Q2 2023 Quest Diagnostics Inc Earnings Call
Welcome to the Quest diagnostics second 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 copyrighted property of quest.
Gnostics 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 Bezeq, Vice President of Investor Relations for Quest diagnostics.
Go ahead please.
Thank you and good morning, I'm joined by Jim Davis, Our Chairman and Chief Executive Officer, and President and Sam <unk>, Our Chief Financial Officer. During this call. We may make forward looking statements and will discuss non-GAAP measures.
Provide a reconciliation of non-GAAP measures to comparable GAAP measures in the tables to our earnings press release.
Actual results may differ materially from those projected.
Risks and uncertainties that may affect quest diagnostics future results include but are not limited to those described in our most recent annual report on Form 10-K, and subsequently filed quarterly reports on Form 10-Q.
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 referred to the performance of our business, excluding COVID-19 testing.
Growth rates associated with our long term outlook projections, including total revenue growth revenue growth from acquisitions organic revenue growth and adjusted earnings growth are compound annual growth rates.
Finally revenue growth rates from acquisitions will be measured against our base business.
Now here's Jim Davis.
Thanks, Sean and good morning, everyone. We had strong base business performance in the second quarter with nearly double digit revenue growth year over year demand for our services remains strong across all regions boosted by the collaborations we have formed with health plans and hospitals and.
<unk> amid an environment, where people are returning to care.
We are particularly encouraged by the revenue growth in our base business of nearly 10% from our health system customers.
Also in the second quarter, we made substantial progress improving the profitability of our base business compared to the first quarter and prior year, Despite persistently high employee turnover.
Total adjusted operating margin improved more than a 170 basis points compared to the first quarter. Despite a decline of approximately $80 million and COVID-19 revenue.
This morning, I'll discuss highlights from the second quarter, then Sam will provide more detail on our financial results and talk about our updated financial guidance for 2023.
Now, let's turn to some of the highlights from the quarter.
As we shared at Investor Day, our strategy is to drive growth by continuing to meet the evolving needs of our core customers.
<unk> hospitals and consumers as they navigate the changing landscape in health care.
We will enable this growth with an intense focus on faster growing clinical areas, including molecular genomics and oncology.
In addition acquisitions will continue to be key drivers of our growth. Finally, our strategy includes driving operational improvements across the business with strategic deployment of automation and AI to improve quality efficiency and service.
So let's review progress we've made in each one of these areas.
And physician lab services, we delivered strong base volume growth from physicians largely through our partnerships with health plans, which have expanded our access to the market.
A growing number of these involve value based arrangements and are generating faster growth and share gains than the traditional relationships. These arrangements position us as a more strategic partner with health plans as we work together on leakage shared savings and redirection programs. In addition, New York Presbyterian recently.
<unk> outreach assets brought us new volume from the physicians.
And hospital Lab services base revenue from health systems grew nearly 10% in the quarter.
Professional lab services business had a very strong quarter as we saw solid growth from both new and existing pls relationships.
We're particularly encouraged by progress with our new Pls partnerships with Northern Light Health Lee Health and tower health.
As hospitals continue to experience financial challenges, we are here to help whether through professional lab services reference testing or purchasing the hospital's outreach assets.
We are now seeing growing momentum with a significant pipeline of potential deals with large health systems.
In consumer health, we had strong base business growth on quest health Dot Com, we continue to optimize our marketing efforts to target our customers more strategically and now expect consumer initiated testing to be profitable through the balance of 2023.
Also during the quarter, we launched kinetic insights our first consumer initiated genetics health test on Quest health Dot com.
This alive based test Leverages, our expertise in next generation sequencing to analyze three dozen genes for inherited risk of conditions, ranging from breast and colon cancer.
Carrier status for cystic fibrosis and Tay Sachs.
We are encouraged by initial demand for this new offering which adds to our growing test options for health minded consumers.
As discussed at Investor Day in March a key pillar of our strategy is to support faster growth across all customer segments through highly specialized advanced diagnostics. These offerings include molecular genomics in oncology tests, such as Germline testing to assess prenatal and hereditary genetic risk.
And somatic testing for tumor sequencing.
Advanced diagnostics also encompasses other key areas, including neurology women's reproductive health and cardio metabolic health.
In neurology, we continued to achieve strong growth from our innovative quest <unk> detector portfolio Waldheim's blood tests, which help identify early indications of beta amyloid and <unk> status.
