Quest Diagnostics Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
October 24, 2023

There are 10 speakers on the call.

Operator

Welcome to the Quest Diagnostics Third Quarter 2023 Conference Call. At the request of the company, this call is being recorded. The entire contents of the call, including the presentation and question and answer session that will follow are the copyrighted property of Quest Diagnostics with all rights reserved. Any redistribution, retransmission or rebroadcast of this call in any form without the written consent of Quest Diagnostics is strictly prohibited. I would like to introduce 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 Jim Davis, our Chairman, Chief Executive Officer and President and Sam Samad, our Reconciliation of non GAAP measures to comparable GAAP measures in the tables to our earnings press release. Actual results may differ materially from those projected. Risks and uncertainties that may affect Quest Diagnostics' future results include, but are not limited to, those described in our most recent annual report on Form 10 ks and subsequently filed quarterly reports on Form 10 Q and current reports on Form 8 ks. For this call, references to reported EPS Any references to base business, testing revenues or volumes refer to the performance of our business, excluding COVID-nineteen testing.

Speaker 1

Growth rates associated with our long term outlook projections, including total revenue growth, revenue growth from acquisitions, organic revenue growth and adjusted earnings growth Our compound annual growth rates. Finally, revenue growth rates from acquisitions will be measured against our base business. Now here is Jim Davis.

Speaker 2

Thanks, Sean, and good morning, everyone. We grew our base business nearly 5% in the 3rd quarter, largely by driving growth in our physician and hospital channels. Our consumer channel also continued to produce solid base business revenue growth. In addition, we are pleased that we have now successfully completed negotiations for all our strategic health plan renewals that were scheduled for this year. These strengthened collaborations will position us to build on growth opportunities going forward.

Speaker 2

Our Invigorate program is on track We delivered 3% annual productivity improvements and savings. In addition, the productivity of our base business improved sequentially and year over year. Given the strength of our business and a robust pipeline of professional lab services and M and A opportunities, We are well positioned for continued growth. This morning, I'll discuss highlights from the Q3. Then Sam will provide more details on our financial results and talk about our updated financial guidance for 2023.

Speaker 2

Now let's turn to some of the highlights from the quarter. Our strategy is to drive growth by continuing to meet the evolving needs of our core customers, physicians, hospitals and consumers. We are enabling growth across our customer channels through advanced diagnostics with an intense focus on faster growing clinical areas, including Molecular Genomics and Oncology. In addition, acquisitions remain a key driver of our growth with an emphasis on accretive hospital outreach purchases as well as smaller independent labs. Finally, our strategy includes driving operational improvements across the business with strategic deployment of automation and AI to improve quality, efficiency and service.

Speaker 2

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

Speaker 2

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

Speaker 2

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

Speaker 2

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

Speaker 2

We are particularly encouraged by growth in our Alzheimer's disease portfolio, which features our AD Detect blood testing services. These innovative services use highly sensitive mass spectrometry technologies to provide insight into Alzheimer's risk based on amyloid proteins and the ATOE genetic risk marker. During the quarter, we saw strong demand for our Alzheimer's Cerebral spinal fluid panel as well, which helps providers identify levels of both amyloid and tau proteins as well as the APOE status. We also grew significantly in women's and reproductive health, especially in non invasive prenatal and carrier screening tests. During the quarter, the FDA granted breakthrough designation for our adeno associated virus called AAV, Companion Diagnostics, which we developed in collaboration with Sarepta Therapeutics for their Duchenne muscular dystrophy gene therapy.

Speaker 2

This FDA designation places us at the forefront of AAV test innovation in the growing area of cell and gene therapies and positions us to build collaborations with other biopharmaceutical companies. Finally, the integration of Haystack Oncology remains on track. The acquisition positions us to enter the high growth liquid biopsy area of minimal residual disease or MRD testing. We expect to launch our first MRD test in early 2024 from our Oncology Center of Excellence in Louisville, Texas. Now turning to operational and productivity improvement.

