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spk12: Welcome to the Quest Diagnostics second quarter 2024 conference call. At the request of the company, this call is being recorded. The entire contents of the call, including the presentation and question and answer session that will follow, are the copyrighted property of Quest Diagnostics with all rights reserved. Any redistribution, retransmission, or rebroadcast of this call in any form without the written consent of Quest Diagnostics is strictly prohibited. Now I'd like to introduce Sean Bevick, Vice President of Investor Relations for Quest Diagnostics. Please go ahead, sir.
spk02: Thank you and good morning. I'm joined by Jim Davis, our Chairman, Chief Executive Officer and President, and Sam Samad, our Chief Financial Officer. During this call, we may make forward-looking statements and we'll discuss non-GAAP measures. We provide a reconciliation of non-GAAP measures to comparable GAAP measures in the tables to our earnings press release. Actual results may differ materially from those projected. Risks and uncertainties that may affect Quest Diagnostics future results include, but are not limited to, those described in our most recent annual report on Form 10-K, and subsequently filed reports on Form 10-Q, and current reports on Form 8-K. For this call, references to reported EPS refer to reported diluted EPS, and references to adjusted EPS refer to adjusted diluted EPS. Any references to base business, testing, revenues, or volumes refer to the performance of our business excluding COVID-19 testing. Growth rates associated with our long-term outlook projections, including consolidated revenue growth, revenue growth from acquisitions, organic revenue growth, and adjusted earnings growth are compound annual growth rates. Finally, revenue growth rates from acquisitions will be measured against our base business. Now, here's Jim Davis.
spk13: Thanks, Sean, and good morning, everyone. We delivered another strong quarter with base business revenue growth of nearly 4% and total revenue growth of 2.5%, as well as continued improvement in productivity and profitability in the base business. This performance is due to growth of new physician and hospital customers, more favorable test mix that includes greater adoption of advanced diagnostics, and continued strength in healthcare utilization. We also made progress improving our operational quality and efficiency through greater use of automation and AI. In addition, we're excited to announce four acquisitions that meet our criteria for growth, profitability, and returns, and that will enable us to expand in strategic growth areas. Our planned acquisition of LifeLabs, a trusted name in laboratory services for millions of Canadians, will enable us to grow in Canada which has a population that is growing and aging faster than in the US. LifeLabs is especially strong in two of Canada's largest and fastest growing provinces, British Columbia and Ontario, which collectively account for about half of the country's population. We are familiar with the Canadian market, having delivered reference testing to many providers there for over 20 years. LifeLabs has been one of those reference partners for about a decade, So we know firsthand that their business, team, and reputation is strong and provides a solid foundation for growth. We expect to complete the transaction by the end of this year. Our recently announced acquisition of select lab assets of Alina Health, a leading nonprofit health system, will enable us to extend our reach in Minneapolis and throughout Minnesota and Wisconsin. We also announced our plans to acquire the outreach lab assets of Ohio Health, a nationally recognized charitable health system in Ohio. Both transactions will broaden our presence in geographic areas of the United States where we've had limited access to providers due to the predominance of health systems. These acquisitions show our ability to attract and partner with top growing health systems that share our commitment to expanding patient access to innovative and more affordable testing. We expect to complete both transactions in the third quarter. We also completed our acquisition of PathAI Diagnostics, which provides a ready-made platform on which to scale digital pathology and AI to help health systems and other providers improve quality, speed, and efficiency in cancer diagnosis. These acquisitions take time and involve teams of dedicated individuals. I want to personally thank my Quest colleagues for delivering on our M&A strategy, and we will now turn our attention to the hard work of integrating these deals. Now I'll recap our strategy and discuss highlights from the second quarter. Then Sam will provide detail on our financial results and talk about our updated financial guidance for 2024. Our strategy to drive growth is focused on delivering solutions that meet the evolving needs of our core customers. physicians, hospitals, and consumers. We enable growth across our customer channels through advanced diagnostics with an intense focus on faster-growing clinical areas, including within brain health and molecular genomics and oncology. In addition, acquisitions are a key growth driver with an emphasis on accretive outreach purchases as well as other independent labs. Our strategy also includes driving operational improvements across the business with the strategic deployment of automation and AI to improve quality, service, efficiency, and the workforce experience. Here are some updates on progress we have made in each of these areas. While we grew total volumes from diagnostic information services 1.1%, with base business volume growth of 1.7%, Volumes from our base clinical business grew 3.2% in the second quarter due to the strength among physicians and hospitals. In physician lab services, we delivered another