structure through our Invigorate initiatives. In the Q3, total revenues were $2,500,000,000 Earnings per share were $2.17 on a reported basis and $2.36 on an adjusted basis. Cash provided by operations was $502,000,000 COVID-nineteen testing revenues were $316,000,000 in the 3rd quarter, down 55% from 2021 and down 11% from the previous quarter.

Speaker 3

After plateauing in June July, our COVID-nineteen molecular testing volumes steadily declined. We expect COVID-nineteen molecular volumes to average $10,000 to $15,000 per day in the 4th quarter. In the Q3, we continued to make progress executing our 2 point strategy to accelerate growth and drive operational excellence. Here are some highlights from the quarter. M and A continues to be a driver of growth.

Speaker 3

We recently announced an outreach lab purchase from Summa Health, A large integrated healthcare delivery system in Ohio. While this is a small acquisition, it's a positive indicator. We are seeing that hospital systems are more open to discussions than before the pandemic. Many large and small health systems face substantial financial and labor pressures that make our range of services very attractive. We're pleased with the activity in our M and A pipeline and hope to share additional news with you later this year.

Speaker 3

We also announced a professional lab services relationship with Lee Health, Southwest Florida's primary community owned health system to provide supply chain expertise for 5 hospitals owned by Lee Health and selected outpatient centers. We will also continue to perform reference testing for Lee Health. Our implementation plans have been slightly delayed by Hurricane Ian, though we expect this relationship will have a positive impact on revenue growth in 2023. Turning now to Health Plans. Both volumes and revenues continued to grow faster than our overall base business in the quarter.

Speaker 3

Value based care relationships continue to gain traction. Not only does this yield benefit for health plans and their members, but also it enables us to gain share. We've begun to renew some of our value based contracts with National Health Plans while continuing to engage and expand our value based footprint with other plans. Value based relationships are appealing to health We're on track to meet our goal of realizing 50% of our health plan revenues from value based relationships by the end of next year. Also, as we continue to extend and renegotiate health plan agreements, we see increased volumes and pricing from these contracts.

Speaker 3

We're seeing a more favorable pricing environment. And over the last 2 years, the majority of our renewals have included stable to positive reimbursement. In Advanced Diagnostics, we saw growth from prenatal genetics and genomic sequencing services in the 3rd quarter. We continue to make investments to strengthen our capabilities to accelerate growth in oncology and hematology, hereditary genetics, Genomic Sequencing Services and Pharma Services. Just last week, we announced the addition of Mark Gardner, our Senior Vice President of Molecular Genomics and Oncology.

Speaker 3

In this new position, Mark, an established leader in molecular genomics, next generation sequencing and oncology diagnostics, is responsible for driving growth and expanding our offerings in these areas. The investments we're making in consumer initiated testing enabled us to recently launch a new e commerce platform. The new site is more powerful and consumer friendly with a compelling user experience and a number of enhancements. We're encouraged by the early success of the site in the 1st few weeks of its launch, and we expect to make further progress in the Q4 and in 2023 toward our goal of $250,000,000 of annual consumer initiated testing revenues by 2025. We also launched a new ad campaign to drive broader awareness of our consumer initiated testing offerings, which cover everything from women's health tests to allergy testing and sexually transmitted infections.

Speaker 3

Check out the new site at questhealth.com and look for the new ads. The second part of our 2 point strategy is to drive operational excellence. We remain focused on improving our operational quality, Service and cost, thereby driving productivity gains and improving the customer experience. Here are a few examples. As COVID-nineteen volumes have declined, we've begun to repurpose some of our COVID-nineteen testing platforms to enhance our quality and reduce costs.

Speaker 3

Today, 75% of our patients are arriving at a PSC with an appointment compared to less than 25% just 3 years ago. This increased number of appointments allows us to flex our workforce to meet demand within a particular geography, which enables us to serve our patients faster. For patients who walk into a patient service center, our new Schedule at check-in program sets expectations in the waiting room and balances the load for our phlebotomists. Walk ins now self register when they arrive and learn how long they'll need to wait. Our average wait time is approximately 5 minutes, which is roughly half the level since 2019.

