Good afternoon. My name is Lisa Gill, and I am Head of Healthcare Services at J.P. Morgan. It is with great pleasure that I have with me Quest Diagnostics this afternoon. For those of you that have followed our research, you may know that I followed the lab industry from 2011 to 2021, and then in 2021, I gave it to our life sciences analyst. So when I had the opportunity a couple of months ago to take it back, it was a great opportunity. So one, I'm super happy to have you here. Second, this is my first time with this management team, so the management team changed over in that two year period of time. To my left is CEO Jim Davis, and to his left is Sam Samad.
It's just a funny background, Sam came from Cardinal Health, and we just reconnected in the fact that I think we met probably 15 years ago?
Yeah, probably somewhere.
So anyway, so with that, Jim is going to open it up and make some just open remarks, and then the three of us are going to have a fireside chat. So with that, I'll turn it over to you.
Yeah. So thanks, Lisa, and welcome back to our industry. As Lisa mentioned, I'm a year into the role. We started November 1st, 2022, but I've been with Quest Diagnostics for 10+ years, so I was leading all the operations of the company. For those of you that may not know us well, you know, we believe we're an integral part of the U.S. healthcare system. You know, on an annual basis, we do over 200 million requisitions. On a daily basis, that's 700,000 requisitions a day. Now, being someone from the University of Michigan, I like to tell people that's filling up Michigan Stadium seven times a day and drawing blood or collecting urine from every one of those people on a daily basis.
So 200 million requisitions, it's about 110 million unique people. So we touch about one-third of the U.S. population every year. We touch about 50% of the U.S. population every three years. We like to think that we know more about the state of the U.S. health, not the U.S. healthcare system, more about the state of the U.S. health than any company in America. We can tell you more about BMI trends, LDL trends, HDL trends than anyone. Now, 2023 was a bit of a year of a transition, not just a transition, for me as a CEO, but in 2022, our company did close to $1.5 billion in revenue. So I had the pleasure of guiding this ship, from about $1.5 billion in COVID revenue down to we guided this year...
Well, we're not going to announce our results today. We'll do that in a few weeks. But our COVID revenue, we guided to about $200 million. So the company dropped over $1.25 billion in COVID revenue. Now, the good news is we replaced about half of that revenue with the strongest base volume, base revenue growth that we've seen since I've been in the company. So we guided to, you know, roughly $600 million of base business growth, which represents just under 7%. But with that we had to do some hard work to align the cost structure of the company to the new revenue structure. And, you know- we guided to an EPS drop year-over-year of about $1.25.
Had we done nothing, our EPS would have come down, well north of $2 a share. So we aggressively took out cost, but more importantly, we drove the base, we drove the operating margin of our base business up significantly higher from 2022 levels. Now, as we think about 2024, I'll just make a few introductory comments, and I know you'll, you'll have a few questions. But, you know, we like to think there's some significant tailwinds as, as we enter the year. Number one, again, our base volume growth, for this year was, was at record levels over the past decade. We think that base volume growth is going to continue, albeit perhaps not at the, you know, 6%-6.5% level that we saw in 2023.
Our long-term guidance around base revenue growth of 5%, we still feel very good about that. We feel very good about the strength of our M&A funnel and about the strength of our PLS funnel. So our M&A funnel, we just announced a small outreach acquisition yesterday, where we purchased certain assets of the Steward Health System. We were doing their outreach work in Massachusetts. Steward operates in many other states, and we purchased the outreach assets there. Our M&A funnel has never been stronger. It's primarily health system outreach opportunities and our PLS business, which is Quest Diagnostics going inside of a hospital and running the laboratory for that hospital. We generally take on the people, we take on the assets of the institution, and we're able to generally bring them 15%-20% cost savings when we do that.