quarter of high single-digit base business revenue growth. This growth was driven by continued strength in healthcare utilization as well as overall market growth and share gains due to new customer wins. We drove favorable test mix as well as growth in test per requisition which we attribute to greater utilization of our expanding portfolio of advanced diagnostics. Finally, we also saw strong volume and revenue growth within Medicare Advantage plans, where narrow network strategies direct testing to high-quality, cost-efficient options like Quest. Our broad health plan access, which extends to approximately 90% of covered lives in the U.S., enabled us to take advantage of high demand for lab services consistent with recent quarters. Health plans value our ability to improve access, scale innovation, and drive costs out of healthcare. We are also working to develop opportunities to serve new geographies with our health plan partners. In hospital lab services, we grew base business revenues by nearly 4%. Growth of reference testing remains higher than historical levels as hospitals struggle to fill open positions especially in technical fields such as histotechnology, microbiology, and cytotechnology. Our advanced diagnostics portfolio provides a compelling alternative for hospitals to send us more reference work. Hospitals face several challenges, including high supply costs, high wages, and decisions about how and where to deploy their capital. Patients want better value from lab services as well as easier access. Plus, diagnostic innovation is evolving at a fast pace. These dynamics are contributing to an accelerating trend of outreach acquisitions and professional lab service arrangements with the national labs. Our specialization and scale empower us to deliver a breadth of quality, innovative and accessible services that are often far more affordable for the patient. That's why top hospitals are choosing Quest for reference testing professional lab services, and outreach asset sales that deliver quality and efficiency. In consumer-initiated testing, our consumer-facing platform, questhealth.com, grew total revenues nearly 40%, while base business revenues grew more than 50% versus the prior year. As we learn more about our customers as our portfolio expands, we are improving growth and marketing productivity. Today, about 25% of our revenues are from existing customers, and 20% of our revenues are from tests we introduced in the past year. In advanced diagnostics, several key clinical areas drove double-digit revenue growth, continuing the trend in recent quarters. This growth was particularly strong in brain health, women's health, particularly prenatal and hereditary genetics, and advanced cardiometabolic health. Our Alzheimer's disease portfolio was the primary driver of growth for our brain health offering. Demand was strong for our AD-DETECT blood test, which assessed risk based on amyloid, P-tau, and APOE biomarkers. Demand was also strong for our CSF test options for AD treatment decisions. Yesterday, we introduced our neurofilament light chain test, which helps assess neuronal damage that may signify Alzheimer's disease as well as multiple sclerosis and other neurodegenerative conditions. In molecular genomics and oncology, we are encouraged by early results of our Haystack MRD early experience program prior to the broad national launch later this year. Physicians from leading cancer institutions are using the Haystack MRD blood test to assess cancer recurrence and treatment response for a range of cancers, including colorectal, lung, and breath. We also grew the body of evidence on clinical and economic value of ctDNA blood testing in cancer care. A study published in JAMA Health Forum in June found that MRD testing could reduce costs for health plans, particularly commercial payers, by identifying patients that would benefit from chemotherapy after stage two colon cancer surgery. In addition, research presented at the June ASCO conference so that the Haystack MRD testing identified complete clinical response to immunotherapy for patients with colorectal cancer earlier than standard assessments, such as PET, MRI, and endoscopy scans. Finally, we recently expanded our Haystack research collaborations to include Lysada Therapeutics, which will use Haystack MRD to study an investigational treatment for advanced pancreatic cancer. Turning to advanced cardiometabolic testing, we are seeing interest in several biomarkers that improve early detection of cardiovascular and metabolic diseases like diabetes and kidney disease. These include insulin resistance, which can identify prediabetes risk before A1C tests, and APOB, a more precise marker of heart attack risk than traditional lipid panels. They also include LP little a, which is an inherited marker of heart disease risk found in up to 20% of the population and for which several therapies are now in development. Turning to operational excellence, our Invigorate program aims to deliver a targeted 3% annual cost savings and productivity improvements. During the quarter, we expanded our use of automation and AI in order to improve productivity as well as service levels and quality. For instance, we advanced our use of automation and front-end specimen processing to now include five of our labs, freeing more of our processors to focus on value-added work. We also expanded our AI capabilities in microbiology to include the ability to segregate out specimens with no evidence of microbial growth so our medical sciences can concentrate on reviewing those with the greatest likelihood of disease. In addition, we broaden our use of AI in customer service to help our representatives access answers more quickly, improving their efficiency and service quality. Now I'll turn it over to Sam to provide more details on our performance and our 2024 guidance. Sam?