Speaker 3

Finally, we continue to drive the use of automation and artificial intelligence to drive productivity gains to help offset inflationary pressures. Now I'll turn it over to Sam, who will provide more

Speaker 1

In the Q3, consolidated revenues were $2,500,000,000 down 10.4% versus the prior year. Base business revenues grew 5.1 percent to $2,170,000,000 while COVID-nineteen testing revenues declined 55 percent to $316,000,000 Revenues for Diagnostic Information Services declined 10.5% compared to the prior year. The decline reflected lower revenue from COVID-nineteen testing services versus the Q3 of 2021, partially offset by solid growth in our base testing revenue despite the impact of Hurricane Ian at the end of the quarter. Total volume measured by the number of requisitions declined 6.2% versus the prior year. Acquisitions contributed 20 basis points to total volume.

Speaker 1

Total and organic base testing volumes increased 1.6% and 1.4% respectively versus the prior year. The performance of our base business strengthened beginning in late July as COVID-nineteen cases and the positivity rate declined throughout August September. The impact of Hurricane Ian represented End of approximately 30 basis points to volume growth in the quarter. COVID-nineteen testing volumes continued to decline during the Q3. We resulted approximately 3,100,000 molecular tests, down approximately 4,000,000 tests and 400,000 tests versus the prior year and Q2 respectively.

Speaker 1

Our COVID-nineteen molecular volumes have averaged roughly 17,000 tests per day so far in October. Revenue per requisition declined 5.1% versus the prior year, driven primarily by lower COVID-nineteen molecular volume. Base business revenue per rec was up 3.3%. The more favorable pricing environment remained consistent with our expectations with unit price reimbursement pressure of less than 50 basis points in the quarter. Reported operating income in the 3rd quarter was $392,000,000 or 15.8 percent of revenues compared to $652,000,000 or 23.5 percent of revenues last year.

Speaker 1

On an adjusted basis, Operating income was $423,000,000 or 17 percent of revenues compared to $694,000,000 or 25% of revenues last year. The year over year decline in adjusted operating income is primarily related to lower COVID volume from nontraditional retail channels, which carry additional expenses. Reported EPS was $2.17 in the quarter compared to $4.02 a year ago. Adjusted EPS was $2.36 compared to $3.96 last year. The impact of Hurricane Ian reduced adjusted EPS by approximately $0.05 in the 3rd quarter.

Speaker 1

Year to date cash provided by operations was $1,380,000,000 in 2022 versus $1,750,000,000 in the prior year period. Turning to our updated guidance. Revenues are now expected to be between $9,720,000,000 and $9,860,000,000 Base business revenues are expected to be between $8,380,000,000 $8,450,000,000 COVID-nineteen testing revenues are expected to be between $1,340,000,000 and $1,410,000,000 Reported EPS expected to be in a range of $8.52 to $8.72 and adjusted EPS to be in a range of 9 point at $0.75 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 As you think about our updated guidance, please consider the following. We are assuming COVID-nineteen molecular volumes to average roughly 10000 to 15000 tests per day in the 4th quarter. We also believe this is a reasonable assumption for run rate COVID-nineteen molecular testing volumes heading into 2023.

Speaker 1

Last week, the public health emergency was extended another 90 days through mid January. We therefore assume average reimbursement COVID-nineteen molecular testing to hold relatively steady through the end of this year. We expect reimbursement to decline when the PHE expires, which we currently assume will happen in January. Given the timing of Hurricane Ian, the impact on our business Has continued in the 1st couple of weeks of Q4. As a reminder, we are making investments this year to accelerate growth.

Speaker 1

We spent approximately $110,000,000 through the Q3, and we expect to invest more than $50,000,000 in the 4th quarter, primarily to support marketing and promotion of our new consumer initiated testing platform. Finally, before getting to your questions, I wanted to say a few words about 2023. I know there's a lot of focus on EPS expectations for 2023. As you might expect, we aren't prepared to provide detailed 2023 guidance today. There are obviously a number of assumptions and dynamics to consider, But I've seen nothing that would prevent us from meeting the current consensus estimates for next year within a reasonable range of outcomes.

Speaker 1

We will continue to review our plans and assumptions and provide our full 2023 guidance in early February. I will now turn it back to Steve.

Speaker 2

Thanks, Sam. Well, to summarize, we accelerated growth in the base business year over year. We grew our base business revenue while continuing to make investments, which position us well for the future. And we have raised our full year guidance based on our performance in the quarter and our expectations for the remainder of As Jim mentioned earlier, this will be my last earnings call as CEO and President, And I will remain as Executive Chairman. I'd like to thank all of you on this call for your interest in the company.