The reimbursement outlook continues to remain strong. This was a business from 2012 to 2019 that was generally seeing price declines of 1%, 100 basis points-150 basis points a year. Last year, our pricing was flat to slightly positive. We renegotiated a significant portion of our health plan contracts last year, and we're happy to report that we expect price to be flat to slightly positive again here in 2024. So all of those are very nice headwinds. In addition, as I mentioned, our Invigorate program delivered in 2023. The dropdown rate on that $600 million of base business growth was in the range of 40%-50%, and we feel that will continue into 2024. Now, there are some headwinds that you know that sit in front of us.
While our COVID revenue dropped to approximately $200 million in 2024, we expect it to just be a normal flu-like test in 2024. It dropped to approximately $200 million in 2023, I should say. So we expect it to drop about another $150 million as we enter here into 2024. Haystack, an acquisition we did in 2023, that gets us squarely into the MRD space. We still, you know, it was dilutive in 2023 to, you know, approximately $0.15-$0.20. We owned it for half a year, so we expect that to double in 2024. And then Sam will talk later about some debt refinancing that we did.
Obviously, that came at a higher interest rate, and so that'll pose about a 25% increment- $0.25 incremental headwind as we enter 2024. So I think it's relatively balanced, but we're optimistic as we start the season.
I wanna start with your initial comment, and that was really around the base business and the organic growth rate that you're seeing. And you talked about 6.5% growth, but maybe moving back towards that kinda traditional 5% growth, can you talk about, have there been areas of growth that have been stronger than other areas, within the base business?
Yeah. So let's segment the base business into two primary markets. There's a health system market, where we do reference testing for health systems, so these are tests that hospitals choose not to do. And then there's a physician-
Mm-hmm
Office book of business paid for by Medicare, Medicaid, and the commercial payers. The health system book of business is really, you know, growing, let's just say, in the 2%-3% range, which says that the physician office book of business is growing significantly faster than that. That's what we saw in 2023. Now, the question is why? This is a business that normally grows at roughly 2% volume growth, right? What is it that drives new growth in lab testing? One is an increase in the population: doesn't grow that fast.
Right.
Second is the aging of the population. Older people get more tests than younger people. It doesn't grow that fast. And then the third is the introduction of new tests, okay? So clearly, in 2023, there was some return to care phenomena. I can't yet split that out to say how much of our growth was just a surge in return to care versus us winning share or taking advantage or introducing new tests. Look, we did see some incremental growth coming from our Alzheimer's book of business.
Mm-hmm.
The new blood-based test for the detection of early-stage amyloid plaque has been a nice addition to the portfolio. That was a Quest development, that's an LDT that we brought to market. In addition, we had a CSF-based test that looks not only at amyloid plaque, but certain tau protein markers.
Mm-hmm.
That test also has continued to grow. So what we're seeing is clinicians are ordering more blood-based, CSF-based Alzheimer's diagnostics tests. Is that because there's a therapy out there? It certainly doesn't hurt.
Okay.
So feel good about the overall strength of the base business as we enter 2024.
You also talked about managed care rates, and I do remember from 2011- 2019 and the declining rates. And when I think about routine versus esoteric testing, did you see improvement in rates in both areas, or is one outperforming the other when we think about managed care rates?
Not really. I think, you know, when we negotiate the book of business with a payer, we generally don't... You know, there's 5,000 tests on the menu-
Right
So we don't go through each one. Now, do we look for specific increases in certain tests, like our Alzheimer's test that we're bringing to market? Absolutely. Importantly, what we do focus on in those discussions, though, is coverage decisions.
Okay.
So importantly, I'll give you a test, you know, that we, you know, presented evidence to UnitedHealthcare. It's a molecular test for vaginosis. Heretofore, it was a microbiology test. None of the payers were covering that molecular test, and we got a positive coverage decision from United, from Aetna, and a few others. So we really focus on coverage decisions-
Mm-hmm
... right? Because denials are still a certain portion-
Right
... of this business, and we attack every denial and try to make sure the coverage decisions are right for the patient.
When you generally get a large payer, like whether it's United or Aetna, to decide to cover the test, do you generally find that the other smaller managed care companies follow?
Generally, if you can... You know, first, we always, you know, go to Medicare, right?
Yeah.