spk02: Thanks, Jim. In the second quarter, consolidated revenues were $2.4 billion, up 2.5% versus the prior year. while base business revenues grew 3.8%. Organic base business revenues grew by 3.1%. Revenues for diagnostic information services were up 2.8% compared to the prior year, reflecting strong growth in our base testing revenues, partially offset by lower revenues from COVID-19 testing services. Total volume, measured by the number of requisitions, increased 1.1% versus the second quarter of 2023, with acquisitions contributing 40 basis points to the total volume. Total base testing volumes grew 1.7% versus the prior year. Total revenue per requisition was up 1.6% versus the prior year, driven primarily by an increase in the number of tests per REC and favorable test mix, partially offset by the timing of certain value-based arrangements in the second quarter of 2023 that did not repeat this year, and lower COVID-19 testing. Base business revenue per REC was up 2.4%. Unit price reimbursement was flat. Clinical base business revenues were up 5.1%, while volumes grew 3.2%. This primarily reflects growth through our physician and hospital channels, which comprise approximately 90% of our total revenues and excludes the impact of lower volumes, primarily in our employer businesses, providing workforce drug testing and employee population health services. Reported operating income in the second quarter was $355 million, or 14.8% of revenues, compared to $348 million or 14.9% of revenues last year. On an adjusted basis, operating income was $398 million or 16.6% of revenues compared to $389 million or 16.7% of revenues last year. The increase in adjusted operating income was due to strong growth in the base business partially offset by lower COVID-19 testing revenues and wage increases. Reported EPS was $2.03 in the quarter compared to $2.05 a year ago. Adjusted EPS was $2.35 versus $2.30 the prior year. Cash from operations was $514 million year-to-date through the second quarter versus $538 million in the prior year. Turning now to our updated full-year 2024 guidance, revenues are expected to be between $9.5 billion and $9.58 billion. Reported EPS expected to be in a range of $7.57 to $7.77, and adjusted EPS to be in a range of $8.80 to $9. Cash from operations is expected to be approximately $1.3 billion, and capital expenditures are expected to be approximately $420 million. Given the uncertainty around when the LifeLabs acquisition will close, we are not including this transaction in our updated 2024 guidance. However, in the first 12 months after closing the acquisition, We expect the transaction to generate approximately $710 million in annual revenues and to be slightly dilutive to GAAP EPS due primarily to amortization of intangibles and other items, but approximately 10 to 15 cents accretive to adjusted EPS. These assumptions include the impact of expected debt financing to close the acquisition. With that said, the following are some key assumptions underlying our updated guidance for you to consider. The increase in our revenue guidance reflects the recently announced acquisitions of PathAI Diagnostics, Alina Health, and Ohio Health, as well as the strength of our base business. The PathAI Diagnostics acquisition closed in June, while Alina Health and Ohio Health are expected to close in Q3. The revenue contribution from these acquisitions represents the majority of the increase in our updated revenue guidance. As a reminder, new acquisitions are typically breakeven to slightly profitable initially, with profitability expanding over several quarters. Therefore, we are not expecting a material contribution to earnings from these acquisitions in 2024, but do expect increasing profitability next year. No change to our expectation for dilution from haystack oncology of an incremental 20 cents to adjusted EPS for the full year. Operating margin to expand for the full year driven by volume growth and improved productivity. Net interest expense expected to be approximately $190 million. This does not include interest expense related to death financing for the Life Labs acquisition. weighted average share count to be flat compared to the end of 2023. Finally, our operations were affected by the worldwide IT outage last week, which limited our ability to collect and process specimens on Friday and through the weekend. Our labs were processing specimens by Friday afternoon, and the rest of our operations, including patient service centers, were largely restored to normal by yesterday morning. At this point, we estimate the IT outage and the minor impact from Hurricane Beryl in Texas earlier this month could amount to a roughly six to eight cent headwind on our Q3 earnings. This is currently reflected in our updated full year guidance. With that, I will now turn it back to Jim.
spk13: Thanks, Sam. To summarize, our business delivered strong total and base revenue growth across our core customer channels due to strong commercial execution, innovative offerings, and ongoing strength in our healthcare utilization. We announced four acquisitions that meet our criteria for growth, profitability, and returns, and position us for growth in new geographic and service areas. We improved productivity as well as service levels and quality through greater use of automation and AI. Finally, I'd like to personally thank my nearly 50,000 Quest colleagues for our strong performance this quarter, which is largely the result of the dedication, care, and collaboration that they show patients, customers each and every single day. This commitment was exemplified by the tireless efforts of our teams to restore outstanding service for our patients and customers this past weekend following the global IT outage. I'm proud to work with so many talented people committed to living our purpose, working together to create a healthier world, one life at a time. And with that, we'd be happy to take your questions. Operator?
spk12: Thank you. We will now open it up to questions. At the request of the company, we ask that you limit yourself to one question. If you have additional questions, we ask that you please fall back into queue. To be placed in the queue, please press star 1 from your phone. To withdraw, press star 2. Again, to ask a question, please press star 1. The first question will come from Anne Hines of Mizuho Securities. Your line is open.
spk00: Hi, good morning. I just have a follow-up question on volumes. I believe you said the total base volume was up 1.7%. But if you exclude employer-based, it's up 3.2%. Can you just give us more detail what's happening in that business? Is it just the overall job market? And maybe if you can provide some profitability versus that position-based business versus the employer-based business and whether or not it was in line with your estimates. And then my second question just has to do around the Canadian acquisition. Can you just give us more details on that market how is it different than the U.S., why you view it as attractive, and maybe some long-term growth revenue algorithms versus the U.S. business. Is it growing in line with the business? Is it a higher growth? That would be great. Thank you.