Speaker 2

Our Invigorate program is well on its way to delivering our targeted 3% annual I'd like to share three examples of how we're improving operations. First, we are deploying front end automation to enhance Specimen processing in our Pittsburgh and Dallas Laboratories, which will improve quality and productivity. More sites are planned to receive front end automation during 2024. We are expanding the use of optical character recognition or OCR To scan in data from samples coming into our labs. By freeing up specimen processors from this manual data entry, We will improve our productivity of paper based RECs coming into all of our regional labs by 30%.

Speaker 2

Finally, we continue to optimize our real estate footprint. Post pandemic, we need less space for some of our call center and administrative functions. We've reduced our real estate footprint by nearly 250,000 square feet by consolidating functions into existing spaces. Before I hand it over to Sam, I'd like to offer our perspective on the rule recently proposed by the Food and Drug Administration that would regulate laboratory developed tests as medical devices. Lab developed tests are essential medical innovations that providers use to guide Care for patients every day.

Speaker 2

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

Speaker 2

Sam?

Speaker 1

Thanks, Jim. In the Q3, consolidated revenues were $2,300,000,000 down 7.7% versus the prior year. Base business revenues grew 4.6 percent to $2,270,000,000 while COVID-nineteen testing revenues declined 92% to $26,000,000 Revenues for Diagnostic Information Services declined 7.9% compared to the prior year, reflecting lower revenue from COVID-nineteen testing versus the Q3 of 2022, partially offset by growth in our base business. Total volume measured by the number of acquisitions declined 0.5% versus the prior year, with acquisitions contributing 50 basis points Total base testing volumes grew 5.7% versus the prior year. Revenue per requisition declined 7.2% versus the prior year, driven by lower COVID-nineteen molecular volume.

Speaker 1

Base business revenue per rack declined 0.4% due to growth in our PLS relationships And lower demand for respiratory panels, partially offset by an increase in unit price reimbursement and test mix. Positive unit price reimbursement was consistent with our expectations. Reported operating Income in the Q3 was $342,000,000 or 14.9 percent of revenues compared to $392,000,000 or 15.8 percent of revenues last year. On an adjusted basis, operating income was $380,000,000 or 16.6 percent of revenues compared to $423,000,000 or 17 percent of revenues last year. The year over year decline in adjusted Operating income is related primarily to lower COVID-nineteen testing revenues, wage increases and higher benefit costs, Partially offset by growth in the base business, lower performance based compensation and headcount reductions.

Speaker 1

We continue to closely manage the costs of our corporate and support functions, and our actions to reduce support costs by approximately $100,000,000 this year remain on track. Reported EPS was $1.96 in the quarter compared to $2.17 a year ago. Adjusted EPS was $2.22 compared to $2.36 last year. Cash from operations year to date was $745,000,000 versus $1,380,000,000 in the prior year period. The decline in operating cash flow was primarily related to lower operating income and timing of collections.

Speaker 1

Turning to our updated full year 2023 guidance. Revenues are now expected to be between $9,190,000,000 9.2 for $4,000,000,000 Base business revenues are expected to be between $8,990,000,000 $9,040,000,000 COVID-nineteen testing revenues are expected to be approximately $200,000,000 Reported EPS narrowed to be in a range of $7.61 to $7.71 and adjusted EPS narrowed to a range of $8.65 to $8.75 with the midpoint of $8.70 unchanged. Cash from operations is It is expected to be approximately $1,300,000,000 and capital expenditures are expected to be approximately $400,000,000 With that, I will now turn it back to Jim.

Speaker 2

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

Speaker 2

And now we'd be happy to take your questions. Operator?

Operator

Thank you. We will now open it up to questions. Our first question comes from Ann Hynes with Mizuho Securities. You may go ahead. Good morning.

Operator

Thank you. Can you just comment on progress on what's happening with the turnover? And do you still feel good about your 16.5% margin goal for 2023. Thanks.

Speaker 2

Yes. Good morning. Thanks. Hey, the employee turnover, Again, improved from Q2 to Q3. So we've certainly seen improvements as we've marched from Q1 to Q2 to Q3 and expect to see more improvements as we go to Q4.