Try to get Medicare to cover. Generally, that's a positive signal to the commercial payers. Generally, if you can get two or three of the big four or five nationals, then the Blues will start to develop it.
Right.
Now, we go after the Blues just as hard.
Yeah.
We may start with them, and that sends a nice signal as well.
And then lastly, as I think about this test volume, is there anything to call out geographically? You know, are you seeing anything different in certain geographies versus another, especially as you talked about the return to the physician office? Is it the same from a national perspective, or are there pockets of growth in one area?
You know, I would say, if we looked at the average growth rate, you know, the volume, we said, you know, 6.5%Nish. The variation across the country, across regions, may be as high as 1.5%, one way or the other.
Mm-hmm.
What I will tell you, in certain regions, we are seeing more health systems that are willing to relinquish the outreach work. We saw NewYork-Presby, right-
Yeah
... which is the parent company over Cornell and Columbia hospitals. And I think when you see an institution like NewYork-Presby decide to get out of the outreach business, I think it makes a statement to the rest of the business, to the rest of the industry. And certainly, NewYork-Presby did not exit the business because they were losing money on their outreach business. They were certainly making money from a laboratory standpoint. But if you were to talk to Dr. Corwin, I think what he would tell you is that when he's faced with investment priorities from neurosurgery, from cancer, from women's healthcare, from cardiovascular work, in an era when the cost of capital is significantly higher than it was five years ago-... he'd rather pour his money into things that really drive market share away from the institutions he's competing with.
I think if you were to ask him, people don't choose to go to Cornell for neurosurgery because of the lab.
They don't, really?
They don't. And so it's not that they weren't making money, it's just they decided that-
Right
... their capital dollars could be invested more wisely in other parts of their, of their institution.
You talked about this large pipeline. I wanna still continue to talk about volumes, et cetera, for a second. When you talk about that large pipeline, is that part of the decision-making process today around outreach, that they say, "Look, we can do this, we make money on it, but there's a lot of better ways for us to be able to spend, spend those dollars so we can really, truly compete?
I think it's absolutely that. I think, again, you know, rising interest rates, your cost of capital is going up.
Yes. Yeah.
On a marginal basis, if there's something that they can invest in that has a better ROI, they'll do it.
Right.
You know, in some institutions, like, you know, in New York, you may be space-limited.
Yeah.
Your ability to expand may be limited from a simple footprint standpoint.
When I think about volumes, and you knew, historically, we've talked about at this conference any incremental updates or color that you can provide on fourth quarter, you know, when we think about volume or mix. Is there anything that you could share at this point?
You know, we're going to announce on February first. What we did say in our October earnings announcement is, you know, we had Q3 base revenue growth of, you know, roughly 4.6%, our volume growth higher than that. And we said in October that our October volumes and revenue growth were consistent with that, so we thought that fourth quarter... Now, you can do the math, what we guided to-
Mm-hmm
... for the total year. You can back into that fourth quarter, growth, but it implied, you know, total base revenue growth for the year on, on the order of, just under 7%.
Right. On the, you know, when we think about the fourth quarter margin ramp, you highlighted what's driving the improvement. And, you know, historically, you've kind of given us some of the road signs to think about-
Yeah
... if that's the right way to think about it. Is there any kind of update that you can give us today as we think about that road to improving margins?
Yeah. So I'm going to let Sam talk to that.
Yeah. Thanks, Lisa. We'll be talking more about Q4 margins on the earnings call, obviously, but let's talk a little bit about some of the drivers.
Yeah
... that we saw this year. So, because it's important to reset for the audience here in terms of what we saw in terms of margin improvement this year. You know, we had $1.5 billion, roughly, of COVID revenues last year.
Right.
In 2022, as Jim said, and in 2023, we have guided to approximately $200 million. So that has a significant margin impact attached to it. That's a lot of volume that basically is dropping at our contribution margin. So we took on a lot of actions to improve margins in 2023, including starting in Q2, to the tune of roughly $100 million of SG&A reductions.
Mm-hmm.