Speaker 2

I've enjoyed our many conversations over the last 10 years, and I thank you for your time and commitment to understand our business. Finally, to the 50,000 colleagues of Quest Diagnostics, it's been the honor of my lifetime to serve as your CEO. Together, we have empowered Better Health with our insights, grown the business And provide a critical testing capacity through one of the most challenging healthcare crisis in our history. I will always be grateful for what you've done to serve our customers. Thank you.

Speaker 2

Now we'd be happy to take any of your questions. Operator?

Operator

Thank you. We will now open it up to questions. The first question in the queue is from Ann Hynes with Mizuho Securities. Your line is now open. Anne?

Operator

Anne, if you're there, please check your mute button.

Speaker 4

Can you hear me now?

Speaker 1

Yes.

Speaker 4

Okay. Sorry about that. Okay. Steve, I just want to say congratulations on your retirement and it has been a pleasure working with you all these years.

Speaker 2

Thanks, Anne.

Speaker 4

So my first question, thanks for the color on 2023. Obviously, it was on top of our investor minds. But just for modeling purposes, can you just maybe tell us what has changed, directionally on the positive side and the negative side Since you first provided that in 2019 and maybe within that, your DTC program, I know it's a headwind to earnings this year. Do we expect you to become profitable in 2003 and maybe talk about the profitability profile in 2024? That would be great.

Speaker 4

Thanks.

Speaker 3

Yes. Thanks, Ann, and good morning. So let me start, and I'll have Sam So, fill in some color here. So, look, there's a lot of changes since 2019, and I'll just talk about a few Tailwinds and headwinds. From a tailwind standpoint, reimbursement has never been better, right?

Speaker 3

We're down Approximately 50 basis points year to date. That's a much better environment without PAMA than 2019 was We are historically losing over 100 basis points, and then PAMA was on top of that. So we feel much better about price going into 2023. Our base volumes are back above 2019 levels. In fact, at Points during the quarter, in September, we exceeded the high point, our February, January point of 2020.

Speaker 3

So feel good about that. You mentioned investments in CIT. Yes, that will be a tailwind going into 2023. We feel good about that. And then as you know, we've made investments in the business, investing in our Advanced Diagnostics portfolio, and we expect to get above normal growth rates out of that side of our portfolio.

Speaker 3

Now we're dealing with some headwinds as well, As you know, we built into our plan a 3rd round of PAMA cuts $80,000,000 to $90,000,000 next year. COVID, which we didn't obviously have in 2019, we expect going into next year, the early part of next year, we'll be 10 to 15 point. And we have some inflation that we certainly didn't see in 2019 that's Running through our business, we estimated $0.05 to $0.08 a quarter, and we expect that inflation to continue into the early part of next year. Sam, any other call?

Speaker 1

Yes. I think you've captured it well, Jim. I mean, again, we're But listen, there's nothing that I've seen so far that we've seen so far that prevents us from meeting the current consensus estimates, again, within a reasonable range of outcomes. In terms of share repurchases, we have made share repurchases this year, dollars 950,000,000 throughout the 1st 3 quarters of the year and that will provide

Speaker 2

Yes. Let me just make another comment about Some of the investments we've made because I think there's a little bit

Speaker 5

of a

Speaker 2

misunderstanding about that adding to our cost You're not helping us as we get into 'twenty three and 'twenty four, and Ann, you alluded to that. So we mentioned that this year we'll be investing about 160,000,000 And as you recall, in 2021, we started the investments. We took some of the proceeds from COVID and made Roughly a $250,000,000 worth of investments in 2 businesses, 1 Advanced Diagnostics and as Jim said and we've probably before, we've already started to see Have faster growth rates because of those investments. And the second is our consumer initiated testing. And We will only make investments as you would expect, if we expect to get a return.

Speaker 2

And so what you're going to see in 2023 It is particularly around CIT, starting to get a return for that investment for CIT. And even though we don't report the financials, you'll see less of a drain on our earnings in 2023 Because of the growth rate we will get from CIT and that will be a tailwind for 2023. And you asked about 2024, Yes, we're not going to give exact details because we will throttle that investment depending upon how fast the market grows and where we have some capacity to accelerate growth. And so we'll hold back on giving you an exact number of our profitability, but we are going to get the return from that $250,000,000 And let me just close by saying that $250,000,000 some of it is permanent because we're building these two businesses of ENSCI Diagnostics and CIT, But some of it was temporal. And so when you think about modeling for 2023 and 2023 And you look at what you might expect for expenses from us for 2022, and these are total expenses R and D and SG and A, what we have modeled and working on is actually expenses in 2023 Coming down versus 2022.