Speaker 2

Having said that, we're still not back to 2019 or pre COVID levels, But we feel optimistic that as we go into next year, it will actually be a continued tailwind for us. Sam, do you want to comment

Speaker 1

Yes, sure. Anne, thanks for the question. So as you recall on the Q2 call, we talked about operating margins Expectations being approximately 16.5%. As Jim mentioned, we're seeing slight improvement in terms of turnover. We have made some investments and are going to be making some investments in terms of frontline phlebotomists in anticipation of Volumes coming into the winter season here, but also the strong utilization that we've seen.

Speaker 1

And With regards to margins, we now expect to be slightly below the approximately 16.5% for the year. We're making really good progress on all the cost initiatives And also the productivity improvement initiatives, volumes have been strong, but we especially in light of volumes, we have to make some targeted investments in terms of frontline staff and phlebotomists.

Speaker 2

Yes. Anne, let me just make one other comment on the margins. If you go back and start with Q1 of this year, in Q1, we were Slightly north of 15%. And in that quarter, we did $120,000,000 of COVID revenue. And as you know, the reimbursement was still at $100 at quarter.

Speaker 2

We go to the 2nd quarter and we improved our margins up to 16.7% With COVID going from $120,000,000 down to $41,000,000 And in the Q2, COVID was at a blended rate of, call it, dollars 75 Now we go back into the Q3 and COVID is really insignificant in our results. It's only a percent of our total revenue And the reimbursement on that small one percent, as you know, for the whole quarter was at $50 and we hit 16.6%, so basically in line with Q2. So we're really proud of the productivity efforts and it's really coming through in these numbers and the progress that the teams have made from Q1 to Q2 to Q3.

Operator

And our next caller is David Westenberg with Piper Sandler. You may go ahead.

Speaker 3

Hi. Thanks for taking the question. So just thank you for the commentary on the FDA's proposal on LDTs. I'm not sure if you can answer it yet because I mean right now it's still kind of maybe a little bit more hypothetical here. But how should we anticipate potential costs If it stands the way it is, I mean, is this about going back to the FDA with some of the more high value tests?

Speaker 3

Or is this maybe about switching out to Maybe IVD cleared products, I mean, how does this look for Quest? And I get some of this is maybe theoretical right now because We don't know what it's going to look like in a month.

Speaker 2

Yes. I think your last statement is accurate. It's largely theoretical at this point because we don't know what it's going And the FDA certainly opened this up to commentary and response Back from industry and HACLA and other associations. Look, having said all that, LDTs are not the most significant part of our operations. In fact, it's on a volume basis, it's Less than 10% of what we do and the 3 labs that we do our LDTs, most the majority of our LDTs in Are actually ISO certified.

Speaker 2

We do companion diagnostics, which is a regulated form of Testing, right? You're on label for a pharmaceutical drug. So it's just not it's not A huge deal for us right now. Now having said all that, we're going to work with our trade association. We don't believe the rule makes sense.

Speaker 2

We don't believe it's fair. And we'll continue to work to arrive at something that we do think is good for everyone.

Speaker 1

Operator, next question.

Operator

And our next question comes from Lisa Gill with JPMorgan. You may go ahead. Thanks very much. Good morning. I'm just curious if you have an update as to how we should think about PAMA or Salsa going into 2024, just given the current environment in DC.

Speaker 2

Sure. Well, you're right. The current environment is a little Uncertain at this point. But here's what I would say. The current standstill in Congress, I think we'll make what we call a comprehensive PAMA reform more difficult, right?

Speaker 2

So salsa, I think, will be more difficult to get through this year. Having said all that, PAMA, a delay in the cuts of PAMA, again, Went to the CBO, so this is a new analysis from the CBO updated versus last year. And again, the CBO scored a 1 year delay as A significant cost savings to the government. And again, the reasons for that is because if you continue to delay the PAMA cuts, you're going to Continue to delay a new data collection process and we, our trade association and obviously the CBO is convinced That a new data collection process will lead to higher rates. So we feel good, that the likelihood of a 4th PAMA delay will occur, but certainly it has to be part of some broader healthcare package.

Speaker 2

And There's a lot of things that will be in that healthcare package that are important to a lot of different constituencies. So we're confident that something will get done there.

Operator

Thank you.

Speaker 1

Operator?

Operator

Our next question comes from Pito Chickering with Deutsche Bank. You may go ahead.

