Earnings Call Transcript - DGX Q2 2023

Shawn Bevec, Vice President of Investor Relations

Thank you, and good morning. I'm joined by Jim Davis, our Chairman and Chief Executive Officer; and President; and Sam Samad, our Chief Financial Officer. During this call, we may make forward-looking statements and will discuss non-GAAP measures. We provide a reconciliation of non-GAAP measures to comparable GAAP measures in the tables to our earnings press release. Actual results may differ materially from those projected. 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 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 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 is Jim Davis.

James Davis, Chairman and Chief Executive Officer

Thanks, Shawn, 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, hospitals, and physicians 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 170 basis points compared to the first quarter, despite a decline of approximately $80 million in COVID 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, physicians, 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 the progress we've made in each one of these areas. In 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, NewYork-Presbyterian's recently acquired outreach assets brought us new volume from the physicians. In Hospital Lab Services, base revenue from health systems grew nearly 10% in the quarter. The Professional Lab Services business had a very strong quarter as we saw solid growth from both new and existing PLS relationships. We are 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 questhealth.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 Genetic Insights, our first consumer-initiated genetics health test on questhealth.com. This saliva-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 through 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 and 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 cardiometabolic health. In neurology, we continue to achieve strong growth from our innovative Quest AD-Detect portfolio of Alzheimer's blood tests, which help identify early indications of beta amyloid and ApoE status. AD-Detect strongly positions Quest to lead in this rapidly evolving Alzheimer's landscape. Emerging therapies for Alzheimer's represent a new era in treatment and testing for this disease. Like many diseases, early intervention in Alzheimer's may promote better outcomes. Our AD-Detect portfolio enables accessible and convenient evaluation of Alzheimer's risk potentially at early stages and the monitoring of progression. AD-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 continue to see strong growth in our cardiometabolic, endocrinology, infectious disease, and carrier and 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 MRD testing. Haystack 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 MRD 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. Haystack is a capabilities acquisition. And as we've said, it will initially be dilutive for 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 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 and productivity. We are also excited by results of a pilot in our Clifton lab that showed AI speed data collection in specimen processing and expect to implement this AI solution across all of our major regional labs later this year. In 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 innovations that help standardize our lab operations. We are encouraged by preliminary results of pilots that use generative AI in our customer service center to automate call 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 return 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 this 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 Samad, Chief Financial Officer

Thanks, Jim. In the second quarter, consolidated revenues were $2.34 billion, down 4.7% versus the prior year. Base business revenues grew 9.5% to $2.3 billion while COVID-19 testing revenues declined approximately 88% to $41 million. Revenues for Diagnostic Information Services declined 4.9% 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 0.2% versus the prior year, with acquisitions contributing 50 basis points to total volume. Total base testing volumes grew 7.4% versus the prior year as we continue to see a broad-based return to care throughout the quarter. Revenue per requisition declined 4.9% versus the prior year, driven by lower COVID-19 molecular volume. Base business revenue per requisition was up 2.5% due to more tests per requisition, changes in 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 compensation 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 $2.05 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 $9.12 billion and $9.22 billion. Base business revenues are expected to be between $8.92 billion and $9.02 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. There 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 demand 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 will continue to improve the overall profitability of the business. Finally, 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 compensation plan also lowered 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.

James Davis, Chairman and Chief Executive Officer

Thanks, Sam. To 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 return to care. 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 costs. 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, Operator

And our first question comes from Jack Meehan with Nephron Research.

Jack Meehan, Analyst

I wanted to start and ask about 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 you're seeing that at all; could that be a positive or negative for Quest?

James Davis, Chairman and Chief Executive Officer

Yes. Thanks, Jack. So it's always hard to discern in this industry what is share gain versus demand return to care and things like that. We don't get perfect data on it. But our sense is it's some of both. On the share gain side, we look closely at our growth through each of the commercial payers. And when we see gains that are above and beyond the average, and we see the benefits of those programs, those value-based programs that we work with them which focus on leakage. It's around focusing on physicians that are using out-of-network labs; we see the benefits of those programs and therefore conclude it's share gain. Certainly, there's been some strong return to care. On the Payment Integrity side, I can tell you that, look, it's a never-ending effort here in Quest Diagnostics to continuously work denials, to make sure that we understand the payer policies, what are the diagnostics that support those policies, and then work back through our physician base to make sure that the tests that they're ordering are appropriate tests. So we haven't seen any discernible impact with some of those policies you are referring to. But we work collaboratively with the payers to understand them and then work back with our physician base to try to correct any errors.