spk13: Yeah, good morning, Anne. So let me start here. So on the employer side, we have two principal businesses that serve employers. One is our employee drug testing business. Second is our employee population health business. There is a third business, if you know, called Exam One that does health risk assessments for life insurance companies. Taken together, all three of those businesses showed meaningful declines in the quarter and really largely represent the difference in the 3.2% that Sam referred to in the 1.7%. In the drug testing market, there's a couple of shifts going on. Number one, a lot of the job growth still coming in the services industry, hotel workers, restaurant workers. And a lot of those industries just have given up on drug testing. And other companies that still do drug testing, as you probably know, many have eliminated marijuana off the panel. So that has created some pressure. And then the final thing I tell you is there's a shift going on in employee drug testing where more companies are doing what we call on-site or oral testing. And if that test is positive, it eventually reflexes back to a central lab. But if it's a negative test, it's just an on-site screen and the employee passes and we don't get that work. On employee population health, we're just seeing companies not spend as much money on these wellness events that they've typically done in the past. Finally, again, exam one, our life insurance business that does risk assessments for life insurance. Just the life insurance policies, you know, we saw a spike during COVID. People started to get life insurance again. Post-COVID, that negative trend has continued, which we were seeing actually pre-COVID. Now, let me turn to the Canada market for just a minute here. So, look, there's a lot to like about the Canadian market. First of all, you know, a population of roughly 41 million people. The population growth rate is actually faster than the U.S. The population growth there at about 1.1%. Here in the U.S., you know, population growing, you know, less than 50 basis points. The aging of the population there as well is a good trend that we like. You know, LifeLabs is really centered in two key markets, British Columbia and Ontario, Ontario being the biggest province in Canada, British Columbia being the second largest province. Collectively, those two provinces are over 50% or close to 50% of the Canadian population. We like the reimbursement model in Canada. It's steady, it's consistent. We think it'll show growth over the coming years. And when we look at things like test per rec, when we look at the types of testing done here in the U.S. versus Canada, we think there's opportunity to grow the types of testing that we bring into that market from an esoteric standpoint, from an advanced testing standpoint. So we feel great about entering the Canadian market. And by the way, it's a market we know. We've served that market for many, many years as a reference provider. We've served LifeLabs. We've served other independent labs and hospital labs up in Canada. So we know the market. We're familiar with it. And we think it's a great opportunity for Quest Diagnostics.
spk02: Maybe a couple of comments to add on the services businesses, Ann, just to give you some financials behind them or at least some percentages. I mean, the workforce health solutions businesses, employer population health, and the employer solutions are less than 5% of our overall revenues. So just to give you a sense of bucketing of how much those businesses are. So they're not that material or not material to our overall revenues. But as Jim said, they have been impacted post-COVID somewhat significantly and with some of the market dynamics in the drug testing business. So they are impacting our growth rates. And then exam one is on top of that. but it's also impacted by some of the dynamics that Jim said coming out of COVID. So these businesses are down significantly year over year, but we don't expect further deterioration as we look forward. So there is a year over year impact, but we don't expect that to further amplify as we go forward.
spk12: The next question will come from Kevin Caliendo of UBS. Your line is open.
spk14: Thanks for taking my question. It's not usually your want to raise guidance by more than a beat, you know, in any particular quarter, yet you did, and now we find out there was actually from what appears to be a core, even a greater upside in the second half than what you had originally had if you back out the impact of the strike and the hurricanes and the like, the IT issues, I mean. So is that mostly driven just by core? Are you expecting margins to expand a little bit, you know, on a year-over-year basis more than what we saw in the second quarter? I guess I just want to understand what's driving the enthusiasm for the second half improvements. You had the M&A stuff that you mentioned, but you said there wasn't a lot of contribution. So I'm guessing it's core, but I'm wondering, is it expected volume? Is it expected mix? Is it expected – costs to come in better, you know, wage, labor, churn, that kind of thing.
spk02: Yeah, so maybe I'll start, Kevin, and Jim can add comments. You know, first let's kind of talk about the, you know, the details in terms of what we shared. We said we're going to take up revenues by $100 million. We said we're going to take up EPS, and this is at the midpoint. We're going to take up EPS by $0.05 to $8.80 to $9.00. Within the 100 million that we talked about, the majority of that is really new M&A. Essentially, M&A that we have signed that we expect to close sometime between mid Q3 and the end of the year. Those reflect the M&A related or the transactions which are Alina Health, Ohio Health. We have some upside from Path AI as well, which we closed in Q2 but wasn't in our original guidance. You know, the revenue has a majority, the majority of the revenues is really driven by the M&A that we expect to close. The EPS increase is related to, you know, contribution from this M&A, although as we talked about in the prepared remarks, M&A ramps up in terms of profitability. So 2024, you know, in the second half, very little contribution in terms of profitability from M&A. The remainder, I would say, is contribution from the base business and some M&A, but little. And we are absorbing, as you said, the impact of the IT outage, which is six to eight cents in Q3 that we expect to, that we have now sized. This is preliminary. We'll get better detail as we go, but we are absorbing that impact. So, you know, in terms of what's driving this improvement or, you know, the raise of EPS, we're basically continuing with a lot of the productivity work and the cost reductions that we have talked about. You know, we have a lot of the AI and productivity improvements that Jim mentioned, a lot of the focus on improving margins. Importantly, base volumes continue to be very strong, and that's the biggest, I would say, driver in terms of improved margins in the business. We continue to see base volumes be strong, utilization be strong. So really, that's the key driver. It's strength of volumes, it's continued productivity and cost improvements, It's also the fact that we have, as we've talked about many times over previous calls, a positive pricing and reimbursement environment, which is now stabilized, which is now flat to improving, as opposed to a negative price impact that we used to see in prior years.
spk13: Yeah. Kevin, you probably saw a meaningful improvement in REV per REC in the quarter. And as Sam mentioned, within that REV per REC calculation, price per task, you know, flat to last year. The improvement is really coming in three areas. One, tests per rec continue to be very strong north of four. Pre-COVID, you know, that was a number that was south of four. It was in the threes. So that's a nice uptick. And, you know, that's coming from some of our advanced testing around allergy, tick testing, cardiometabolic testing, and neurology testing. And in that also is a mixed improvement that comes from some of those advanced tests. The final thing I'd say is, you know, we saw, again, strength in our overall Medicare Advantage and Medicare Book of Business. That pricing, as you know, tends to be better than the average. And we also see more advanced tasks coming on those requisitions versus our normal general health and wellness requisitions. So we expect those trends to continue into the back half of the year.