Detect strongly positions quest to lead in this rapidly evolving all timers landscape.
Emerging therapies for all timers represent a new era in treatment and testing for this disease like many diseases early intervention and all timers, they promote better outcomes.
Our <unk> portfolio enables accessible and convenient evaluation of all timers risk potentially at early stages and the monitoring of progression.
A D detect is now available to our physician customers in the U S and we believe it also has the potential to generate strong consumer demand. In addition, we continued to see strong growth in our cardio metabolic endocrinology infectious disease and carrier in prenatal genetic screening services.
In June we completed our acquisition of Haystack oncology, which positions us to enter the high growth area of minimal residual disease or <unk> testing.
<unk> has developed a highly sensitive technique for early detection of residual or recurring cancer with the potential to improve outcomes for patients being treated for cancer.
The integration of Haystack is on track and we continue to expect to introduce our first MRP I'm R&D test in early 2024.
We intend to launch this test from our oncology center of excellence in Lewisville, Texas, where we also recently introduced our solid tumor expanded panel for tumor sequencing and therapy monitoring.
I'd like to say a little more about our M&A strategy.
Stack as a capabilities acquisition and as we've said it will initially be dilutive to earnings per share. However, our primary focus in M&A continues to be on traditional hospital outreach purchases and tuck in lab deals that are accretive to earnings in the first year.
To underscore what I said earlier, our M&A pipeline is robust as hospital systems face continued margin pressures due to labor challenges and a shift from inpatient to outpatient care turning to operational and productivity improvement. Our invigorate program is well on its way to delivering our 3% annual productivity.
<unk> savings target.
As we discussed at Investor Day, Invigorate includes deploying automation and AI to improve quality efficiency and service.
In the quarter, we implemented our automated microbiology solution in Lenexa, Kansas next up is Lewisville, Texas when complete four of our major laboratories will use automated microbiology lines with embedded artificial intelligence identifying positive and negative cases, leading to improved quality.
<unk> and productivity. We are also excited by results of a pilot in our Clifton lab that showed AI speeds data collection and specimen processing and expect to implement this AI solution across all of our major regional labs later this year in.
And genomics, we're utilizing AI in bioinformatics to improve and speed variant classification and prioritization.
These are just a couple of the many examples of our use of AI and automation to continuously improve our operations.
In addition, we believe generative AI has great potential to deliver insights and content not only to better target and serve customers, but also to create innovation that helps standardize our lab operations.
We are encouraged by preliminary results of pilots that used generative AI and our customer service center to automate caller's sentiment analysis and quality control and in our marketing operations to improve market research and customer targeting.
Now before I turn it over to Sam I'll close by saying that we always knew 2023 would be a challenging year as we transitioned away from COVID-19 testing and supported the nation's returned to care.
Our dedicated employees on the front lines and everyone else, who supports them have done a magnificent job of bringing our purpose to life.
Working together to create a healthier world one life at a time.
I'm really proud to be leading as quest diagnostics team.
And now I'll turn it over to Sam to provide more details on our performance and our updated 2023 guidance Sam.
Thanks, Jim in the second quarter consolidated revenues were 234 billion down.
Down four 7% versus the prior year.
Base business revenues grew nine 5% to $2 $3 billion, while COVID-19 testing revenues declined approximately 88% to $41 million.
Revenues for diagnostic information services declined four 9% compared to the prior year, reflecting lower revenue from COVID-19 testing versus the second quarter of 2022, partially offset by strong growth in our base business.
Total volume measured by the number of requisitions grew <unk>, 2% versus the prior year with acquisitions contributing 50 basis points to total volume.
Total base testing volumes grew seven 4% versus the prior year as we continued to see a broad base returned to care throughout the quarter.
Revenue per requisition declined four 9% versus the prior year driven by lower COVID-19 molecular volume.
Base business revenue per req was up two 5% due to more tests per req changes and test mix and benefits recognized with certain value based arrangements.
Unit price reimbursement was flat in the quarter consistent with our expectations.
Reported operating income in the second quarter was $348 million or 14, 9% of revenues compared to $388 million or 15, 8% of revenues last year.
On an adjusted basis operating income was $389 million or 16, 7% of revenues compared to $435 million or 17, 7% of revenues last year.
The year over year decline in adjusted operating income is related primarily to lower COVID-19 testing revenues, partially offset by growth in the base business.
Compared to the first quarter, we made strong progress improving the profitability of the business.