Speaker 2

So that's a change because some of these investments were temporal. So I'll just leave it there. Thank you.

Speaker 4

Thanks.

Operator

Next question is from Kevin Caliendo with UBS. Your line is now open.

Speaker 6

Thanks. I actually want to expand on Steve's comment right there because thinking through this, thinking through the guidance and getting to the numbers First is sort of what the run rate is coming out. There has to be a pretty meaningful amount of expenses coming out. So of the 160, Should we be thinking about that is like half of that goes away to get to sort of Including PAMA, we're talking $80,000,000 to $100,000,000 of expenses that would need to come down unless you think volumes So, can you maybe give us a little bit more on the expense side and how to think about modeling that? Is it just like percentage of that 160 that comes out?

Speaker 3

Yes. Thanks, Kevin. And Let me turn it to Sam, if he can give some color on that.

Speaker 1

Yes. So Kevin, as you think about next year, I mean, yes, we are taking Expenses down. So there's going to be some reductions as we look at expenses given the macro environment that we are in. I would not assume right now strategic investments necessarily coming down. That's not an assumption that I would make.

Speaker 1

And we also have our Invigorate program where we expect to have productivity in the business and that's an ongoing program that we do that we have every year, but we are In a way reinvigorating invigorate to have further productivity from the business. So I think as you look at margins, you have to consider those things. We have Maybe a consistent inflationary environment is the assumption wages increasing by salaries, wages and benefits increasing by 3% to 4%, but we are Taking expenses down next year in other areas and we are focusing on Invigorate.

Speaker 6

If maybe I can ask it a little bit different way. Your base margins, I know you don't think about base margins versus COVID margins, but we all try to model it If we were to think about it, would you then think that base margins could look or be better than what they were in a pre COVID setting?

Speaker 1

Let's we should talk about kind of the assumptions that we have right now for 2020 We're not going to comment right now on base margins versus total COVID margins, but I think the way to think about it is the pricing environment is improving. So we are seeing a less of an impact in terms of price reductions. There is the PAMA impact for next year, but we are seeing Historically low pricing pressure on our business, which as we said in the quarter was 50 basis points. So that's an improvement. I talked about some of the cost reductions that we're going to make And I talked about the Invigorate productivity savings that we're going to make.

Speaker 1

So we are going to definitely see some productivity improvement in the business, but I won't give a specific Base margin number here.

Speaker 6

I tried. Thanks so much guys. That's really helpful. Thank you.

Operator

Next question is from Jack Meehan with Nephron Research. Your line is now open.

Speaker 7

Thank you. Good morning. I wanted to ask about utilization. So there was a lot of worry heading into the quarter because of the Xytheon data and your Base growth actually accelerated to 5%. So I'm just curious what you think is going on here driving the relative outperformance versus What it looks like the market might be doing?

Speaker 3

Yes. So thanks, Jack. As we mentioned in the opening comments, Our volumes improved every month through the Q3. So July was weak, August was better and September, Even with the hurricane impact, was obviously much better than the average that we reported. In addition, We reported 5.1 percent revenue growth in the quarter on the base business.

Speaker 3

And a chunk of that did come from revenue per rec. Despite a 50 basis point, headwind on price, our clinical mix and business mix improved in the quarter, which contributed to that Strong base performance. So we were happy with the utilization levels. Physician offices appeared to be strong and even our Health Systems segment, which is a combination of our reference testing in PLS was also strong in the quarter.

Speaker 7

Maybe just trying to dig in a little bit more, I think everyone's trying to understand the market growth and share dynamics. Are you what's the What's your dialogue like with hospitals now around either outreach sales or more kind of reference work getting sent out? Or Have you heard more about labor being an issue? Just any thoughts on all that would be great.

Speaker 3

Sure, Jack. So I can tell you that our opportunities with health systems has never been stronger on multiple fronts. Now in the quarter, we announced the Suma Health Outreach acquisition. Suma is a health system in Akron, Ohio. We announced a PLS new PLS relationship with Lee Health in Florida, and the funnel of opportunities continues to grow.

Speaker 3

There's not a day that goes by that we don't read in one of the journals about health systems reporting Margin pressures and exacerbated by some of the pressures they have with wages, particularly on the nursing side. So It's a very opportunistic for us to go into health systems and explain to them how we can help them reduce their lab spend by upwards of 10% to 15% to 18% and so or monetize their outreach book of business to provide some cash infusion to them. So it's an opportunistic time for us.