spk09: and um and you know that's that's contributing to the improvements that were that we're laying out there operator next question the next question comes from michael tourney of leering your line is open uh good morning and thank you so much for taking the question maybe if i can just dive a little bit into the market i know there's still some small moving pieces i appreciate the color you've given so far on some of the employer testing if I sort through all of the data points you have, the 3.2 billion base business volumes, A, I just want to make sure I got that number correctly, and then B, as you think about that number, how do you think about that in terms of translating where you see the health of broad-based market utilization versus where your competitive position is allowing you to take share? I guess just trying to understand fully where you see utilization baked into the implied second half guidance, versus what we've seen over the last six, 12 months on a baseline business. Thanks so much.
spk13: Yeah, again, the 3.2% represents the volume growth that we see through what we call our core base business. And that means our physician business, our hospital reference business, our hospital PLS business, And embedded in that is both clinical as well as anatomical pathology. So that entire book of business, which is about 90% of the company, the volumes grew 3.2%. Down from Q1, but the compare in Q2 was higher. But again, the 3.2%, you know, we feel really good about that. Now that 3.2% volume growth, again, translated into 5.1% revenue growth. And that was coming again on the strength of test mix plus the test per REC increase that we've been seeing year over year. So we feel good about that, again, going into the second half of the year. In terms of the implied growth in the second half of the year, you know, it's in the 3.7% revenue range. So, you know, again, and that's just the base organic that's without acquisition. Timing of the close of these acquisitions, we've said in Q3 with Alina in Ohio Health. We just don't know when in Q3, okay? So there's still some uncertainty about when these deals will officially close.
spk02: And Mike, good morning. Maybe I'll add a couple of comments just in terms of utilization. I mean, as we have been mentioning, utilization continues to be strong. We've seen it strong in Q1. We've seen it strong in Q2. The year-over-year compare in Q2 was maybe a little bit tougher. versus Q2 of 2023. We had some lapping of some wins. And just overall, we saw more of a resurgence in the base business in Q2 of last year. But in terms of the dynamics there, we do believe that both in terms of there's strong utilization out there. We think some of it is return to care, but also just general strength of utilization by just additional testing. And that's reflected in the higher number of tests per rec that we're seeing. But also, we are gaining share. We do believe that we are gaining share, and we're gaining share through some of these also outreach acquisitions that we're doing that help us direct more testing to Quest.
spk12: Operator, next question. The next question comes from Patrick Donnelly of Citi. Your line is open.
spk10: question, guys. Sam, maybe just expand on the utilization piece. Obviously, you guys have seen pretty nice elevated levels there the past couple quarters. Can you just talk about what you're seeing and then what the guide implies in terms of how you're feeling about it? I know previously the guidance assumed normal utilization. Obviously, it stayed a little bit elevated here. And just how you're thinking about the trend. Does it gradually come down to normal? We'd like to just discuss that a bit. Thanks.
spk02: Yeah, I mean, as we've talked about before, Patrick, we do expect eventually utilization to level off to, you know, essentially what we've talked about in terms of our long-term growth algorithm, which is roughly around, you know, three percent-ish in terms of organic growth. And then, you know, as we said before, in terms of long-term growth, we expect one to two percent contribution from acquisitions. So we still think longer term, if you're thinking, you know, over the next, let's say, longer period. I'm not going to necessarily bracket it with a time period, but I think that's the right algorithm to be thinking about. In terms of for us, our current guide, right now at the midpoint, we're saying total growth is close to 3%, 3.1%. Our base revenue guide is somewhere around 5% for the full year. Our second half, if you think about second half, that's Essentially, on the base revenue growth, it's about a 5.3% second half growth. Now, recall the 5.3% in the second half, and this is revenue, includes, as we said, the majority of the $100 million take-up of the guide is acquisition. In that 5.3% second half, there is a significant portion which is acquisition. You know, in effect, if you look at just organic, as Jim just alluded to, it's actually a slightly slower second half than what we saw in the first half. So, you know, embedded in that is the expectation, Patrick, that this utilization doesn't continue at the same level but starts to slow down a bit. So, you know, again, total growth first half base or, sorry, full year base is 5%. Second half base is 5.3%, but within that there's some acquisitions, so the second half is closer to something between 3.5% to 4% in terms of base.
spk12: Operator, next question. The next question comes from David Westenberg of Piper Sandler. Your line is open.
spk03: Hi. Thank you for taking the question. I just want to take a little bit more of a long-term look at the business here. How should we think about digital pathology companies in light of the acquisition with Path AI. Can we see a more immediate path to incorporate it more broadly? If so, would there be cost savings in the intermediate term? And then is there any maybe potential for pricing benefits given that a human plus AI kind of reading probably is a better outcome and so maybe would justify kind of a higher price? And just as a background, can you talk about maybe a broader framework for how much revenue of your business is pathology overall, just anything you feel comfortable with. Thank you.