Speaker 4

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

Speaker 1

Yes, Kieran, this is Sam. Thanks for the question. So I think some of the drivers that you would expect in Q4 are what we've been Executing and seeing in Q3 and earlier in the year, I mean, Jim talked about the sequential improvement in operating margins despite the fact that COVID is coming down significantly. So what we would expect in Q4 is the following that helps our margins, which has been Playing out so far over the course of the year. One is price.

Speaker 1

We continue to see a healthy positive environment around price and we in fact saw Positive price in Q3 and we expect to see positive price in Q4 and that's driven by all the work that we're doing around the strategic plan, The 3rd party plan renewals and some of the value based contracting that we're doing there, so definitely the Healthiest pricing environment that we've seen in a while. CIT, as you said, is a factor. It was dilutive in the 1st quarter. It turned profitable in the 2nd quarter. It was profitable in the 3rd, and we expect it to be profitable again in the 4th.

Speaker 1

We continue to do the cost I mean, The benefit of the cost reductions in Q4, we talked about $100,000,000 of annual impact of cost reductions on the SG and A line, and we expect to see that At least 1 third of that be in Q4 as well because those savings started in Q2. And then we're taking a lot of actions As well around improving productivity, Invigorate is one of them that you mentioned, but that's also factoring into margin. So all of that is driving the better than pre pandemic Trends that you've talked about. Now as I said earlier, we are still seeing turnover in higher than what we would It has improved slightly in Q3, but it is still trending higher than where it was pre pandemic. And As I said, given the strong utilization that we're seeing across the business and we saw that in Q3 as well, we're having to make some targeted increases across frontline staff and phlebotomists to help service some of these volumes and we expect that to be an impact in Q4, an offsetting More of a headwind of an impact.

Operator

Our next caller is Elizabeth Anderson with Evercore. You may go ahead.

Speaker 5

Hi, guys. Thanks so much for the question. I guess I just want to double click on the gross margin a little bit more in the Q3. I think in different answers, you've given us bits and pieces. But if you could just talk either Sequentially or on a year over year basis sort of a rank or either if you have dollar amounts or sort of rank order the biggest contributing factors.

Speaker 5

And then secondly, it sounds like you have Some good sight line and to invigorate savings to the Q4 and some continued productivity initiatives. How do we think about the flow through Of that into as we start to think about 2024, and sort of what we might be expecting from those sort of cost savings and Invigorate programs? Thank you.

Speaker 1

Yes. Thank you. So with regards to gross margin, gross margins in Q3 were in line with our expectations. I mean, the key driver, I would Say for them being below Q2 levels, where the fact that we had lower revenues of $45,000,000 Going in Q3 versus Q2, so sequentially we saw $45,000,000 lower revenues. Now a portion of that was COVID, not the biggest portion, it was about Roughly $15,000,000 lower revenues in terms of COVID.

Speaker 1

And then because of seasonality, as expected, we saw lower revenues on the base business as well. So when you think about the impact on gross margins and gross margins were down a percentage point sequentially, that's almost entirely driven by revenue, the revenue decline. And then on COVID, we're also talking about or what we are seeing in Q3 was a lower price Around COVID, in Q2, driven by the fact that the PHE didn't end until midway through the quarter, we saw a higher price on average for COVID. We saw lower price in Q3, so that has an impact on gross margin as well. So those are the key drivers on gross margin.

Speaker 1

It's in line with our expectations. Invigorate and Jim will make a couple of comments on Invigorate here. But with regards to Invigorate, the actions are yielding the 3% Productivity improvements and cost reductions that we expected and those will continue into 2024. But Jim Maybe make a couple of comments.

Speaker 2

Yes, certainly, Elizabeth. So we're going to set targets going into 2024 that are similar to what we've done in the past. So we expect to generate approximately 3% variable cost productivity throughout our entire operations. That's phlebotomy, logistics, The front end of our lab and then actually all of the processing. We've talked broadly about the use of automation.

Speaker 2

We're driving that Fast and furious as we can. We've talked about the use of artificial intelligence to do some of the manual work that our lab techs, This could be automated reading of curves. We've talked about in the past the use of artificial intelligence in microbiology, hematology, And then we continue to work the standard things that we always work as a business, reimbursement and denials. There's always a big bucket of opportunity for us. Paper recs, I talked in the prepared remarks about implementing, OCR technology to read all of these paper recs That still come in.