We have looked at productivity improvements through our Invigorate actions that basically net 3% of productivity and cost reductions every year, and we have executed on that successfully in 2023. Now, you know, we still have, and we have had volume growth-
Yeah
... that's obviously helped us from a margin perspective as well. Now, we are still facing a tough labor environment, you know, a labor inflation environment. Traditionally, we've seen labor inflation in the roughly 2%.
Mm-hmm.
During COVID, and as recently as last year, we've seen it in the 3%-4%, at the high end of that range. So we're still fighting a tough labor inflation environment. So when I think about margins, you know, we had guided to 17% at the beginning of the year.
Right.
The last thing we said on our Q3 earnings call is that we expect it to be somewhere closer to 16%.
Right.
Really, the driver, you know, the difference between that 17% and 16% is the impact of additional approximately 1% of labor inflation-
Right
... higher than what we thought going into the year. Health, employee health costs much higher than-
Mm-hmm
... we initially expected as well. You know, we talked about Haystack. That has some dilution impact and impact on margins for the year as well. And the COVID mix of the business, not just the COVID reduction, but the mix of COVID in terms of where the testing is being performed, more in the hospitals, less in urgent care and physician offices, that has a profitability impact.
Right.
But I don't want to, you know, absolutely have anybody overlook the fact that we've taken so many actions across margins to reset the base this year.
Maybe we can spend a few minutes talking about the opportunity within sequencing, the genome sequencing, particularly the shift of it to whole genome sequencing. And what are some of the key factors and some of the opportunities in this shift in the market?
Yeah. So two types of sequencing, right? One is what we call germline sequencing that looks for... You know, there's really three segments to that market. One is carrier screening and prenatal genetics.
Mm-hmm.
So people that want to get pregnant, and then after a woman conceives, to be able to do prenatal testing. That's one segment of germline. The second is early childhood development. A child may not be on the right growth curve. Could there be some neurological issue that is genetics-related? And then there can be rare diseases later in life-
Mm-hmm
... Huntington disease. Then obviously, you know, on the germline side, hereditary, hereditary genetics. Look, in the germline industry, if you were to add up all the service providers in the germline industry, that would be us, our nearest competitor, Ambry, Invitae, you name it, it's not a profitable industry. All right? So we need the cost of sequencing to come down.
Mm-hmm.
You saw that we announced something this morning with Ultima Genomics. Ultima believes they can get to a $100 cost point for whole genome sequencing. Now, the fact is, there's not many people doing whole genome sequencing today from a germline perspective. NIPT, NIPS testing is not whole genome, carrier screening is not whole genome. Some of the neurological panels that we run on young children are really not whole genome, probably more whole exome. So it does have an opportunity to lower the cost point. More importantly, it allows us to standardize all those tests on one platform, whole genome sequencing, and then just from a bioinformatics standpoint, you look at the genes that you need to look at. So we're really excited about that. Now, on the somatic side of the equation, this is sequencing of actually tumor specimens to look for mutations.
Mm-hmm.
Those mutations then inform one, what is the appropriate therapy for that cancer, and then more importantly, with this Haystack acquisition we made, you know, how do you really monitor and look for the minimal residual disease? Today, most of those tests are actually based on a clinical exome or a clinical sub-exome. The test can become more accurate if the backbone, if what informs that test, we call these tumor-informed-
Right
... tests, if those tests are actually based on a whole genome, okay? So that's the direction that we're moving, it's the direction that the whole industry is moving. We're excited to have competition in this space and excited to be working with Ultima.
You touched a little bit on this with Haystack, but at your Analyst Day, which was a little pre my time, but I did get through the slides. You did talk about oncology and being a really big opportunity for you on a-
Mm
... go-forward basis. Can you maybe just walk us through the strategy when we think about therapy selection, therapy monitoring, recurrence management-
Yep
... any other programs that you have in place when we-
Yeah
... think about oncology?