Jack Meehan, Analyst

Super. Sam, one question on margins. Sorry if I missed this. What is the guide now assume for margins for the year? And can you just talk about what you're assuming in terms of the pace of productivity improvement?

Sam Samad, Chief Financial Officer

Yes. Thanks, Jack. So we are assuming for the year, operating margins to be at approximately 16.5%. In terms of productivity, you'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 momentum on our Invigorate programs. We're seeing 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 other side, we are also seeing, as you heard in the prepared remarks, a tough labor and turnover and macro environment. So turnover continues to persist to be higher than we expected, and that's driving pressure also on margins. But we are expecting approximately 16.5% for the year in terms of operating margin.

James Davis, Chairman and Chief Executive Officer

Yes, Jack, I would just add that you can clearly see the improvement in margins from Q1 to Q2. The math on the margin enhancements from Q2 of last year to Q2 of this year supports that, especially considering the decrease in COVID-related revenue. We're very satisfied with the margin improvement from Q2 of last year to Q2 of this year and pleased with the increase from Q1 of this year to Q2 of this year.

Operator, Operator

Our next question is from Elizabeth Anderson with Evercore ISI.

Elizabeth Anderson, Analyst

Congratulations on a good quarter. My question is about the considerable noise surrounding the deferred compensation and how it impacts the overall situation. What is your assumption regarding what is included in your guidance for the second half of the year? I understand that it may vary depending on future stock prices, but I want to know if it aligns with last year's trend or if it reflects a different outlook moving forward. Additionally, you mentioned labor productivity and the ongoing high turnover. How do you weigh the potential costs of investing more in wages against the productivity benefits that could result from such investments?

Sam Samad, Chief Financial Officer

Thank you, Liz, for the congratulations. I want to discuss deferred compensation and then Jim will address productivity and the related trade-offs. Regarding deferred compensation, I want to clarify its meaning and impact. The expense affecting SG&A relates to the rise in market value of obligations in our supplemental deferred compensation plan. This does not affect EPS since it is counterbalanced by a benefit in nonoperating income, making it net neutral for EPS, although it does affect operating margin. Sometimes the impact is not significant, as it depends on market movements. This quarter, it had a notable impact of 30 basis points on operating margin percentage. If we exclude that, our operating margin percentage would have been 17%. When comparing to last year, things get a bit more complex. Last year, we had a benefit related to deferred compensation plan expenses from changes in fair market value. Thus, compared to Q2 2022, there's a 1% impact. So when looking at Q2 2023 operating margin versus Q2 2022, we would appear relatively flat in operating margin percentage quarter-over-quarter, despite a significant year-over-year decline in COVID revenues of about $300 million. Looking forward for the rest of the year, we do not forecast deferred compensation. We consider it to have a net neutral effect on both the P&L and EPS, as well as on operating margin. The impact we experienced in the first half, about 30 basis points of operating margin, will carry through the year, influencing the full-year operating margin of 16.5%. That's the best characterization I can provide.

James Davis, Chairman and Chief Executive Officer

Yes. And on the labor front, we previously showed that pre-COVID, our turnover rate for our frontline roles, which include phlebotomy, logistics, specimen processing, and call centers, was around 14%. In the fourth quarter, that figure increased to over 23%. Although it has decreased slightly at the beginning of this year, it still hasn’t returned to pre-COVID levels or where we would like it to be. It's a trade-off between increasing wage rates and the costs associated with this turnover. We estimate that each turnover can cost us between $8,000 and $10,000 depending on the role, primarily due to lost productivity or the time it takes to train new hires to the efficiency level of someone with over two years of experience in the role. This could lead to an impact of around $20 million in the second half of this year. We are currently at the high end of our wage rate guidance of 3% to 4%. If adjustments are necessary, we will evaluate the return on investment for those changes. In certain markets, we will make adjustments to bring turnover to an acceptable level.

Operator, Operator

Our next question is from A.J. Rice with Credit Suisse.

A.J. Rice, Analyst

Maybe just to pivot over and ask you about your Health System Business. I think last quarter, you said in aggregate, it was growing about 70%. And this quarter, the press release says it's just under 10%. And I suspect with NewYork-Presbyterian and so forth coming online fully in the back half, it might be even higher than 10%. When you think about your margin targets and what you're shooting for, can you comment on how the growth in that side of the business is impacting margins and the opportunity? And if there's any updated thoughts on the pipeline that you're seeing, maybe give us that as well.