Speaker 2

We work them down every single year, but there's still a fair number, even if it's 15% to 20%, when you do the math on that close to 200,000,000 racks, There's still a ton of opportunity there. So we feel good about our productivity efforts going into next year. We invest in it. We put Talented teams are around it and we'll continue to drive it hard.

Speaker 5

Great. Thanks so much.

Speaker 6

You're welcome.

Operator

Next call is Mr. Brown with Bank of America. Please go ahead.

Speaker 6

Hi, good morning. Thanks for taking my question. So I've got 2. The first one just going back to PAMA. In 2023, it got delayed and I think it will probably get delayed in 2024.

Speaker 6

But in 2023, We didn't see a lot of the savings drop down to the bottom line because of Haystack and some of the other investments that you're doing. I guess for 2024, Does that drop down if we're to get delayed, I. E, is it accretive to what your plans would be? Is that you're going to do it? Or Does it get offset by that?

Speaker 6

So that's the first one and then I've got a follow-up.

Speaker 2

Yes. Well, first I'd say, with respect The drop down, when we look at the drop down on the incremental growth that we've gotten through our base business and we look at the drop down on that growth, we're pretty Okay. And that is after the dilution effect that we've seen from Haystack, the investments we're making there, which are going to propel future growth. As we go into next year, we will take we're not going to give guidance today, but we're going to take a close look if PAMA does get delayed. We'll obviously look at both investment opportunities to drive future growth.

Speaker 2

We'll look at investment opportunities to drive margin improvement and invigorate investments. And then we'll also obviously look at returning Like we always do, the majority of our free cash to shareholders.

Speaker 6

Thanks. And just on the Alzheimer Diagnostics, Are you going to seek FDA approval for that? I'm just really curious on reimbursement, patient costs, what's the test cost in doing it? I'm just curious on sort of Strategy is there, given that it is a new diagnostic category.

Speaker 2

Okay. So there is reimbursement for the test Today, CMS has established about $100 reimbursement for the blood based AB-four thousand two hundred and forty test. Having said all that, the preponderance of our orders and the preponderance of our reimbursement actually comes from Client bill, where we directly bill health systems that are caring for these patients. And I would tell you that the reimbursement is better than what we see on average from Medicare because it's an incredibly value added test. So we price it appropriately.

Speaker 2

At this point, we're not seeking FDA approval for it. It's an LDT like many of the And so we're pretty happy with it. The growth has been substantial. And I would also tell you that the growth of our CSF testing, the cerebral spinal fluid testing is also significantly up in the quarter As clinicians are using both CSF and blood based biomarkers to make to help with the diagnosis of patients.

Speaker 1

And Derek, maybe just to come back to the PAMA question and add a couple of points there for you and others that are on the call. Given the uncertainty around PAMA, we will plan today as if PAMA is going to come back and will not be delayed in 2024. That's I'd say that's the prudent thing to do. That's the only thing we can do at this stage given the uncertainty. So we will plan as if Prices will come down next year because PAMA will come back.

Speaker 1

Now if as we I would say on balance, I'd say there's a likely chance that PAMA will get delayed. And if that were to happen, and as we've talked about before, we could see an $80,000,000 to $90,000,000 Benefit as a result of that delay, not benefit versus this year, but benefit versus our planning. And when that and if that happens, I should say, Then we will assess how much we invest in the business to everything that Jim said earlier and how much potentially could drop to the bottom line to EPS. But that decision It's not made yet. We'll make that decision when we set guidance.

Speaker 1

And we will evaluate investments that we can make and then evaluate what we can drive as EPS improvement.

Speaker 6

Great. Thanks for the clarity, Sam. Appreciate it.

Operator

Our next caller is Andrew Breckman with William Blair. You may go ahead.

Speaker 2

Hi, guys. Good morning and thanks for taking the question. And, Jim, I want to go back to your comments around reducing leakage to high cost labs. I think you talked about in your opening remarks. I know that's sort of part of the strategy here, but can you maybe just sort of talk about that opportunity broadly and just sort of quantify how big that could be for your growth going forward?