Yeah. So let's start with the big picture on oncology and Quest Diagnostics. We're, you know, we guided to roughly $9.2 billion in 2023. About $1 billion of that $9.2 billion is in the cancer space today. And what are the components of that? It starts with, first, the largest anatomical pathology business in the industry. It's a $400 million business in Quest Diagnostics. The other $600 million in testing is really made up of common tests, PSA, HPV, Pap smears, FIT tests, and things like that. So we start with an incredible presence in oncology today. Now, when we do that anatomical pathology work, we have the specimen. We've decided, we've made the decision: Is it cancer or not cancer?
The next logical step, if you've made a cancer diagnosis, is to provide that diagnosis back to the referring physician, and then the question is: What is the appropriate therapy?
Right.
Okay, so if surgery is needed, post-surgery, and this is where the Haystack MRD comes in. Post-surgery, the surgeon comes out and generally says, "Hey, I think I got it all.
Mm.
But the question is: Did they really get it all?
Right.
Before we just apply adjuvant therapy, which is pretty much-
Mm
... the standard of care, especially if it's cancer in a source as well as in one of the nodes, you're gonna get adjuvant therapy. But in fact, if the surgeon did remove it all, and if you can come to that conclusion based on a blood-based test, where you don't see any fragments of DNA from those-
Mm
... cancer cells, you can really help the patient avoid that chemotherapy.
Right.
Now, if fragments of DNA are detected and chemotherapy is needed, then the next question is: Did the chemotherapy get it all?
Right. Did it work?
So, did it really work, right? Now, today, what is the standard of care post-chemotherapy? Standard of care post the chemotherapy is let's wait six months-
Right
... and let's do a PET-CT.
Right.
I came from the imaging world, and PET-CT is a wonderful modality.
Mm.
But the problem with PET-CT is, by the time you see it in a PET-CT image, it's metastasized to such a point that it has rooted itself in another portion of the body, whether that's liver, bone, brain, breast, lung. And so the hope with these minimal residual disease tests is to be able to detect the presence of cancer, either post-surgery or post-therapy, long before you see it in a PET-CT image.
That, to me, is something... I mean, one, just as a managed care analyst, I think about the cost savings, right? But from a patient perspective, I would think that if I were a patient, that would be amazing to not have to go through chemotherapy-
You know what?
if you didn't have to.
It is amazing.
So is there any pushback around this test or, or-
I don't think there's pushback.
Mm.
I think we as an industry have to establish the clinical confidence in the test. There's no downside. You can still do a PET-CT-
Mm
... in six months or whatever time period the clinician deems appropriate, but there's no downside to it. But obviously, until you forgo the PET-CT test, it represents an incremental cost.
Right.
Very important to continue to generate the clinical evidence that would give a clinician the confidence that I can avoid a $1,800-$2,200 dollar-
Right
... PET-CT exam.
Where are you on getting that clinical significance for the clinician?
Yeah. So when we bought Haystack, Haystack was basically. It had an assay. The assay was up and running. They participated in several clinical trials, are part of several research consortiums, and we were confident and comfortable with the clinical evidence that was generated to date. We're in the process now of moving the test from a small lab in Baltimore, Maryland, to our Oncology Center of Excellence in Lewisville, Texas.
Mm-hmm
... right outside of Dallas. So we're industrializing what was an R&D-based test.
Right.
We're gonna scale it. We're gonna automate it. We're gonna automate the bioinformatics chain. We're gonna perfect the whole exome portion of it. We're actually gonna in-source that. That was done by a third-party provider. So we'll be ready to go at some point here in 2024 to offer it from a commercial standpoint, but in the meantime, they continue to participate in several clinical trials. They're part of several R&D consortium efforts, and so they continue to do testing, they continue to generate clinical evidence. There'll be clinical publications that come out that prove the limits of detection that we all believe in.
Well, and financially, Lisa, just to punctuate this, you know, from a financial standpoint, Jim talked earlier about the fact that it's an additional $0.15-$0.20 dilution-
Dilution, yeah
-in 2024 versus 2023, because it's a full year dilution. This is the peak dilution of the deal is in 2024. We launch in 2024 the assay. 2025, it's actually less dilution, and it's an improvement year-over-year. 2026, we expect it to be accretive.