Adjusted operating margin expanded 170 basis points sequentially, while total revenues were essentially flat versus Q1.
We also absorbed higher SG&A costs related to an increase in the market value of the obligations in our supplemental deferred comp plan in the second quarter, which lowered adjusted operating margin by 30 basis points.
This has no impact on EPS.
We continue to closely manage the cost of our corporate and support functions.
Since last fall, we have taken a series of actions to reduce support costs.
Which will save more than $100 million this year.
Those savings largely began in Q2 and we're on track with our estimates in the quarter.
Frontline employee turnover improved marginally earlier this year, but the pace of improvement has not met our expectations and it remains well above historical levels.
We continue to feel the effects of the tight labor market, which has had an impact on productivity and wages.
Turnover continues to be a drag on productivity. Despite the strong base business growth reported EPS was $2 <unk> in the quarter compared to $1 96, a year ago.
Adjusted EPS was $2 30, compared to $2 36 last year.
Cash from operations year to date was $538 million versus $882 million in the prior year period.
The decline in operating cash flow was primarily related to lower operating income.
Turning to our updated full year 2023 guidance revenues are now expected to be between $9 one to 922 billion.
Base business revenues are expected to be between $8 92 and $902 billion.
COVID-19 testing revenues are expected to be approximately $200 million.
Reported EPS is expected to be in a range of $7 52 to $7 92.
And adjusted EPS to be in a range of $8 50 to $8 90.
Cash from operations is expected to be at least $1 3 billion and capital expenditures are expected to be approximately $400 million.
Here are some things to consider for the remainder of the year.
We've raised our base business revenue guidance to reflect our strong performance through the first half and our expectations for the remainder of the year.
Note that the year over year comparison for the base business becomes more difficult in the second half of 2023 as we begin to lap some pls wins later in the year.
Also we are not expecting demands for respiratory panels to be as strong as we saw in last year's flu season, which could be a headwind to revenue of nearly 100 basis points in the back half.
We expect revenue and adjusted EPS to be more even in the third and fourth quarters, which is a slight departure from our typical earnings seasonality due to the following factors.
Unit price reimbursement is expected to improve in the back half.
Our CIT business turned profitable in Q2 and is expected to be more accretive to both revenue and earnings as we move throughout the second half of 2023.
And cost actions taken throughout the first half of the year, we will continue to improve the overall profitability of the business.
Lee as I noted earlier, we continue to experience higher frontline turnover and a tight labor market, which has had an impact on productivity and wages.
Higher SG&A costs related to our supplemental deferred comp plan also lower the operating margin by 30 basis points in the first half of 2023, but had no impact on EPS.
As a result, our updated guidance reflects an adjusted operating margin of approximately 16, 5% for the full year.
With that I will now turn it back to Jim.
Thanks Sam.
Summarize we had strong base business performance in the second quarter with nearly double digit revenue growth as our collaborations with health plans hospitals and physicians enabled us to benefit from strong demand amid a broad returned to care we've.
We made substantial progress improving the profitability of our base business compared to the first quarter and prior year.
This was slightly offset by persistently high employee turnover, which weighs on productivity and increases cost.
And finally, our updated guidance reflects our expectations for revenue growth and improved profitability in the base business.
Now we'd be happy to take your questions operator.
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And our first question comes from Jack Meehan with Nephron Research you May go ahead.
Thank you good morning.
Good morning, good morning.
I wanted to start and ask about kind of the health plan commentary is it possible to tease out how much of this growth could be share gain related versus just strong underlying demand and somewhat related we have heard more discussion about national payers being more active around payment integrity. I was just curious if youre seeing that at all.
Could that be a positive or negative request.
Yeah, Hey, Thanks Jack.
So you know, it's always hard to discern in this industry what is share gain versus demand.
<unk> returned to care and things like that we don't get perfect data on it but our sense is it's some of both the share gains side, we look closely at our growth through each of the commercial payers and when we see gains that are above and beyond you know the average and we see the benefits of those programs those value.
Based programs that we work with them, which is around <unk>.
Leakage it's around.
Focusing on physicians that are using out of network labs, we see the benefits of those programs and therefore concluded its share gain certainly theres been some strong returned to care on the payment integrity side I can tell you that.
It's a never ending effort here at quest diagnostics to continuously work denials to make sure that we understand the payer policies what are the diagnostic codes.
That support those policies and then work back through our physician base to make sure that.
That the tests that they're ordering are appropriate tests. So we haven't seen any discernible impact.