Speaker 2

Thanks. Yes. I think there's 2 buckets of opportunity there. 1 is reducing leakage to out of network labs And then the second is what I would call steerage of work from high priced in network labs, generally in health systems to independent labs like Quest Diagnostics. So generally 2 different initiatives, but it really starts with very strong and collaboration with our commercial payers.

Speaker 2

We work hand in hand with them. They provide us the information on What physicians are using out of network high priced laboratories and they provide us the information that what doctors are sending work into health system labs, which as you know, not good for patients who are going to pay higher deductibles, higher co pays and obviously not good for the people that are For the healthcare in general, that's still employers in the country. So it's a really tight partnership. We get the information. We distribute that information out to our commercial team.

Speaker 2

We call on the customers, try to convince them to move the work. At the same time, we're always messaging as are the commercial payers out to patients to remind them that they can save money by using independent labs Likewise Diagnostics, we continue to message physicians and providers and that's why we're seeing Significantly higher growth rates with the commercial plans where we have established these types of relationships. Operator? Our next

Operator

caller is Kevin Caliendo with UBS. You may go ahead.

Speaker 7

Thanks and thanks for taking my question. Congrats on the contract renewals with your major payer partners. Can you maybe talk a little bit about if there's anything new in the contracts, the duration of the contracts? Is there The last time you did this, there were incentives that actually benefited you in terms of driving volumes. Just wondering if anything has changed Both positively or negatively, pricing, duration, terms, incentives, that kind of thing?

Speaker 2

Yes. We certainly don't talk about the terms, duration, things like that. But what I will tell you is that the trend continues. We seek to establish A fair price, 1st and foremost. And then second, as I just mentioned in the previous question, where we can move These requisitions and improve our share of the commercial payer spend, we try to design incentives Around that, in addition, we try to design incentives, when we do a hospital outreach acquisition And the prices go from 300% of Medicare as an example down to our rates.

Speaker 2

We try to step those rates down over a period of time So that we derive benefit and the commercial plan derives benefit. So we work hard to build those types of incentives into the agreement And I think the trend just continues in the direction we want.

Speaker 7

Does this lead to sort of more value based care Potential for

Speaker 1

you guys going forward?

Speaker 2

Well, I separate again value based care from value based contracts. These are what we call value based Contracts, meaning, when we deliver value back to the commercial payer, there can be incentive payments, involved in that. When we talk about value based care, these are really our arrangements with some of these ACO reach organizations and some of the other large physician groups that have taken on risk from Medicare Advantage plans. And we continue to embed ourselves Within these ACO REACH programs and continue to work closely with large physician groups that take on this risk. And As we said in the past, when these types of relationships are really good for the lab If you're managing risk, you're managing the cost of healthcare to a fixed number every year, You're generally going to be incented to provide early care and early diagnostics so that you don't let disease progress into more Expensive inpatient care, and we continue to work towards that.

Speaker 7

Thanks so much. You're welcome.

Operator

Our next caller is Jack Meehan with Nephron Research. You may go ahead.

Speaker 7

Thank you. Good morning. I had a couple of cleanup questions for Sam. First is on collections. So seeing a little AR build, I know you called it out, but anything any color you can add on that?

Speaker 7

And then second is on the base growth. 5% Pretty good. I was just wondering if weather or weekdays had any impact could have actually been better on an underlying basis? Thanks.

Speaker 1

Yes, sure. I'll take the first one, Jack, and Jim will talk a little bit about the any one timer, so to speak, weather or days. Listen, collections, nothing of note there. I think AR trending or DSO is trending a bit up. That's really more normal Trends given the reduction in COVID.

Speaker 1

With COVID, I think that would help our DSOs overall. It's a shorter collection window And DSOs were down as a result of a higher mix of COVID. But if you look back to pre pandemic, I think the DSOs are kind of trending back to where they were pre pandemic. So Really nothing of note there. There's some timing at the end of Q3 as well, but that's just normal timing within quarters.

Speaker 1

So I would say In general, collections are on track and we're happy with where things are. But Jim, did you want to make a couple of comments around base revenue growth and any one timers?

