Labcorp Holdings Inc. (LH) Earnings Call Transcript & Summary

Good afternoon, everyone, and welcome to our next session in Morgan Stanley's Global Healthcare Conference. I'm Ricky Goldwasser, Morgan Stanley's health care services analyst. It's a real pleasure to have me with me today here in our fireside chat, the Labcorp C-suite. Adam Schechter, Labcorp's CEO; and Glenn Eisenberg, Labcorp's CFO, are joining us for the next 30 minutes. And before we will kick off our discussion, just wanted to make a couple of quick disclosures. First of all, on the disclosure side, this presentation is for Morgan Stanley clients only, not for members of the press. And for any important holding disclosures, please see the Morgan Stanley website. In addition, just wanted to highlight to everyone, the Morgan Stanley Alliance for Children's Mental Health that uses the resource of the Morgan Stanley Foundation in collaboration with the expertise of our key nonprofit member organization in the mental health space to help address children's mental health. And specifically, the far-reaching challenges of stress, anxiety and depression. And now more than ever, we need urgent coordinated efforts to prevent the existing global crisis in children's mental health from escalating. And all of us can play a role in this effort. So we do encourage everyone on this webcast just to learn more about the issues that children are facing around their mental health and become advocates for change. And you can learn more by visiting morganstanley.com, The Mental Health Alliance. And with that, thank you. Thank you all for being here with us. Adam, Glenn, great to see you again. Hopefully next time, in person, not just over Zoom. But Adam, I would like to hand it off to you for some introductory remarks to help frame the conversation.

Yes. Thank you, Ricky. It's such a pleasure to see you again, and good afternoon to everybody joining us. I want to first start off by saying, it's great that you're raising the awareness of children mental health. There are so many issues out there. And I think COVID has exasperated some of those issues around the world, so thank you for bringing that to people's attention. I also want to thank each of my colleagues at Labcorp. All of them continue to work tirelessly to help the country and frankly, the world, through the pandemic. At the same time, they're working so hard to enable us to run our core businesses, which continue to be important to help people's health and well-being in the United States and around the world. Frankly, Labcorp's been at the forefront of science and innovation for more than 50 years now. And that's been our focus since the beginning of the pandemic: science, innovation and technology. We've continued to contribute very significantly in COVID testing, PCR testing, antibody testing, but also in vaccine and treatment development. At the same time, we continue to build capacity and capabilities. And that's what's been able to allow us to meet the current surge of the virus with continued quick turnaround times and with additional capacity above and beyond what we really need at the moment available. When the administration announced new guidance for vaccination for protection last week, we continue to mobilize our team, we're even bringing up a few more laboratories to create additional capacity. Also, if you look at the financial guidance that we gave on our second quarter call, it was intentionally wider than we typically would provide. And the reason we did that is because we know there's still uncertainty in the second half, particularly around COVID testing. That's also why we're trying to help as much as we can by providing guidance on the base business and COVID testing separately. We expect to update our guidance on the third quarter earnings call. That's going to give us about a month, maybe 1.5 months more of visibility and we can take into account the current information from the announcements last week, and I think we'll better be able to give you a sense of what the rest of the year is going to look like. But what I can tell you is if you look at COVID testing, it had declined for the first 6 months of this year. It increased significantly in July and August. At the same time, if you look at our base business and diagnostics remains strong, we've seen some but minimal impact from the recent surge. If you look at our drug development business, that remains strong as well. We still have about 70% to 80% of sites that are fully open despite the surge in the virus. The other thing I'd say is we continue to spend significant amount of time looking and evaluating strategic opportunities. We plan to add capacity and capabilities in strategic areas like oncology and cell and gene therapy. And we also continue to have a good pipeline of local lab and hospital lab acquisitions that we're looking at in order to deploy capital in an opportunistic but a very disciplined fashion. Where I'll end with my opening remarks is that we'll continue to deliver on our mission to improve health and improve lives, and I'm optimistic about the future. I'm optimistic about the future of the country, the world and what Labcorp can do to help improve all of that. So with that, Ricky, I'll turn it back to you, and I'm ready to answer any questions that you may have.

Great. Thank you for the update, Adam. And let me just start with the utilization topic that you've highlighted. The COVID hotspots are in areas where Labcorp has leading share. You said that you are seeing sort of that spike in COVID testing as expected. But I think your commentary on core volumes are really important and that you're still seeing the same momentum as in the first half. So could you maybe just give us a little bit more color around that?