With some of those policies you're referring to.
But we work collaboratively with the payers to to understand them and then work back with our physician base to try to correct any errors.
Super.
Sam one question on margins I'm, sorry, if I missed this what does the guide now assume for margins for the year and can you just talk about what youre, assuming in terms of the pace of productivity improvement.
Yeah. Thanks, Jack So we are assuming for the year operating margins to be at approximately 16, 5%.
In terms of productivity, we've seen good benefits from our invigorate program and we expect those to if anything continue for the rest of the year and even accelerate in Q3 and Q4.
So we are seeing good good momentum on our invigorate programs. We're seeing you know the $100 million of SG&A savings that we've talked about we're seeing those materialize as of the beginning of Q2 and they will continue for the rest of the year as well for a total year impact of $100 million.
On the on the other side. We are also seeing as you heard in the prepared remarks, you know it.
Labor and turnover and macro environment. So turnover continues to persist to be higher than we expected and that's that's driving pressure also on margins.
But we are expecting approximately 16, 5% for the year in terms of AUM, Yeah. Jack I would just add obviously you can see the base you can see the margin improvement from Q1 to Q2 that comes through pretty clear.
You can do the math on the base margin improvements from Q2 of last year to Q2 of this year when you make the assumptions on the dropdown of the Covid revenue, which.
<unk>.
You're in the range with the numbers you've used in the past. So we're really pleased with the base margin improvement from Q2 of last year to Q2 of their share and very pleased with the improvement from Q1 of this year to Q2 of this year.
Thank you. Our next question is from Elizabeth Anderson with Evercore ISI you May go ahead.
Hi, guys. Good morning, and congrats on a good quarter and my question is I realized there was a ton of noise this quarter on the deferred comp and how that nets out.
Could one like what is your assumption in.
In terms of what's embedded in your guidance for the back half D. I appreciate that it can be different based on what happens to the future stock price, but I just wanted to understand whether you're just sort of continuing the forecast of last year's trajectory into this year, our <unk> going forward or or what have you and then secondarily. How do you think about you mentioned the labor productivity.
The trial still elevated turnover.
Think about sort of the cost benefit analysis of perhaps like investing more in wages or something like that versus the productivity.
<unk> that you would be.
You could potentially receive from that thank you.
Okay. Thanks, and appreciate the congrats.
So let me talk about DCP deferred compensation and I'll turn to Jim for productivity in some of the trade offs that you're referring to there. So in terms of DCP, but let me just clarify you know what it is and the impact so first of all the.
So we saw which impacts SG&A is the related to the increase in the market value of obligations and our supplemental deferred comp plan that does not have an impact on EPS because it is offset on the nonoperating income line, where the benefit so it's a net neutral on EPS, but it does impact the operating margin you know, sometimes we don't see it.
Materially impact us it's related to market movements this quarter it impacted us materially to the tune of 30 basis points impact on operating margin percent. So if you exclude that it would be our operating margin percent would've been 17%. If you compare it to last year because last year and this is where it gets maybe a bit more complicated but last year.
We actually had a benefit in terms of expenses on related to deferred compensation plan our market value.
The fair market value change and so compared to last year Q2, it's an impact of 1%. So actually if you compare Q2 2023 O M versus Q2, 2022 O M. We would've been relatively flat in terms of operating margin percent quarter over quarter last year.
Even despite the drop in Covid revenues, a significant drop to the tune of approximately $300 million that we saw year over year in terms of Covid revenues now as you look towards the rest of the year Liz we don't forecast.
The FERC compensation plan I mean, that's that's not something that we forecast we assume it's a net neutral impact both on the P&L on EPS and on operating margin. So you know the impact that we saw in the first half which is roughly about 50 basis points of operating margin or 30 basis points I should say is carried.
Through for the rest of the year and so you.
You know that 16, 5% full year operating margin is impacted by the DCP in the first half. So that's the best way I can characterize it.
Yes.
Labour front.
At Investor Day, we showed a chart that said pre COVID-19, our turnover of what we call our frontline roles, which is phlebotomy logistics specimen processing our call centers was in the 14% range our total turnover.
A chart that said in the fourth quarter. It was upwards of 23% it's come down modestly in the first part of the year, but still hasn't come down to the levels I, obviously, a pre COVID-19 or to where we would like them now you're right. It's a trade off between increasing wage rates and the pricing and the cost you pay.
For this turnover we've estimated that.