Okay.
You know, this MRD market today is sized about $500 million. Natera plays a big role in it. But by some estimates, third-party estimates, in 10 years, this could be a multi-billion-dollar market.
Mm-hmm.
So quite significant.
With good margins?
With good margins.
When we think about your Invigorate program, and you talk about 3% annual productivity savings, can you give us a breakdown of where these cost savings are mainly coming from, and if you continue to expect to achieve something similar in 2024?
Yeah, I'll start, and Sam can fill in. Look, go all the way back to 2012. We've had a history of producing, you know, 3%—roughly 3%.
Yeah
... variable cost productivity. In that timeframe from 2013-20 19, it was offsetting a lot of price-
Mm-hmm
... erosion in the business and some labor inflation, and now it's really offsetting a lot of labor inflation-
Right
... and some supplies inflation. And we've, as we've said, price has been, you know, flat to, slightly up. Look, there's three or four buckets that we work on continuously, right? Number one is the use of automation and artificial intelligence in our laboratories. And there's not a process in the laboratory today that we don't take a hard look at, and if we see manual work being done, we try to find ways to automate that. So, you know, an example, you know, the pipetting of urine out of a urine cup. You know, it's just not a great job, okay, in the laboratory. Unfortunately, urine cups come in all shapes and sizes, but we've worked with an outside vendor that's designed a device that can handle multiple different kinds of cups.
It unscrews the cup, it sticks something in, pipettes into a tube. That tube then feeds an instrument. In microbiology, I think you all know what that is, that's growing things in a dish. You would put it in an oven, you streak a dish, you put it in an oven, you pull it out of the oven every, you know, 8 hours-12 hours, you look at it under a microscope. You won't see that in a Quest Diagnostics lab anymore. First of all, it's automatically streaked. The cap is put on the plate, it moves down an assembly line, it's put into an oven. We take digital pictures of that plate every 8 hours-12 hours, and the system actually interprets what is growing or not growing. The system actually does the count.
Today, the FDA has approved that piece of equipment. It's made by COPAN.
Mm-hmm.
And so the workflow reduction, the human effort reduction is tremendous. And by the way, the quality of the tests have improved as well. We don't review negatives; we glance at positives. Hematology, urinalysis, anything that we look at in the laboratory where we see people look under a microscope, you know, I think 5 years-10 years from now, you will never see another microscope in a laboratory. Pathology is the next frontier. As you know, you still have to make a slide.
Right
... but digitizing that slide allows really two big opportunities. One, we can move that image anywhere in the United States. As I mentioned, we have a $400 million pathology business. We have pathologists all over the United States. If our breast pathologist guru sits here in San Francisco, I can't move a slide from New York to San Francisco. I can, but the time delay is tremendous. I can move an image.
Right.
So we can take advantage of the expertise that we have in the company that may be geographically based. Second, and most exciting, is the potential application of algorithms to that slide. Now, initially, that's gonna be helping a pathologist focus in a certain area. We call those region of interest tools, using algorithms to help pinpoint an area of the image that we want the pathologist to look at. But, you know, the work of PathAI and others is really some exciting advancements in that area.
Will the PathAI take over for that pathologist over time?
You know, look, I came out of the radiology world, and, you know, we first started digitizing images, you know, back in, you know, 1997. I would tell you, by 2002, 100% of the images coming out of MR, CT, X-ray were all digital. I would tell you that, you know, we're now 35 years beyond that-
Mm-hmm
... thirty years beyond that, and we haven't replaced radiologists. I think, you know, for screening types of procedures, mammography, there may be hope. On the pathology side, I think let's get comfortable with tools that are, you know, region of interest, and that can be used as, "Hey, the pathologist has called this. What has the tool called it?" If there's a tie, then we get another set of eyes.