Speaker 2

Weather and days and things like that, versus last year, weather was a slight help. I Not significant at all, Jack, but it was a slight help because last year's hurricane in September was worse than this year's hurricane. The only other comment on days that I would make is, early in the quarter in July, The 4th July fell on a Tuesday this year versus a Monday last year. So in essence, your Monday Tuesday Really, really bad days versus a year ago. You only had one bad day called a Monday because the 4th fell on a Monday.

Speaker 2

But again, that's one day out of 90, so yes, I mean a little bit of an impact there, but not that significant.

Speaker 7

Appreciate it. Thanks guys.

Speaker 1

Thanks, Jeff.

Operator

Our next caller is Patrick Donnelly with Citi. You may go ahead.

Speaker 1

Hey, guys. Thanks for the questions. Maybe a couple of follow ups on Haystack. It sounds like still a 'twenty four timeline there. Can you just talk about, I guess any more specific timing and the catalyst set there, when we could expect to see some data?

Speaker 1

And then just also the spend expectations related to getting that Through the approval process as we work our way through 2024 would be helpful. Thanks guys.

Speaker 2

Yes. As we said, Haystack continues on the timeline that we set For ourselves, for the team, there's been evidence generation. Obviously, that's What we made are was part of our decision making process. Now as we get, the assay, What I call ready for commercial release, commercial production. We're in the process of establishing relationships with some of our Key oncology partners, so when the assay is ready, we'll start to do some of the testing.

Speaker 2

Likely, We'll use a lot of that early testing to then seek reimbursement once we get a substantial Build up of testing that we feel good about approaching the Maxon, and so far so good. We're bringing The assay as we mentioned in our Louisville, Texas Oncology Center of Excellence and feel good about that. I'll let Sam touch on the financials with respect to

Speaker 1

Yes, sure. I mean with regards to spend, I'll talk in Dilution terms and EPS terms here this year and then I'll talk address your question around 24, Patrick. So again, very pleased with the progress that This year we're expecting EPS dilution to be in the $0.15 to $0.20 range. We talked about that on Q2 call is still in the same range $0.15 to $0.20 If you look towards $0.24 what we said and this still applies Is that the annualized dilution in 2024 is going to be less than what we expect to see what you see this year. So the $0.15 to $0.20 if you annualize that, That's $0.30 to $0.40 next year.

Speaker 1

So we expect on an annual basis next year to be less than where things are trending this year. So improvement just on an annual basis. And then, as we look forward, we expect 25 dilution to be lower than 24 And then we expect 26 to actually be accretive. So that's consistent with what we said when we announced the deal, consistent with what we said On the Q2

Speaker 6

call. Understood. Thank you,

Speaker 1

guys. Thanks, Barry.

Operator

Our next caller is Erin Wright with Morgan Stanley. You may go ahead.

Speaker 8

Great. Thanks. You laid out some of those Key profit drivers for the Q4 and as we think about what kind of continues into 2024, I think You mentioned in the previous question kind of or a previous question, productivity gains should continue and I understand there's PAMA dynamics as well that are somewhat unknown. But Should we anticipate a deviation from the long term profit guidance of like 50 to 100 basis points operating margin expansion next year?

Speaker 1

Well, let me clarify, Aaron, and thanks for the question, by the way. So what we talked about at Investor Day is an improvement of 75 basis points to 150 basis points over the 3 years. And that's off of the rate that we have for 2023. We had said at the time the rate was approximately 17%. We said we could improve over the next 3 years by 75 to 150 basis points In terms of operating margin with the lower end being if PAMA did come back in 2024 and the higher end of 150 Being either if we had comprehensive reform around salsa or PAMA gets delayed.

Speaker 1

So the $75,000,000 to $150,000,000 over the 3 years Still applies. That has not changed. Now it's going to apply off of a lower base in 2023 because our operating margin expectations have come down. As I said earlier on the call, we expect it to be slightly below marginally below the approximately 16.5% that we talked about on the Q2 call. The positive drivers and by the way, that operating margin expansion was for 3 over the 3 years, not for 2024, but the positive drivers in 2024 still apply.