Each turnover each person can cost us upwards of eight to $10000, depending on the row role and that is simply the lost productivity or the time. It takes to get somebody from day, one to as efficient in that in that role as it S. A person who's been in the role for two plus years. So it's about.
Eight to $10000, which if you do the math on that you know.
It could have a upwards of a $20 million impact in the second half of this year.
Now we're at the high end of our wage rate guidance that we gave we said 3% to 4%. We're certainly at that high end and you know if we need to make adjustments.
We obviously look at the ROI on that and and we're faced with those decisions and in certain markets, we will make adjustments to get the turnover.
To a place that we're comfortable with.
Got it thanks, so much.
Yes.
Thank you. Our next question is from a J Rice with credit Suisse. You May go ahead.
Thanks, Hi, everybody.
Maybe just to pivot over to ask you about your health system business I think last quarter, you said in aggregate it was growing at about 7% in this quarter. The press release says, it's just under 10% and I suspect with.
New York rest here and so forth coming online fully in the back half it might be even higher than Ted when you think about your margin targets in what you're shooting for.
Can you comment on how the growth in that side of the business is impacting our margins in the opportunity and if there's any updated thoughts on the pipeline of interesting maybe gibbs that as well.
Yeah, Thanks, a J.
Just on the New York Presbyterian book of business, when we buy that outreach book of business. It actually is in our physician bucket not our health system bucket because it's it's.
It's physician offices.
We build third party payers for that.
Our health system business in the quarter.
Was really helped by the Pls side, a reference book of business was strong as well, but our pls growth was very very strong cited by the three deals that we mentioned in the script with tower Health Lee Health and northern light being some of the newer ones. So it was.
That generated substantially more growth in the quarter.
Now as we've always said.
Pls has slightly lower operating margins than our normal physician office book of business.
We really like the ROI.
Okay. So it's kind of a strong return on capital and that's why we continue to do this so in terms of the outlook.
Our funnel of opportunities is strong.
We hope to have more closed in the second half of this year on both the pls side as well as new reference what rough wind. So we're optimistic that the health systems portion of our business will continue to grow and one additional comment a J so with regards to the expectations in the second half on Pls.
As Jim said, we are seeing strong growth in that business in the second half from a year over year perspective, we had some big wins in the first half of last year as well that ramped up in the second half of last year. So from a year over year perspective, we do lap some of those pls wins in that mutes, our revenue growth to some extent.
But we are seeing really great momentum on the people side of the business.
Okay. Thanks, a lot.
Thank you. Our next question is from Patrick Donnelly with Citi. You May go ahead.
Okay.
Okay.
Sam again that 16, and a half is that now the right number to work off in terms of the long term guide I know you've talked about a few of the moving parts. The unit pricing, maybe looking a little better labor hitting at any of these things one time that would wear off and then all of that pricing and I know you guys negotiate kind of a quarter of the contracts annually can you just talk about the pricing.
Environment at the moment.
Yeah, no. It's a so the 16 and a half would be the launching point, if youre thinking about the three year outlook, Patrick and the improvement that we guided in the in Investor Day, which is the 75 to 150 basis points improvement that's still the right number to be thinking about longer term off of the 16, 5% launching.
Point at the end of this year in terms of you know a couple of things that you mentioned you know one time items I think we talked about the DCP, which was more significant in Q2 and for the first half of the year. You know maybe you can call that onetime, but although it is recurring but you know we don't forecast for it sometimes it's a benefit sometimes it's a negative in terms of an operating margin percent.
You know last year in the first half it was actually a benefit this year in the first half it's a negative.
Pricing environment is very good it's really good we're seeing good momentum with the health plan value based contract arrangements that we have and we expect the pricing environment actually in the second half or the pricing benefit in the second half to improve versus the first half now you know as we think about 'twenty four we've talked about before.
That Panama is still an uncertainty and so until we have more certainty around whether there's another pam a delay or a salsa bill that gets passed.
Still some uncertainty there for 24.
Operator next question please.
The next question is from Brian <unk> with Jefferies. You May go ahead.
Hey, good morning, guys congrats on the quarter.
Hey, Sam maybe I'll follow up just on Patrick's question right. So as I think about your previous comments on 2024 guidance or targets for operating margin does this push out what you had previously guided to for 2024, and then maybe kind of related to that as I think about the 100 million of corporate savings that you've outlined it began in Q.
Two I mean is there more to squeeze or is this sort of the target run rate and you know, we're just going to see it flow through the P&L and into next year as well. Thanks.