Value-based care is a lot of different definitions. Lots of companies think and talk about it in different ways, and, and I've heard you speak to the opportunity around value-based contracting, with managed care. Can you talk to what managed care is looking for in a value-based contract, how you define value-based care, and, if I just want to make sure I have your target correctly, that greater than 50% of revenue will be based on some type of value-based contracting?
... Yeah, so two very different topics. Let's start with value-based contracts, and, and these are contracts that we enter into with, our commercial payers. And it's simply, it, it's simply just the establishment of certain goals and objectives. They're generally around moving share from expensive health system laboratories-
Mm-hmm.
or expensive out-of-network laboratories into our laboratories.
Right.
And so we, you know, we agree on a price per test, and then there's a set of incentives that are designed that if we are able to demonstrate that we've moved expensive requisitions from health systems into our independent labs, there'll be a bonus for doing that.
Mm-hmm.
Okay, that's one element of it. Some of our value-based contracts, you know, there's provisions in there around quality metrics. You know, TNPs, you know, test not performed, testing questions. There could be metrics around PSE, patient services wait times. There could be metrics around call center performance for physicians, all things that delight their customers. And then finally, when we do these outreach acquisitions of something like a NewYork-Presbyterian. I don't know exactly what the NewYork-Presbyterian rates were, but they were probably three to four times our rates.
Right.
When we do those acquisitions, we don't bring them down to our rates right away. We have agreements that we may step them down from 300% of Medicare in year one to 200%, then down to 100%-
Mm
... and ultimately to what our rates may be. So we share in the upside. They get a benefit, we get a benefit.
Mm-hmm.
So those are some of the value-based contracting efforts that we have in place with payers, that allow us to earn something above and beyond the price per test that we've negotiated. Now, when it comes to value-based care, value-based care arrangements are what large physician groups enter into. These are generally the delegation of Medicare Advantage lives, or the delegation of Medicare lives into these large physician groups, where the physician group has agreed to take care of that life for a fixed amount of money.
Right.
So they'll agree to take care of grandma for $12,000 a year. At that point, what we see is, number one, if that large physician group has their own physician office lab, generally, they're not gonna use that lab for that work because our pricing on that work is going to be lower than their cost. So they'll immediately start to send that work to us, and we price that, it's a client bill arrangement. Second, when you've agreed to a fixed amount of money per life, you become much more thoughtful about the use of diagnostic testing to detect disease early, and more importantly, to stop the progression of disease. So labs become much more strategic. Because the last thing you want if you're getting paid $12,000 a life is for that human being to end up in a hospital.
Right.
And so somebody with chronic kidney disease, somebody with cardiovascular issues, you're gonna monitor that patient much more closely.
Mm.
Labs become much more strategic. So we love the development of value-based care, and we applaud the continued push by Medicare and Medicare Advantage plans.
No, that, that's really helpful. You talked about managed care and managed care contracting, and the third quarter call, you talked about your relationships and the completion of rate negotiations. You noted earlier that you're happy with where rates are, but can you give us any additional color on, you know, how should we think about rate negotiations going forward? Was it an anomaly in 2023 that rates are in a better place than they were for the previous ten years? Has something changed within the industry? You talked about how managed care is really trying to shift that site of care. And I agree with you. I think when we think about value-based care, one thing is shift in site of care to a lower cost setting, and-
Mm
... clearly, an independent lab does that. But, you know, how should we think about the relationship there going forward?
Yeah, so we have a two-year trend now, right? Where we've been able to keep pricing flat to slightly up. Now, that- when we say pricing flat to slightly up-
Mm
... that's on the entire $9.2 billion book of business.
Mm-hmm.
Now, what I would tell you is our pricing in the health system segment has been under pressure, which means actually that the pricing on the physician book of business, which is-
It's better.
It's better. Good. So, it's a two-year trend. Now, what's enabled that? Look, I think the first part is the realization of, of the commercial payers that pit us against our, you know, nearest competitors, is actually not. It doesn't really help them.
Right.