spk13: Yeah, we said in the past, just on our revenue from anatomical pathology, that it was, and this was pre-Path AI diagnostics, that it was roughly a $500 million book of business. But we're excited about the digital pathology opportunity on numerous fronts. On the surface, unlike radiology, digital pathology does not naturally lower your cost because you're actually, you still need to create the slide. Once you've created the slide, then you digitize the slide. Okay, so there's actually an extra step in the process. Now here's where it creates productivity, and as you said, we think better quality. Number one, You know, we do anatomical pathology in over 20 locations across the country because you want the pathologist to sit right near where you're repairing the slides so that you don't have to move slides and vehicles and things like that. So we believe that digital pathology will allow us to collapse the network of sites that actually do what we call the histology work or the preparation of the slides. So there will be cost savings when we collapse that network. Second is it allows us to route the image to expert pathologists wherever they sit in the country. So if our guru for breast pathology sits on the West Coast, you move those slides out there. If the prostate guru sits on the East Coast, you move those slides there. And, yes, we believe once you've digitized that slide, there's many companies out there that are working on algorithms. There's one or two that have been FDA-approved. that allow you to apply algorithmic analysis to the digital image in order to improve the quality of the read. In terms of reimbursement, we absolutely believe there's a strong case to be made for higher reimbursement using these algorithms. The final thing I would tell you is that with digital pathology, it opens up a realm of new just histology only types of operations, meaning we will take on the histology work for a health system. They'll still keep the pathologist, but they'll shut down their histology operations. We'll do the slide preparation, digitize it, and send that back to the hospital pathologist for them still to do the reading. We call this a technical-only solution, and it's a solution that's starting to take off, and the margins on the technical component of histology are quite good. So we're bullish on the overall market opportunity here.
spk11: Operator, next question.
spk12: The next question comes from Erin Wright of Morgan Stanley. Your line is open.
spk06: Great. Thanks for taking my questions. I have a two-parter here. But on value-based care contracts, you mentioned that you lapped some of the payments that were made through those contracts or relationships last year. I guess how much did that benefit you last year and how should we be thinking about modeling that on a quarter-to-quarter basis? Will those incentive payments or contributions, are they relatively one time in nature? Is that something you'll be breaking out for us going forward? And how material have those payments been, I guess, year to date? And then a second part of my question would just be more on the regulatory environment, just what you're thinking in terms of PAMA and SALSA and your expectations into 2025 on that front. Thanks.
spk13: All right, so let me start with your value-based care comment. I'll ask Sam to add some color and then I'll come back and address Pama and Salsa. So on the value-based care, it made positive contributions in the second quarter of this year. They just weren't bigger than the second quarter of last year. Last year we had a meaningful gain. We acknowledged that last second quarter. Again, this year it was positive, but the delta between last year and this year was a headwind for us. It is very difficult for us to give you guidance on how to model these things. There's really two principal components to these value-based payments. One is from shared savings from acquisitions, and those are lumpy. They're based on the acquisitions they do. And in some cases, payments can be six months post-deal closure. Some cases, it could be a year post-deal closure. It just depends on the contract. The other type of value-based incentive payment that we have with some of our payers is around the movement of requisitions from high-priced, either out-of-network laboratories or high-priced health system laboratories And, again, that could be a once-a-year true-up, and depending on when we sign that contract, could be in June, could be in January, could be in April. So very, very hard to model these things.
spk02: So, Sam, any other color on this? I think you've really captured it, Jim. You know, the key thing there, Aaron, is it's difficult to give you a sense as to how the pacing is going to be. We always said these are lumpy. And, you know, sometimes there's also accounting nuances on these where if it's a shared service, shared savings commitment, for instance, We might accrue for that shared savings as if we're not going to achieve it, but then when we do achieve it, we have to release that accrual, so to speak, and get a benefit in that quarter. Suffice it to say that these continue to be a positive for us in terms of our overall pricing. In Q2 of 2024, it was a pricing or a positive benefit for us in the quarter, but on a year-over-year basis, we had a significant benefits in 2023. So it impacted us negatively in terms of total revenues on a year-over-year basis. So I think everything that Jim said stands in terms of the difficulty of giving you a modeling algorithm for these. And then Pama, Jim, did you want to comment?
spk13: Yeah, in terms of Pama and SALSA, while we continue to, we and our trade association and other independent labs continue to push the case for SALSA, We acknowledge it's going to be difficult to get that through in a year with an election year, especially now given many of the changes that occurred in the last week. Having said that, you know, we will continue to push very hard for another one-year delay in PAMA. The recent CBO scoring on this was actually bigger than it was last year. They projected it would save the government over $3 billion. And in addition, you know, the committee in the House that overlooks this is looking for a pay-for program to pay for continued telehealth benefits. So this becomes a really nice, you know, pay-for program that can satisfy the requirement to fund the telehealth. So we're confident that at a minimum there would be a one-year delay in PAMA, and hopefully we can get this done and figure it out in the October-November timeframe as opposed to waiting for the December timeframe like we've seen in the past.
spk11: Operator, next question.
spk12: The next question comes from Brian Tequila of Jefferies. Your line is open, sir.
spk04: Hey, good morning, guys, and congrats to my quarter. Maybe, Sam, as I think about your comments on Haystack, I understand maintaining the drag guidance here, but how are you thinking about the ramp on that as we think about 2025 and given some of the announcements you've made on new partnerships there? So just curious how we should be thinking about the development and the ramp of Haystack going forward. Thanks.