Yeah. So with regards to thank you Brian first of all for the question. So with regards to 'twenty four we didn't guide 24, we gave some long term targets around what we expect our operating margin to look like over the next three years as we continue to execute on productivity improvements invigorate and apply cost savings.
So the business the $100 million that you referred to which by the way next year will be part of our run rate. So you wouldn't expect to see an improvement year over year and 24 versus 23, because we're except for maybe one quarter.
But you know I would say the 16, 5% as I mentioned to Patrick becomes the launching point for the future and we do expect with continued invigorates offsetting inflation with the.
The cost reductions in the business that we've applied and now will continue.
And that are generating the you know the expected improvements we do expect to to drive improvement in our operating margins long term. There is the uncertainty about Panama, which is what drives the range of either 75 to 150 basis points improvement over the three years.
Yes.
Then in terms of the cost take out $100 million.
We're always looking to be the most efficient we can and obviously spend every dollar as wisely as we can but we're also going to continue to invest in this business. We've made strong investments in CIT.
I think as you heard in our script, it's paying off for US we got really nice growth out of that it has now turned profitable.
All timers tests that we've brought to market that requires investment and we're going to continue to invest in that space, we're going to continue to invest in molecular and genomics in oncology, because we're getting growth in that space and with a haystack acquisition, we're going to continue to invest there to try to get that test to market as quickly as possible and build a stronger.
Present, so we're always going to balance the two but we're investing in this business for the future.
Thank you.
Next question is from Peter Peter Chickering with Deutsche Bank, You May go ahead.
Hey, good morning, Thanks for taking my question.
There's been a big debate among both the corporates investors on.
Sustainability of the current trends of utilization.
Talk about what you're seeing in July and sorry, if I missed this but how much of the two Q.
Organic growth was organic versus the pls transactions and how do you how should we be thinking about organic growth continuing in the back half of the year.
Yes, so we're optimistic that the growth will continue here in the second half of the year July to date has been strong.
Consistent with what we saw in June .
We generally don't break apart our pls growth from.
<unk>.
The growth in our core business, we've said externally that our pls growth is our pls business is about a $600 million franchise.
He said the health system market grew at 10%.
Pls grew north of that reference grew less than that so I think it can get a sense for what that contributes to our total growth.
But we're.
We're optimistic on the prospects with our health systems. The funnel of Pls opportunities remained strong health systems need our help and we think we've got a great offering that helps meet their needs and Peter maybe I can give a couple of additional comments on sort of second half versus first half, which is I think where you are.
Driving out here.
So listen we've had a great first half you know close to 10% revenue growth, but as you think about the second half there are a couple of things to keep in mind first of all we had some easier compare in the first half versus 2022, obviously, we were in the midst of Covid based business was.
Impacted by that so there was some easier compare in the first half that we don't expect to repeat in the second half on the prepared remarks, we talked about the Covid flu panel, which is about a 1% negative impact on growth in the second half definitely compared to the first half we talked about lapping some pls wins, which also has a muting effect on our <unk>.
Growth in the second half so when you factor all of these combined obviously you can look at our implied growth in the second half based on guidance and it's.
While lower than the first half and it's driven by some of these factors that I. Just gave you in terms of July you know, we are still seeing higher than.
Our traditional utilization so we're still encouraged by what we're seeing in terms of utilization in July so.
But you know we're being.
Appropriately conservative in the second half you know in terms of what the what.
What the utilization will look like.
Great. Thanks, so much.
Thank you. The next question is from Andrea Alfonso with UBS you May go ahead.
Thanks, It's Kevin Kelly Endo.
So I guess, if I can just bridge all this.
If we just take go back to the starting point was 17 and then the operating margin that went to 16 eight with Haystack now at 16, five and we had this sort of one time issue in the quarter with DCP, which took that down but you're also calling out some some labor trend issues maybe is the delta.
Patient around the labor costs and churn like is there a way to quantify that and should we expect that to continue going forward and I'm just trying to bridge all of these things and then think about the impact of 24.
We get this sort of margin expansion that was originally expected for 'twenty four with these sort of headwinds that are playing out.
Yes, Kevin let me take the labor piece, and then I'll turn it over to Sam here. So on a previous question, we talked about pre COVID-19.
Our attrition rate of of our frontline positions was in the 14% range.
In December Q4 was 23% to chart, we showed at Investor day in March.