James Davis, Chairman and Chief Executive Officer

Thank you, A.J. Regarding the NewYork-Presbyterian business, we categorize that outreach business under our Physician services rather than our Health System segment, as it involves physician offices, and we bill third-party payers for it. Our Health System segment saw significant support from the PLS area this quarter. Our reference accounts also performed well, but the growth in PLS was especially strong. We are enthusiastic about the three new partnerships we highlighted: Tower Health, Lee Health, and Northern Lights, which contributed significantly to our growth this quarter. As previously mentioned, PLS has slightly lower operating margins compared to our traditional physician office services, but we are pleased with the return on invested capital, which is why we pursue this path. Looking ahead, we have a robust pipeline of opportunities and anticipate closing more deals in the second half of the year, both in PLS and new reference accounts. We are confident that the Health Systems segment of our business will continue to expand.

Sam Samad, Chief Financial Officer

Yes. 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 and that mutes our revenue growth to some extent. But we're seeing really great momentum on the PLS side of the business.

Operator, Operator

Our next question is from Patrick Donnelly with Citi.

Patrick Donnelly, Analyst

Sam, again, that 16.5%, is that now the right number to work off in terms of the long-term guide? And you talked about a few of the moving parts, the unit pricing, maybe looking a little better, labor hitting it. Any of these things onetime that would wear off? And then on that pricing, I know you guys negotiate kind of a quarter of the contracts annually. Can you just talk about the pricing environment at the moment?

Sam Samad, Chief Financial Officer

Yes. The 16.5% serves as a starting point if you're considering the three-year outlook. The improvement we mentioned during Investor Day, which is an increase of 75 to 150 basis points, remains a key figure for the long term based on the 16.5% starting point by the end of this year. Regarding some items you brought up, we previously discussed the DCP, which had a more significant impact in Q2 and the first half of the year; you might categorize that as a one-time event. However, while it is recurring, we don't include it in our forecasts. It can fluctuate between being beneficial and detrimental to operating margin percentages. Last year, it positively contributed in the first half, but this year it has negatively impacted it. The pricing environment is very favorable, and we are experiencing strong momentum with the value-based contract arrangements we have with health plans. We anticipate that the pricing benefits in the second half will improve compared to the first half. Looking ahead to 2024, we've previously noted that PAMA remains uncertain. We will need more clarity regarding potential delays in PAMA or whether a SALSA bill will be passed, as this adds uncertainty for 2024.

Operator, Operator

The next question is from Brian Tanquilut with Jefferies.

Brian Tanquilut, Analyst

Congrats on the quarter. 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 kind of guided to for 2024? And maybe kind of related to that, as I think about the $100 million of corporate savings that you've outlined that began in Q2. I mean is there more to squeeze or is it sort of the target run rate and we're just going to see it flow through the P&L into next year as well?

Sam Samad, Chief Financial Officer

Thank you, Brian, for the question. Regarding 2024, we haven't provided specific guidance. Instead, we've shared long-term targets for our operating margin over the next three years as we focus on productivity improvements, our Invigorate program, and integrating cost savings into the business. The $100 million you mentioned will be included in our run rate next year, so we do not anticipate a year-over-year improvement in 2024 compared to 2023, except possibly in one quarter. The 16.5% I mentioned to Patrick will serve as a foundation for future growth. We expect that through continued efforts in Invigorate and cost reductions, we will mitigate the impacts of inflation and enhance our operating margins in the long run. However, there is some uncertainty regarding PAMA, which is what affects our forecasted improvement range of 75 to 150 basis points over the next three years.

James Davis, Chairman and Chief Executive Officer

Yes. Then in terms of the cost take out $100 million. Look, 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. And I think as you heard in our script, it's paying off for us. We've got really nice growth out of that. It's now turned profitable. The Alzheimer's test that we've brought to market requires investment, and we're going to continue to invest in that space. We're going to continue to invest in molecular genomics and oncology because we're getting growth in that space. And with the Haystack acquisition, we're going to continue to invest there to try to get the test to market as quickly as possible and build a stronger presence. So we're always going to balance the two. But we're investing in this business for the future.

Operator, Operator

The next question is from Pito Chickering with Deutsche Bank.