Operator

Next question is from Erin Wright with Morgan Stanley. Your line is now open.

Speaker 8

Hi. Could you give us an update on your relationships and negotiations with the commercial payers and Offsets in terms of pricing dynamics there? And where we at in terms of those preferred relationships helping to Dear volume and do initiatives such as United's Laboratory Benefit Management at Optum that was more recent, does that have any impact on your business at all? I believe it's targeting some over testing on the esoteric side. Thanks.

Speaker 3

Yes. So thank you, Aaron. So our relationships with commercial payers, if you want to measure the output of The relationship, again, we'll turn to the pricing environment. It's never been better. We are only down 50 basis points In the quarter, and you go back to 2018, 2019, we were losing 100 basis points.

Speaker 3

We've also said that the majority of the negotiations we've had with payers over the last 2 years have resulted in either flat to positive price increases, and so we consider that a victory. We've also said that The number of value based relationships that we're entering into, meaning that there's opportunities for us to Create value for them and earn value back for us by working very closely with the likes of UnitedHealthcare and Anthem. And we work together as teams and we target physicians that are using out of network labs. We target physicians that are using expensive health system labs and collectively, our teams work this day in and day out. And yes, we've been able to move REX from High priced institutions to better quality, lower priced labs like Quest Diagnostics.

Speaker 3

Yes.

Speaker 2

Two comments on Jack's question and then Aaron's. First of all, our plan is to gain share. And One element of gaining share is the relationships with health plans. And we do believe we're making progress and that progress will continue As we pick up more share, particularly with the nationals, I just want to make sure we remind you that the 50 basis point It's not exclusive to commercial payer pricing, but all pricing. So commercial payer pricing is within it and that has improved to Jim's comment vastly versus where we were, but we have price pressure with client relationships with physicians.

Speaker 2

We have price concessions with hospital reference works. So there's other price concessions in that number. But on the commercial payer side, it's less than 50 basis It's much improved from where it was years ago.

Speaker 8

Okay. Thank you so much.

Operator

Next question is from Brian Tanquilut with Jefferies. Your line is now open.

Speaker 5

Hey, good morning, guys. Congrats on the quarter. So as I think about just the core testing, obviously COVID is declining here. How should you be thinking about your outlook here for 2023, especially given the economic backdrop that we're seeing and then the broader inflation trends that we're seeing And how that's impacting the consumer, essentially the patients?

Speaker 3

Yes. So thanks, Brian, for the question. The way I would think about it is, again, COVID continues to come down, although we may be at an inflection point here on COVID. Too early to tell, but obviously these two new variants, the BQ1 and BQ1.1, are growing in terms of concern. It's now 12% of all new cases higher in the East, reported to be over 20% in the New York City area.

Speaker 3

But as of now, we're thinking 10000 to 15000 a day as we go into next year. We reported that our base business, the volumes recovered as we move through the Q3. We expect that trend to continue. And but remember, physicians are only part of it. Again, we feel great about opportunities to help our health system partners, Whether it's additional reference testing or PLS, and then we feel great about our acquisition funnel.

Speaker 3

And we're Looking at several outreach opportunities, we announced one that closed, but stay tuned. There should be some more announcements as we get into the early part of next year.

Speaker 2

And I'll just remind you all that there is a correlation between COVID volumes in our base business. And so as COVID improves, we believe that could help our base business and we clearly started to see that in Q3. And to some extent, as we've talked before, we have somewhat of a natural hedge because if COVID goes out and base softens, we have seen that in the past. And therefore, The improving COVID situation should be a tailwind on base growth going forward. And as we said before, most of our major markets Have recovered.

Speaker 2

We still have not seen full recovery in New York City, and we still believe that we'll gradually, You'll step by step improve over the next couple of years and we'll go back to where we were in 2019. So that's the only But major metropolitan area that we haven't seen full recovery. So from an overall perspective, the COVID Direction should be favorable to base.

Speaker 1

Awesome. Thanks guys.

Speaker 2

Thank you.

Operator

Next question is from A. J. Rice with Credit Suisse. Your line is now open.

Speaker 9

Thanks. Hi, everyone, and best wishes, Steve, in the future there.

Speaker 5

Thanks, Jason. Thanks, Jason.

Speaker 9

Maybe just to talk a little bit about capital deployment. You're talking about, obviously, you did A lot on the share repurchase year to date, as you mentioned. So that continues to be part of the story. You've got these hospital opportunities. There are other M and A potentially tuck in deals out there and then some of the investments consumer, direct and so forth.