Slightly better than that we have quantified. It we've said, it's about eight to $10000 per employee and in the second half of the year, we think it can be.
<unk> of a $20 million impact.
Versus where we would want it to be at this point in the year. So now.
Is the labor market's easy you know.
Unemployment rate sits at three 6% right now the fed has signaled that they're trying to actually get the unemployment rates back upwards of $4. One by up to 414, 5%. The interest rates are going to take a notch up again today. So we think theres going to be easing in the markets going forward, but it's hard to predict.
And so right now I think were being appropriately conservative on the guidance in the second half yeah. So Kevin Let me give you some commentary around second half versus first half margins.
And and why you should have confidence in the margin outlook that we gave the six to be approximately 16, 5% for the year.
So first of all and just to remind everybody in Q2, our margins expanded by 170 basis points sequentially. Despite an $80 million dropped in Covid 80 million roughly $80 million drop in Covid. So we had some great momentum in terms of operating margin as we look towards second half versus first half here are some of the dynamics that you should factor.
Our <unk> business, which was net dilutive on operating margins in the first half becomes accretive in the second half. So we expect to see that business as we're very encouraged by the momentum and it becomes actually it's become profitable in Q2, and it's going to be accretive for the second half of the year pricing is a net.
Also net accretive and will continue to improve in the second half and it's definitely a step up from the first half.
SG&A.
We started to achieve those $100 million annualized savings.
In Q2, and so we expect to achieve the remainder.
In Q3, and Q4, we didn't have that benefit in Q1 of this year, we talked about DCP and I don't want to focus too much on that but it was a headwind in the first half, which we don't expect in the second half offsetting that is the fact that we have some lower COVID-19 revenues in the second half because right now per our guidance, we're expecting approximately $40 million and the <unk>.
Second half, which is definitely well south of the 160 that we achieved in the first so but as you look at this momentum of all of these things plus the ramp up of invigorate improvements that we expect to see in the second half and yes. There is some heightened haystack dilution, which is to the tune of about 15 to 20 for the year, but as you look.
At all of these factors, we were very confident about the ability to achieve the outlook that we gave in terms of operating margins. Kevin. The last thing I'd add is when you think about price in this business. We tend to always think about commercial payers and Medicare and Medicaid you have to remember that there's another $2 $5 billion on an annual basis.
Where we price directly to health systems to physicians and then we have $800 million worth of other businesses between employer solutions, our drug testing business, our wellness business.
And our exam, one business, which serves life insurance companies. So we are getting price in those segments of our business and as Sam indicated.
Our price performance will be better in the second half than it was in the first half primarily from the lift we're getting in that on that side of our portfolio.
Super helpful guys. Thank you so much.
Youre welcome.
And our next question is from Lisa Gill with J P. Morgan you May go ahead.
Great. Thanks, very much good morning, I just want to go back to your earlier comments around value based care, where you talked about leakage out of network opportunities, but can you maybe just talk about how you see this over time and how you see the evolution of value based care as it pertains to lab is this a margin enhancing opportunity or just more of a volume opportunity.
You know how do I think about that and then just secondly, you know what.
I heard you talk about the pipeline of health systems is there any way to size what that current pipeline looks like.
Yes. So on the first question I just want to make sure we're not confusing terminology here value based care and value based incentives. So when we talk about value based care. These are generally arrangements, where Medicare is put lives directly into these ACO reach programs core Medicare advantage plans.
Delegate lives into large integrated physician groups now in both of those situations. We are contracting directly with these ACO reach organizations and directly with these large physician groups and we believe that those value based care programs that Medicare and Medicare advantage are driving.
Are very good for the lab business because generally they delegate lives at a fixed price and in fact labs become much more useful.
In terms of helping physicians ensure that diseases and conditions do not progress. So we feel good about that I think what we're generally.
When we talk about the health plans and we talk about these things called value based incentives. So these are programs that we structure with the health plans to help them reduce leakage to out of network labs and to help us redirect requisitions that are flowing into more expensive health system laboratories.
And have those requisitions flow directly into quest diagnostics. So when we are successful in those efforts there can be value based incentives that we earn when we help them earn when we achieve those targets of reducing leakage and moving work from higher priced hospital labs into independently.
Like quest diagnostics. So we seek to do more of both of those programs value based care programs with ACO reach and these value based incentive programs with our large payers.
Thank you operator.
And our last question is from Eric Coldwell with Baird. You May go ahead.