spk02: Yeah, sure. And good morning, Brian. So as we said in the prepared remarks, haystack dilution this year will be somewhere in the 35 to 40 cent range, which is about a 20 cent increase in terms of dilution from prior year. For 2025, Brian, the way we see it is it's still going to be dilutive, but it's going to be less dilutive than we see in 2024, because we will start to recognize revenues on the assay as we launch later this year. In 2026, we expect Haystack to be slightly accretive. And we expect by the end of 2025 also to get to a positive return on invested capital from this acquisition. In terms of all the things that we've seen, the early launch has been really successful. We've had a very, very high interest in terms of number of key thought leaders and cancer centers that have signed up for this. So everything that we see today is really encouraging. And you touched on the partnerships that we've made as well. We continue to sign new partnerships in terms of, you know, cancer centers that are or companies that are partnering with us to evaluate the use of the assay and MRD in a specific type of cancer. So really excited about the upcoming launch. I think the early launch has been very positive. And hopefully this gives you a sense as to the, you know, the financial impact in terms of accretion dilution.
spk12: James Moore- operator next question. James Moore- The next question comes from Lisa gill of JP Morgan your line is open.
spk01: Lisa Gilmour- Thanks very much and good morning um since you last reported the LGBT rule came out, can you maybe just talk about what the impact is there, I heard your comments on payments also but anything else on the regulatory front that we should be aware of.
spk13: Yeah, thanks Lisa. So as you know, our Trade Association filed a lawsuit in the Federal Court of Texas District Court of Texas. And work by outside counsel that the Trade Association has retained continues. We expect movement in the case in the latter part of this year, November, December and probably into January of next year. Having said that, the rule is in place. We are running the company and operating the company with the rule in place. There's certain requirements that we need to have in place by May of next year, including a complaint handling unit up and running, as well as the ability to report adverse events. And these capabilities, some of which we have in the company, some of which we have to add, you know, are ongoing as we speak. We continue, we've launched training for the organization, in particular our R&D teams, our product marketing teams around design controls. And again, we're living with the rule and implementing things for the directive of the FDA. We've said this year it's not going to add material cost into the business. But we continue to evaluate what we need to be fully compliant, especially if the lawsuit is not successful.
spk12: Operator, next question. The next question comes from Michael Riskin of Bank of America.
spk15: Hey, thanks for taking the question, guys. I'm going to stay on the regulatory side. It's still fairly recent, but we've had a couple questions come in from investors on Chevron deference, the Supreme Court ruling to overturn the Chevron doctrine, what it could mean for deregulation. It's still kind of a hypothetical, I think, but just curious what your take on that is given your place in the industry.
spk13: Well, it certainly doesn't hurt the case that we believe is in front of, again, the federal district court in Texas. I'm not a legal expert by any means, but as you know, look, Congress is the one that sets the operating parameters for various departments that exist like the FDA. We believe what Congress authorized the FDA to do is to regulate medical devices. Um, and, um, Congress also authorized the CLIA act of 1988 that talked about the regulation of clinical laboratories. Um, so we believe it's, it's very clear what, what Congress intended. Um, obviously, um, others don't see it that way. Um, but we do believe that yes, what, um, has come out of the Supreme court recently, um, is favorable. and clearly dictates what should occur within the four walls of regulatory bodies.
spk11: Operator, next question.
spk12: The next question comes from Jack Meehan of Nefron Research. Your line is open, sir.
spk11: Thank you. Good morning. Either for Sam or for Jim, I was wondering if you'd give an update on what you're seeing in terms of cost trends, how are wage costs trending, an update on turnover. And sorry if I missed this, Sam, what's the full year margin target? Thank you.
spk13: Yeah, so from a wage standpoint, you know, we said at the beginning of the year that we expected wage increases to be in that 3 to 4% range. We're still operating within that 3 to 4%, so we're comfortable with that estimate for the back half of the year that it'll play out in that range. In terms of turnover, you know, last year, all in for our frontline positions, patient services, logistics, specimen processing, our laboratory workers, we were north of 20%. In the first quarter, we came down below 20% into the mid-18s, and we kind of hung there in the second quarter. So we feel good that generally you can see an uptick sometimes after your first quarter, after bonus payments and things like that. But we've maintained a relatively flat position. We obviously have some hotspots around the country in certain job categories that tend to be competitive related, either with health systems or with other industries. And so we address those hotspots, and we expect to make meaningful improvements in the back half of this year.
spk02: Yeah, and for a margin target, Jack, we didn't give one, so you didn't miss it. We did say that operating margins are expected to be up year over year, which is what we had shared also on the Q1 call.
spk11: Operator, next question.
spk12: The next question comes from Andrew Brackman of William Blair.
spk16: Hi, guys. Good morning. Thanks for taking the questions. Sam, maybe one for you just on the balance sheet and the upcoming debt maturities. Nietzsche, anything that you can sort of share in terms of your expectations for time or timing or interest costs associated with those refinancing? And I guess just related to that, any color that you can provide on the debt assumptions for the LifeLabs acquisition? Thanks.