Speaker 9

Does that how do you see capital priorities and capital deployment as we exit this year and think about the next year or 2?

Speaker 1

Yes. Thanks, A. J, for the question. This is Sam. So as you think about our position right now, we've generated $1,380,000,000 of operating cash flow through 3 quarters of the year.

Speaker 1

We're sitting on a very healthy amount of cash of 700,000,000 When you think about our capital deployment philosophy, it's very consistent. We said that we're going to return the majority of our free cash flow back to shareholders. And we're going to focus on making sure that obviously we invest in the business that's we talked about the strategic investments. This year we expect to make $60,000,000 of strategic investments. We've net of the $400,000,000 of capital, whatever free cash flow that we have, we're going Return back to shareholders in the form of dividends, in the form of share repurchases And M and A.

Speaker 1

Now to the extent that I think we have a robust pipeline of M and A transactions and opportunities, as Jim mentioned, To the extent that we we're going to be very disciplined about M and A though. I mean to the extent that we don't have accretive deals that we believe really add strategic value to us and produce the and meet the ROIC threshold that we have and are accretive, then we're going to return back that cash in terms of share repurchases. Okay. Thanks a lot.

Speaker 3

Thanks, Digi. You're welcome.

Operator

Next question is from Pito Chickering with Deutsche Bank. Your line is now open.

Speaker 10

Hey, good morning, guys. Thanks for taking my questions. And Steve, thanks for all of your help over the years. I mean, I have just sort of a different question. So the 4th quarter guidance Of $1.91 annualizes to $7.64 and has good guys for the improved base pricing business as well as strong COVID pricing.

Speaker 10

So if we put $0.50 of PAMA in that one, that would be the launch pad in 2023 Is 713, which seems like a pretty big gap versus 850 consensus number? So can you give us some more color on How to bridge the gap between $7.13 $8.50 $8.50 $10 between revenue growth and cost

Speaker 1

cutting? Yes.

Speaker 3

Thanks, Pito. And let me start and then I'll have Sam pipe in here. So first, our long term guidance on the growth rate of the company remains. We expect to grow our top line on the base business 4% to 5%, and we expect to get nice margin accretion off of that 4% to 5%. We still feel good about that 4% to 5% next year.

Speaker 3

Obviously, we've said 2 percentage roughly 2 percentage points of that can come from acquisition. We've said we've Got a great list, a good funnel of both tuck ins from Outreach as well as a few, what I would call, deals that Enhance our capabilities, fill in some gaps in our portfolio. So feel good about that. We also feel good about our Invigorate program And continuing to work that, as Sam said, reinvigorating our Invigorate program to offset some of the margin pressures that we've seen from inflation. So we feel good about it.

Speaker 3

We feel good about the investments that we're making in ADX, and we've said that consumer

Speaker 1

initiated testing next year should be a tailwind

Speaker 3

to us. And then We are fine tuning the cost structure and we'll make the necessary rebalances in the cost Sure to deliver what we need to deliver next year. So we feel good about it. Yes. Maybe I'll add a couple

Speaker 1

of comments to Jim's. So just we are not going to give you obviously guidance right now, but just maybe directionally give you some things also to build into Or to think about as you build your model for next year, expense reductions is an important one. Jim mentioned that. The fact that the CIT investments will drive growth in that consumer segment and so they will be less dilutive as you look at next year versus this year. The fact that when you think about pricing, it's a definitely improving environment for us.

Speaker 1

As we've said, 50 basis points In Q3, so that's additional number that maybe some of you used of 1% pricing, negative pricing impact It is no longer the case in terms of what we're seeing because of all the things that we talked about around value based contracts with the health plans. And then when you think about COVID, I mean COVID is The assumption going into 2023 is that it's 10000 to 15000. There's variability around that, but that's our assumption right now. And the 10000 to 15000 is so it's coming down, COVID testing is coming down. There's an improvement in the base business as a result of that.

Speaker 1

But also the fact that with the PHE Ending at least our assumption is that it ends in January, even though that average reimbursed price comes down, that's not a straight impact to margin because we have Costs that we incur in the nontraditional retail channels right now that we will no longer incur after the end of the PHE emergency. So you can't also take The margin on COVID as being completely impacted by that price or by that reimbursement decrease.