Thanks, Good morning, I have two first one a bit higher level more strategic so unitedhealthcare preferred lab network was updated in July I saw that they removed Mayo, but were there any other notable changes in that contract or your relationship there and then broadly.
On that same topic, what what's the outlook for other M. C O opportunities to narrow networks or move the national labs, like like you and lab core into.
Say more preferred roles are there are there opportunities being discussed in the market today.
Yeah. So on the first part of your question.
We did not note any other notable changes with respect to the preferred lab network. We still remain part of that preferred plan planned networking and that's our plan going forward.
In terms of narrowing networks.
When we speak to all our commercial payers, we always think it's better from their perspective to have.
Bolt independent labs and network.
That actually improves their ability to making sure that requisitions are going to lower cost lower priced environments, which is good for the payer is good for the employer and its good for the patient.
And so we don't see any change in that trend to narrow networks that restrict access to independent laboratories now having said that there's laboratories at play on the fringe that could be expensive single type test environments, and I think payers are always looking at.
Specialty labs versus independent labs that can do some of that specialty work as well.
My my other question and I apologize.
I think you've got close to entering this a few times and I've been toggling a couple of events. This morning, but did you quantify or could you quantify the reduction in investment spending seen year over year in the second quarter and also the portion of the incremental 100 million plus cost action that you actually captured in <unk>.
So we have a sense on what's left for the rest of the year.
Yeah sure Eric So no we didn't quantify the reduction in investment spend we did have lower investment spend in Q2 versus Q2 of last year, but we haven't quantified how much it is.
With regards to the SG&A benefits in the $100 million I think the assumption that you can make is it's about.
One third of that $100 million that was realized in Q2.
<unk>.
And we expect the same to occur in Q3 and Q4, okay. Yeah.
Just want to remind me.
We're going to continue to invest for growth in this business as we mentioned again in the script, we've invested in <unk> and we're really starting to see the fruits of that investment we look at a metric called return on AD spend it's now positives. So we're going to continue to invest here because we believe its driving growth and it's now driving profitable growth we've talked about are all.
<unk> portfolio of tests, we're going to continue to invest in that area. These blood based test.
We have the <unk>.
$42 40 test up and running we have the April test up and running these blood based test.
These are going to be more useful than CSF for pet scans.
And less costly.
Yeah.
Due to the environment.
We're going to continue to invest in the molecular side of our business, we're going to continue to invest in the oncology business and that's going to all of these things are going to position us for the higher growth segments of the laboratory industry and assure our long term outlook.
Thank you very much guys.
Yes.
We did have one more question come in our last question is from Derek de Brown with Bank of America. You May go ahead.
Hi, Good morning. This is John on for Derek.
Good morning talked about this quite a bit but talked about the focus of the M&A pipeline will be on the deals you've traditionally done before and it seems you certainly have plenty to come in the coming quarters and you have a lot to.
Lots of balance and of course, you are investing in all of the Simon portfolio and whatnot, but as you look to launch your first MRV product in 2024 could you just talk about potential deals or products that you can see with complement your current oncology portfolio that you don't have in your current.
Internal pipeline.
Well, we think with the combination of Haystack, which as you noted is centered on minimally residual disease testing.
Post to cancer diagnosis.
And we've brought up our own internal assay for therapy selection. So from a therapy monitoring and therapy selection standpoint, we believe we're very well positioned for future growth we continue.
To invest on the genetic side of our business hereditary genetics.
Genetic offerings for diagnostic purposes, and then the family planning in prenatal genetics is also an area that continues to receive folk.
Receive focus so.
We believe we're well positioned on the cancer side, we continue to make some investments on the genetic side.
And that's where the.
We think we're well positioned now again, our focus so right now we will continue to focus on hospital outreach deals and other small tuck ins that are accretive to our business.
Yeah.
Thank you operator.
Thank you and that was our last question.
Alright, well thank you everyone.
We are.
Again believe we had a strong quarter here the outlook for the second half we've taken up our revenue guidance feel good about that and thank you for supporting plus diagnostics have a great day.
Thank you for participating in the quest diagnostics second quarter 2023 conference call.
Transcript of prepared remarks on this call will be posted later today on quest diagnostics website at Www Dot Quest diagnostics dotcom.
A replay of the call may be accessed online at Www Dot quest diagnostics, dotcom slash investor or by phone at 203369.
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The phone replays will be available from approximately 10 30, a M. Eastern time on July 26th 2023 until midnight Eastern time August 9th 2023 Goodbye.