Speaker 1

I mean, 1st of all, 1st and foremost, I would say is the pricing environment. We are very encouraged by the pricing environment. We talked about the strategic relationships that have been renewed and we're seeing positive price Ex PAMA depending on what happens next year, but we're seeing positive price and we expect that to continue. We're seeing the growth investments starting to yield fruit And CIT being one of them, and we talked about that becoming profitable. Productivity improvement, both in terms of Invigorate And also hires that we do, for instance, phlebotomists that we're adding, we expect that productivity or their productivity to improve next As well as they gain more experience and they're more productive.

Speaker 1

So all of those drivers we expect to continue. Turnover is a bit of an Uncertain item, we don't necessarily expect it to become worse than it is today, but it's too early to say right now whether that Improves markedly in 2024. The early signs that we saw in Q3 right now were encouraging. We saw some slight improvement, but it's too early to say to project what that would mean for 2024.

Speaker 2

Yes. Aaron, the last thing I'd say is we're encouraged by the volume trends. And as you know, incremental volume coming into the business In a business that has lots of fixed costs, certainly, mixes up the existing margin rate. So we feel good about the volume trends in our We feel good about the volume trends in health systems. And as I mentioned in the script, we feel good about our funnel of M and A Opportunities that are in front of us as we march through the Q4 early next year.

Speaker 1

Operator?

Operator

Our last caller is Brian Tanquilut with Jefferies. You may go ahead.

Speaker 9

Hey, good morning, guys. I guess, Sam, just to follow-up on Aaron's question really quickly. If we think about the composition of margin between gross profit and G and A, Is this the right baseline to build off of factoring all the things that you mentioned, such as productivity gains and maybe PAMA? Then maybe just Jim, a quick follow-up. Hospital deals, obviously, you've had some growth there.

Speaker 9

How should we be thinking about the pipeline and your ability to And the growth rate given what's in the pipeline today? Thanks.

Speaker 1

Yes. I mean with regards to the first question, Brian, we believe it is The right baseline to build off of. 2024 is not the period to look at in terms of that improvement that we talked about, the 75 to 150, there are a couple of factors in there. One of them is there's the uncertainty of FAMA obviously, but the other one is COVID, which is approximately $200,000,000 this year is going to be a factor next year in terms of the drop off. It's going to be a negative factor again, Albeit a much smaller one than what we saw from 2022 into 2023, but it's still going to be a factor in terms of the approximately CAD200 1,000,000 going to Something we believe much less than that as it becomes just another regular test like a flu test for instance.

Speaker 1

But the baseline we believe is the right one And we are still confident about the 75 basis point to 150 basis point improvement on operating margin over the 3 years.

Speaker 2

Yes. Brian, as I said in the script, we're encouraged by the breadth and depth of our funnel of opportunities in hospital And I say that our teams are working them very hard And the trends are pointing in our direction, right? With the cost of capital going up for health systems, Their investments, I think, are truly focusing on the things that will drive growth for health systems, whether that's investments in Neurology, cardiology, cancer, obstetrics, those are the things that drive growth in health systems. And so When you make all those investments, albeit now at capital costs that are significantly higher, they can turn to us to make the investments they need in laboratories. When you see institutions like New York Presby Sell their outreach book of business and really focus their investments on the things that are driving their growth.

Speaker 2

I think that's a good Sign of how healthcare systems, the really good strategic ones are really thinking today. All right. Everyone, thanks again for joining our call today. We certainly appreciate all your continued support. I also want to thank the Quest Diagnostics team who, as we've transitioned away from COVID, have really done a magnificent job And continuing to drive growth in our base business, drive productivity and continue to satisfy our patients, providers And all those that use Quest Diagnostics.

Speaker 2

So thanks everyone and have a great day.

Operator

Thank you for participating in the Quest Diagnostics Third Quarter 2023 Conference Call. A transcript of the 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/investors or by phone at 203-369 3,502 for international callers or 1-eight hundred-nine forty five-five thousand seven hundred and fifty nine for domestic callers. Telephone replays will be available from approximately 10:30 am Eastern Time on October 24, 2023 until midnight Eastern Time, November 7, 2023. Thank you and goodbye.

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Earnings Conference Call
Quest Diagnostics Q3 2023
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