Speaker 2

And Pito, remember that our base business is growing In 2023, okay. So when you think about modeling it off the Q4, remember the base will grow, okay. And then secondly, just to underscore Jim's comments is this company and will continue under Jim and Sam's leadership has a long track record of productivity improvements. And so Jim in his prepared remarks talked about our operational excellence program. And we have a specific program called Invigorate and that Invigorate program is to drive 3% productivity.

Speaker 2

So when you think about 2023 and you think about potentially getting a PAMA cut, You need to think about the expense reduction, base growth as well as Invigorate offsetting some of the inflationary pressure as well as potentially a PAMMICA. And I can tell you, we highlighted this before in our investor presentations, There's a lot more room for us to drive productivity, particularly around automation And digitization going forward, and Jim will be driving that as he leads the company.

Speaker 10

Great. Thanks so much, guys.

Speaker 2

Thank you.

Speaker 1

Thank you.

Operator

Next question is from Patrick Donnelly with Citi. Your line is now open.

Speaker 5

Hey, guys. Thank you for taking the questions. Maybe one on

Speaker 1

a similar vein, at least on

Speaker 5

the cost side, just in terms of some of the labor retention, labor inflation that you guys have seen. Can you just talk about, I guess, where we are And that process and then secondarily, kind of on the back of that, the supply chain as well. I know it's been a

Speaker 3

bit of a What kind of issues pop up

Speaker 5

and you guys handle them well? Has that plateaued getting better? Maybe just a little bit of color there would be helpful.

Speaker 3

Yes. So thanks, Patrick. So first, on the labor inflation. So what we're seeing this year is between 3% 4%. And our plan next year is to have a merit increase of roughly 3 across the company.

Speaker 3

But we would expect to have to make some other equity adjustments along the way. So I think from a planning modeling standpoint, That 3% to 4% range still feels good from a labor utilization. What I'll tell you on our employee retention and attrition is that it has Stabilized here in the Q3, albeit it stabilized at a higher level than we would like, which Obviously, it affects productivity. So we continue to work really hard on making Quest the employer And it's not just about wages. There's a lot of other things, as you can imagine, that go into that.

Speaker 3

In terms of Inflation on the supplies and materials front. We purchased north of $2,000,000,000 What we call pre analytical and analytical supplies. And on that roughly $2,000,000,000 About 80% of it is locked up in terms of it's under contract. And most of those contracts That we've entered into in previous years actually do not contain price indexes or price going up. If anything through the contract period, sometimes prices improve.

Speaker 3

So we feel good about that, but 20% of Roughly $2,000,000,000 is a big number that is not completely locked up, and that's where we do see some inflationary pressures. In addition to the preanalytics And analytical supplies, we have a lot of we have roughly $800,000,000 $900,000,000 of other spend, that is logistics, professional service, janitorial services, travel, living expenses. So all of that is really not under contract, And that's where we see the majority of inflation in our business today. Will it get better next year? Will it get worse next year?

Speaker 3

Hard to predict, but everything that the Fed is doing will Please slow those inflationary pressures that we are seeing. But again, we're committed and we work real hard through

Speaker 1

That's helpful. Thank you. Yes.

Operator

Next question is from Derik De Bruin with Bank of America. Your line is now open.

Speaker 5

Hi, good morning. Steve, thanks for all your time and patience with me. I appreciate over the years. Thank you. I guess just a couple of questions since a lot of might have been answered already.

Speaker 5

But Are you expecting any sort of relief or do you expect SALT for the past and sort of like your update in PAMA? And then A follow-up on that or another one. As we sort of head into a recession and inflation picks up, I mean, are you seeing any increase in bad debt From your customers, any concerns on people opting not to pay bills as they're sort of struggling right now? Thanks.

Speaker 2

So let's start with the Salsa PAMA comment. So as we said for many years now, you should plan on a Pam McCott in 2023, that's what we assumed. And until we have news that's better than that, we should assume that. Number 2 is in my prepared remarks, I talked about the effort on Salsa. What I'll add to those comments is the support, congressional support And this is on both sides of the aisle and both in the House and in the Senate is very strong.

Speaker 2

So there is alignment that we need to have a permanent fix To the implementation of PAMA. But as you can imagine, Washington is busy. There's a lot of topics on the table and we're trying to find A vehicle that we can attach it to and I would expect if we were successful with Salsa, it will be late in this year They will know that. And also, it's going to cost money. So we're in the process of getting a score from CBO And there needs to be a pay for.