spk02: Sure, Andrew, and good morning. So let's start with the LifeLabs. What we are assuming, I mean, I shared in the prepared remarks that we expect the acquisition. First of all, we're not expecting LifeLabs to close this year, at least in our guidance assumptions. It could, but we're not assuming it's in guidance. But for 2025, it's a 10 to 15 cent EPS accretion, or at least in its first year, let's call it that. It's 10 to 15 cents. We're assuming that it's funded by a combination of debt and cash, but within that assumption of 10 to 15 cents is that 75% of that purchase price is funded with debt. So the roughly billion dollars purchase price, 75% of it is debt funded, which is what drives the 10 to 15 cent accretion in the first year. In terms of just broadly on, you know, debt assumptions and liquidity, et cetera, I think you talked about, you know, balance sheet assumptions. Listen, a lot of that is going to depend on market conditions and depend on the timing of the close of some of these acquisitions, not just life laps, primarily life laps. But also we have Ohio Health, Alina Health. We also closed Path AI in June. So, you know, as we've been talking about, we've had a busy M&A pipeline and it's starting to come to fruition. So we're going to evaluate market conditions. We've got the flexibility to access the capital markets. We've got very strong short-term liquidity through the access to our facilities. And, you know, but our goal continues to be to target a 2.5 to 3X leverage ratio. That's our goal. You know, there could be some slight tip above that higher end of 3, but then we expect to be levered back to somewhere within that 2.5 to 3 in short time, given the growth and the accretion from these acquisitions. So, again, no specific debt number right now, but we'll keep you posted as we get more timing on the closes of these acquisitions.
spk12: Operator, next question. The next question comes from Pito Chickering of Deutsche Bank. Your line is open, sir.
spk05: Hey, good morning, guys. Thanks for fitting me in. A multi-part question here. How are volumes looking at from your preferred network customers versus everyone else? Looking at both the physician market and the hospital market, are you losing, gaining, or maintaining share? Any quantification of any of those would be helpful.
spk13: Okay, so on volume from our payers with preferred arrangements, the volume with several of them, Patrick, is higher. Now, some of that can be also driven by Medicare Advantage, the various size of the Medicare Advantage books of business. But in general, when we operate within these preferred networks where we have incentives in place to move you know, share from out-of-network labs, high-priced health systems, we definitely see benefits. You know, in terms of market share statistics around our physician book of business and our health system book of business, you know, it's hard to tell, right? There's just not great industry reports that talk about that. But I can tell you, when we said that that book of business was up 5.1% from a revenue standpoint, Um, our physician growing faster than that, um, health system, uh, growing, um, slightly lower than that, but still they're growing in ranges that are significantly above what we saw from a pre COVID standpoint. So that leads us to believe, and also just based on the number of new wins with large physician groups, the number of new wins in our reference book of business, it leads us to believe that yes, we are picking up share in this industry. And much of that share, we believe, is coming from health systems that potentially aren't as aggressive on some of that outreach book of business, from specialty labs, and also from small, very small little regional labs.
spk11: Operator, next question.
spk12: We have time for one last question, and that is from Stephanie Davis of Barclays. Your line is open.
spk07: Hey, guys. Congrats on the quarter, and thank you for fitting me in. I was just curious if there's anything that's changed either the environment or maybe in strategy that's had this pick up in M&A so much this year. And how sustainable is this or how much of this does kind of strike them on the iron cot? Thank you.
spk13: Yeah, no change in the strategy at all, Stephanie. And as we've been saying for many quarters in a row, the M&A funnel is full. Now, we don't go into a year planning on getting four deals announced in one quarter. In fact, you would prefer to space these out a little bit, but there's always somebody on the other end that you're negotiating with, and these things sometimes take time. Look, we're really excited about all of these. You know, Alina Health in Minneapolis, it represents a market where the independent labs basically have really, really low share in that market space. So, really excited about the Minneapolis marketplace. We're also very excited about Columbus, Ohio, dominated by two health systems, very difficult for independent labs to operate there. This gives us a substantial, um, you know, foothold within that Columbus marketplace, obviously excited about, uh, the Canadian marketplace as we talked. And again, path AI represents both a nice opportunity in the Memphis marketplace itself, where we believe we can grow our book of business there. And as well, um, it doesn't really matter where that lab is located because a lot of the work is done digitally. So it accepts specimens from, from all over the country. I would tell you that there's still opportunities within the funnel. The emphasis continues to be on these outreach tuck-in deals. It continues to focus in markets where our share position or access to independent labs is waning, and that's where our focus will be in the second half of this year.
spk02: One other thing I'd add, Stephanie, is all of these acquisitions that we announced meet our criteria. They basically hit the mark on all of the criteria that we have accreted in the first year. They meet our return on invested capital threshold. They meet our NPV criteria. So, again, you know, the activity would depend also if these acquisitions are going to hit our profitability criteria and our ROIC hurdle rate, and they do.
spk13: Okay. So that concludes our call today. We really appreciate everybody joining. Thanks for your support and have a great week ahead.
spk12: Thank you for participating in the Quest Diagnostics second quarter 2024 conference call. A transcript of prepared remarks on this call will be posted later today on Quest Diagnostics website at www.questdiagnostics.com. A replay of the call may be accessed online at www.questdiagnostics.com forward slash investor or by phone at 866-363-1805 for domestic callers or 203-369-0193 for international callers. Telephone replays will be available from approximately 10.30 a.m. Eastern Time on July 23, 2024 until midnight Eastern Time, August 6, 2024. Thank you for your participation and you may disconnect.
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