Philip Chickering, Analyst

There's been a big debate among both the corporates and investors on the sustainability of the current trends of utilization. Can you sort of talk about what you're seeing in July and sorry if I missed this, but how much of the 2Q organic growth was sort of organic versus the PLS transactions? And how should we think about organic growth continuing in the back half of the year?

James Davis, Chairman and Chief Executive Officer

We are optimistic that growth will continue. The performance in July has been strong and is consistent with June's results. Generally, we do not separate our PLS growth from our core business growth. We have noted that our PLS business represents about a $600 million franchise. The health system market grew at 10%, while PLS grew at a higher rate and reference grew at a lower rate. This gives an idea of what contributes to our overall growth. We remain positive about our health systems, and the pipeline of PLS opportunities is robust. Health systems require our assistance, and we believe we have a strong offering that meets their needs.

Sam Samad, Chief Financial Officer

I can share a few additional comments regarding the comparison between the second half and the first half, which I believe is what you are asking about. We had a strong first half with almost 10% revenue growth. However, for the second half, there are several factors to consider. Firstly, the first half had some favorable comparisons to 2022 since we were still dealing with COVID, which affected the base business. Therefore, we do not expect to see those favorable comparisons in the second half. In our prepared remarks, we noted that the COVID flu panel is expected to negatively impact growth by about 1% in the second half compared to the first half. Additionally, we mentioned that we will be comparing against some PLS gains, which also dampens our growth in the second half. Considering all these factors, you can see that our projected growth for the second half, based on our guidance, is significantly lower than in the first half. This is influenced by the factors I just mentioned. For July, we are still observing usage levels that are higher than usual, which gives us some encouragement regarding utilization. However, we are being cautiously optimistic about what utilization will look like in the second half.

Operator, Operator

The next question is from Andrea Alfonso with UBS.

Kevin Caliendo, Analyst

It's Kevin Caliendo. To summarize everything, we started at a 17% operating margin, which has since dropped to 16.8% with Haystack and now stands at 16.5%. We faced a one-time issue this quarter with DCP that contributed to this decline. Additionally, you're mentioning some trends regarding labor costs. Is there a way to quantify the impact of labor cost and churn, and should we anticipate this trend to continue? I'm trying to connect these points and consider how they might affect our margin expansion expectations for 2024 amid these challenges.

James Davis, Chairman and Chief Executive Officer

Yes, Kevin, I'll address the labor aspect and then I'll pass it to Sam. Previously, we mentioned that our frontline attrition rate was around 14% before COVID. In December, during the fourth quarter, it rose to over 23%. While it has slightly decreased in the early part of the year, it has not returned to pre-COVID levels or reached where we would prefer it to be. You are correct that it's a balance between raising wage rates and the costs associated with turnover. We estimate that each turnover can cost us between $8,000 and $10,000, depending on the role, due to lost productivity and the time required to train a new employee to reach the efficiency of someone who has been in the position for over two years. Therefore, this could potentially lead to a $20 million impact in the latter half of this year. We are hitting the top end of our wage rate guidance, which we indicated would be 3% to 4%. If adjustments are necessary, we will evaluate the return on investment for those changes. In certain markets, we will implement adjustments to manage turnover to a more acceptable level.

Sam Samad, Chief Financial Officer

Yes. Kevin, let me provide some insights regarding the margins for the second half compared to the first half, and why you can be confident in our margin outlook of approximately 16.5% for the year. In Q2, our margins increased by 170 basis points sequentially, even with an $80 million decline in COVID-related revenue. This indicates strong momentum in our operating margin. Looking ahead to the second half, there are several factors to consider. Our CIT business, which negatively impacted operating margins in the first half, will become beneficial in the second half. We are encouraged by its momentum, and it achieved profitability in Q2, contributing positively for the remainder of the year. Pricing will also be a positive contributor and is expected to improve in the second half compared to the first half. We began realizing $100 million in annualized savings in SG&A during Q2 and anticipate completing the remainder of those savings in Q3 and Q4, as we did not have that benefit in Q1. Although DCP was a challenge in the first half, we do not expect this to be an issue in the second half. We anticipate lower COVID revenues in the second half, projected at around $40 million compared to $160 million in the first half. However, considering the aggregate of these factors, along with the expected enhancements from Invigorate in the second half, we remain very confident in achieving the margin outlook we provided.

James Davis, Chairman and Chief Executive Officer

Kevin, the last thing I'd add is when you think about price in this business, we tend to always think about commercial payers, 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 ExamOne 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 on that side of our portfolio.

Operator, Operator

And our next question is from Lisa Gill with JPMorgan.