Speaker 2

So we're working through that, but I could tell you the alignment and the support of my colleagues throughout this industry has never been stronger And we're doing grassroots efforts to send letters into Washington. So really a full court press to get salsa over The goal line. Now if we don't or if we're not successful with Salsa, the question is, could we get another year of relief? We've got that in the past. Again, I'm not going to indicate that we're going to get that again.

Speaker 2

But if we don't get saucer, there obviously will be a pivot to ask for another year of relief and we'll push on that. But again, we're not planning that in our 2023 planning. Jed, do you want to comment on the second piece?

Speaker 3

Yes. So Dirk, your question on are we seeing an uptick in our patient concession rate, our patients less with the patient. No, we're not seeing any impact As of yet, on that, in fact, our patient concessions have actually improved rate has actually improved year over year and we're going to build in improvement into next year. We do a lot of things to work this, and we work it real hard. We have what we Call real time adjudication.

Speaker 3

So a patient comes into our PSC, we take the requisition and we can literally adjudicate that claim, ex the payment coming to us. So we know real time what tests on that requisition are going to be approved or denied, and we know what the patient balance is. And then we provide multiple ways for that patient to pay the bill or give us a form of payment, so that when the claim is adjudicated, We know how to charge the patient. We're working on things to actually move that whole process upstream. So when the patient makes an appointment And that requisition has already been delivered to us because the physician has sent it to us electronically.

Speaker 3

We can do that Pre adjudication, if you will, as the patient is making an appointment online. So even before they come into the PSC, we can Pre adjudicate that claim, we're going to build the capability to do that. And so it improves our PSC productivity as well as gives the patient Knowledge of what they're going to be billed before they walk into the PSC. So lots of things we're doing to make it easier to pay, to inform the patient

Operator

And the last question in the queue is from Eric Coldwell with Baird. Your line is now open.

Speaker 11

Thanks very much. I'm going to come back to a topic that's been hit a few times, but maybe asked a different way. The base revenue per acquisition, very, very strong here. I know we've heard a lot of comments on pricing improving or really being less bad down 50 bps, which would I think imply that your mix component and other components must have been something more like 4% growth on a per test basis. So I'm curious if you can quantify for us or give us some Qualitative color on what type of mix improvements you saw, what categories of testing were you Seeing the number of tests per acquisition go up this quarter more than normal, was there a changing impact from PLS volumes in the numbers this Quarter or were there some nuances with value based contracts that maybe aren't fully Understood by The Street that could have been driving some of this upside, mix driven revenue per rec.

Speaker 11

I know I'm throwing a lot at you, but it feels like that was A pretty big number, so want to dig into it.

Speaker 3

Yes. So thanks, Eric. So as you know, there's a lot of things that go into the rev rec Calculation. So let's take price per test out because we already said that it was down about 50 basis points. So your math is directionally correct.

Speaker 3

All other things were up About 3.8% in the quarter. There's really 3 very different types of mix that enter into that. There's clinical mix, business mix and payer mix. And from let me just start with clinical mix. I'll just tell you that the investments we're making in advanced diagnostics are paying off.

Speaker 3

We're getting a higher mix of Molecular and other genetic and advanced based tests, hematology was good, some of our cancer testing really good in the quarter. From a business mix standpoint, There's a lot of things there. First, from a commercial payer standpoint, there's a mix of cap and fee for service. And we'll just tell you, in the quarter, fee for service was better and cap was less. And if cap is less, then Obviously, you get a fixed payment, so that certainly helped us.

Speaker 3

Our Health Systems business was actually just a pure reference was good in the quarter, And that tends to mix up our rep per rec. And then finally, there's payer mix issues. What portion is coming from commercial? What portion is coming from Medicare? What portion is coming from Medicaid?

Speaker 3

And that was favorable in the quarter. And then finally, CIT, our consumer initiated testing business has a higher Revenue per rep, the pricing is better in that market and we're getting some lift from our CIT business. So, a lot of factors go into it, But that's kind of the summary of it.

Speaker 1

Thank you, Jim.

Speaker 3

You're welcome.

Speaker 5

Okay. I think that was the last

Speaker 2

So a question, again, thank you for your support over the years. You added up the math and this is my 42nd Call, it's been a pleasure working with all of you. Thank you for all your support. And I'm sure you're going to be seeing me

Operator

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 203-369-3609 for international callers or 888 566-0462 for domestic callers. Telephone replays will be available from approximately 10:30 am Eastern Time on October 20, 2022 until midnight Eastern Time November 3, 2022. Thank you and goodbye.

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Earnings Conference Call
Quest Diagnostics Q3 2022
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