So they pit the two of us together. They may be able to get a better price by kicking one of us out of the network. But when we leave their network, and I'm gonna just, you know, make up some numbers here, if we had 100 recs, when we leave the network, if you think that all 100 of those recs are gonna go to the nearest independent lab, they're not. Maybe 40 make their way to our nearest competitor, but the other 60 are going to go into expensive-
Right
... health system recs at 2 times-3 times the price that. And so net, net, it didn't create any economic value for the commercial plans. So that's why UnitedHealthcare has both of the largest independent labs in-network. That's why Aetna put both of the largest independent networks back in-network. And so I think it's a realization that we actually work well together, and we can help them generate significant savings. So it starts with that, and I think they've all come to that realization. Now, has inflation and has that helped some of our discussions? It absolutely has, because we wanna continue to provide great phlebotomy services.
Mm-hmm.
We wanna continue to invest in the digital capabilities of the business to make us even more competitive versus those health system labs.
Right.
So yes, we plead our case on wage inflation, supplies inflation, and things like that, but I think it's the combination of the realization of the value that independent labs can provide and the investments that we wanna continue to make-
Mm
... to improve our service levels so that more patients can come in.
... On PAMA, you know, we saw the delay again in 2024. I'm looking at Shawn, because we're like, "Do we put it in the numbers? Not put it in the numbers?
Yeah.
We decided to put it in the numbers rather than, you know, have to make an adjustment the other way, so we get to make a positive adjustment. That should be a positive when I think about kinda cash flow and the impact in 2024. So how should we think about investing those dollars, and then how do you think about longer-term resolution, right? We're waiting for SALSA.
Yeah, I'll let Sam talk about, you know, the financial piece of this. But it's not a help versus 2023, right?
Oh, right. It's just, it's just not a headwind-
It's not a hurt.
... that we expected-
It's not a hurt.
In 2024, right?
Right. So, Sam, why don't you touch on that, and then I'll come and talk about the strategy.
Yeah.
Yeah, I mean, if PAMA had happened in 2024, that would've been an $85 million-$90 million price cut for us-
Right
... which is really a price cut on the government book of business. The fact that it doesn't happen allows us to have the flexibility to continue to make some investments, to grow the business, to invest in, you know, both ongoing things like Haystack and other parts of our business. If PAMA had happened, we would've had to make potentially some painful cuts. We would not have been able to offset the full $85 million-$90 million, but this allows us and gives us the flexibility. But what we said, just to kind of ground the audience again in terms of what we said long term, Lisa, you know, we said we can grow operating margins over the next three years by a range of 75 basis points-150 basis points-
Mm-hmm
... basis points.
Right.
If PAMA were to happen in 2024, we'd be on the low end.
On the low end of that
... of that range. Now, since PAMA has been deferred, and hopefully deferred indefinitely... but it might come back in 2024, you know, it can help us get back up to that high end-
Right
... of that range in terms of operating margin expansion.
All right, so the long-term strategy here. Look, our trade association, ACLA, is fabulous and has been hard at work at trying to come up with a permanent fix. We call that permanent fix SALSA.
Mm-hmm.
We didn't quite get there in 2023. You know, Congress was a bit difficult to work with last year. We actually don't anticipate them being easier to work with in 2024. It's an election year. So, now, look, the reason the cuts were delayed, why would Medicare delay cuts? The reason they delayed the cuts, and they continue to delay the cuts, is because the cuts are going to trigger a new data collection process. And we think they know that the new data collection process may actually lead to rates going up when they actually collect data in a fair way. Okay, so a delay actually saves the government money because it delays a new data collection process, okay? Now, that's not what we want.
We don't wanna have this continue to hang over our head, so we will continue to work a solution. We call that solution SALSA. We'll continue to work with the two committees in the House, the one committee in the Senate, to try to get bipartisan support. I think that's gonna be difficult, to tell you the truth-
Mm
... in an election year.
I would agree.
But we're gonna be our trade association-
Mm
... works hard to try to do that.
Great. Well, we are out of time. Thank you so much for your time this afternoon. Thank you everyone for joining us this afternoon with Quest Diagnostics. Thank you.
Thank you.
Thank you.