Lisa Gill, Analyst

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? One, how do I think about that? And then just secondly, I've heard you talk about the pipeline of Health Systems. Is there any way to size what that current pipeline looks like?

James Davis, Chairman and Chief Executive Officer

Yes, I want to clarify the terminology between value-based care and value-based incentives. Value-based care refers to arrangements where Medicare enrolls people in ACO REACH programs for Medicare Advantage plans that delegate patients to larger integrated physician groups. In both cases, we are contracting directly with these ACO REACH organizations and large physician groups. We believe that the value-based care programs driven by Medicare and Medicare Advantage are beneficial for our lab business because they typically offer fixed-price arrangements, making labs increasingly valuable for helping physicians manage diseases and conditions effectively. When we discuss health plans, we refer to value-based incentives, which are structured programs aimed at reducing leakage to out-of-network labs and redirecting requisitions from costly hospital labs to Quest Diagnostics. Success in these efforts can lead to value-based incentives when we help health plans meet their goals of minimizing leakage and transitioning work to independent labs like ours. We aim to expand both value-based care programs with ACO REACH and value-based incentive programs with our major payers.

Operator, Operator

And our last question is from Eric Coldwell with Baird.

Eric Coldwell, Analyst

I have two. First one, a bit higher level, more strategic. So United Healthcare 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's the outlook for other MCO opportunities to narrow networks or move the National Labs like you and LabCorp into, say, more preferred roles? Are there opportunities being discussed in the market today?

James Davis, Chairman and Chief Executive Officer

Yes. 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 network, 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 both independent labs in network that actually improves their ability to make sure that requisitions are going to lower cost, lower price environments, which is good for the payer. It's good for the employer, and it's 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 are laboratories that play on the fringe that could be expensive single-type test environments. And I think the payers are always looking at specialty labs versus independent labs that can do some of that specialty work as well.

Eric Coldwell, Analyst

Okay. My other question, and I apologize if I think you got close to answering 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 2Q. So we have a sense on what's left for the rest of the year.

Sam Samad, Chief Financial Officer

Yes. 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 and 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, and we expect the same to occur in Q3 and Q4.

James Davis, Chairman and Chief Executive Officer

Yes. I want to remind everyone that we will continue to invest for growth in this business. As mentioned earlier, we have invested in CIT, and we are beginning to see the benefits of that investment. We measure success using return on ad spend, which is now positive. Therefore, we will keep investing there because we believe it drives growth, and it's now contributing to profitable growth. We discussed our Alzheimer's portfolio of tests and will continue to invest in that area. We have the AB42, 40 test and the ApoE test operating. These blood-based tests will prove to be more effective than CSF or PET scans and are less environmentally costly. We will also continue to invest in the molecular side of our business and in oncology. All of these efforts will position us for growth in the higher segments of the laboratory industry and support our long-term outlook.

Operator, Operator

We did have one more question come in. Our last question is from Derik De Bruin with Bank of America.

Unidentified Analyst, Analyst

This is John speaking on behalf of Derik. We have discussed this extensively, but the focus of the M&A pipeline will be on the types of deals you have traditionally pursued. It appears that you have a substantial number of opportunities lined up for the upcoming quarters, and you maintain a strong balance. Additionally, you are investing in your Alzheimer's portfolio. As you prepare to launch your first MRD product in 2024, could you elaborate on any potential deals or products that you believe would enhance your current oncology portfolio, which are not already in your internal pipeline?

James Davis, Chairman and Chief Executive Officer

Well, we think with the combination of Haystack, which, as you noted, is centered on minimally residual disease testing post cancer diagnosis. And we 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 genetics side of our business, hereditary genetics, and genetic offerings for diagnostic purposes, and then the family planning and prenatal genetics is also an area that continues to 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 we think we're well positioned. Now again, our focus right now, we'll continue to focus on hospital outreach deals and other small tuck-ins that are accretive to our business.

Operator, Operator

That was our last question.

James Davis, Chairman and Chief Executive Officer

Thank you, everyone. I believe we had a strong quarter. The outlook for the second half looks positive as we've raised our revenue guidance. We appreciate your support for Quest Diagnostics. Have a great day.

Operator, Operator

Thank you for participating in the Quest Diagnostics Second Quarter 2023 Conference Call. A transcript of prepared remarks on this call will be posted later today on Quest Diagnostics website. A replay of the call may be accessed online at Quest Diagnostics website. Goodbye.