Yes. Sure, Ricky. If you go back and you look at the last quarter, we said that we were doing around 54,000 tests on average per day. And if you look at the month of June, which was the last month of the quarter, it was significantly less than the average. Well, July turned it around and August also turned it around. Right now, we have the capacity to do more than 300,000 PCR tests per day, and we're using less than half of that capacity. So we still have significant capacity available. However, even using half of that means that it's significantly higher than where it was back in the second quarter, particularly in June. If you look at our core business, we said that we continue to see rebound. And we look back to 2019 to kind of give you a sense as to what is the core volume. If we look at the most recent months, we've seen some impact from the COVID surge, but it's been minimal. So we continue to expect the base business to perform well.

Great. So now to the big question that we get a lot from investors. And for our audience on the line, if you have any question for Adam or Glenn, please just type it into your web browser and I'll ask it on your behalf. But I already got a question on this topic. It was also kind of like one on my list. If you think about strategic planning, right, and we think about the market for clinical trials, stronger than ever. And you're seeing momentum in your book of business. That said, at least from a market perspective, you're still not getting the appropriate multiple for it. What's your current thinking around unlocking value? And what's the pros and cons, right, of keeping versus kind of expanding the CRO asset?

Yes. I obviously knew you were going to ask that question. I was just surprised it was the second question versus the first question. We do see momentum across our businesses. And I think we've executed really well on our strategy and executed well in the marketplace vis-a-vis competition. With that, I continue to believe that there's additional value that we can realize for Labcorp. I think you know we began a strategic review earlier this year, and we're looking at both our structural but also capital allocation, and we're looking at every option. Everything is on the table. The Board, working with the management team, also working with several outside advisers, are working hard, and we're looking at everything, and we're making a lot of progress so we can identify the best path forward to unlock shareholder value while also, of course, continuing to support the patients and the customers we can serve around the world. I'm not going to have any significant updates today but we look forward to sharing our conclusions once the review is complete. And as I said in the second quarter, that will happen in the fourth quarter of this year. In the meantime, we're going to continue to focus, make progress and execute on our current strategy and continue to have strong performance.

So along these lines, Adam, can you talk a little bit about the investments that you made in the CRO business? Because so this year, you made investments in branding investments, investments in assets. Can you just kind of talk a little bit about that?

Yes. So what I would say is we're continuing to focus on our strategy and deliver the execution in the marketplace that we've been known to do for the last several years and even before that. So we want to make sure we continue to execute well in the marketplace and move our strategy ahead. At the same time, separate and distinct from that, we're doing the review of our structure and our capital allocation. We're kind of running 2 parallel paths. And then, of course, at some point, they'll come together that we'll look forward to sharing our conclusions in the fourth quarter. When you look at the branding that we did, I mean, that work was underway quite some time ago. I mean, literally, it takes years sometimes to get that done and to figure out all the things that you need to do to change. So of course, we continue down that path, and then we made the changes that we announced early this year that we moved our businesses over to Labcorp. And then we have Labcorp Diagnostics, we have Labcorp Clinical Development, we have other parts of Labcorp like Employee Services. And it's just a way for us to bring the company together. A part of that was because we are now a household name in the United States. And even in other parts of the world, they're really starting to know Labcorp and what we stand for when it comes to science, innovation and technology. So we thought it was good to get the name coordinated consistent around the world. That was something that we're working on for a very long time. And until we reach conclusions on the strategic review, there was no reason not to continue down the path that we were on.

As we think about sort of strategy and positioning, you entered a partnership with Walgreens a couple of years ago. They're now going through their own sort of changes in evaluation. They recently entered a partnership with Village. How has the relationship played out to date? Is it an important part of your long-term strategy?

Yes, I also think the relationship is terrific, and we have very good productive dialogues with them in a very routine base list. We're approaching almost 300 locations that are either live or in the final stages of building process. And there's been some delays to the pandemic, but I think we've been really able to keep things, to a large degree, on track. If you look at the Net Promoter Scores that we have for the Labcorp service centers that are in Walgreens, they still remain higher than the ones outside of Walgreens. I think that works and serves well for our customers. And I think a big part of that is customers like to be in a Walgreens, so they can do other shopping and do other things that they need to do while they're waiting to do their blood test. So I think it's a win-win scenario. At the same time, we're supporting their drive-through COVID testing programs. I think we're servicing about 1,000 total locations between now and what will be done by the end of the month. And we also have our Pixel by Labcorp available through all, I think, Walgreens locations. So it's a very good productive relationship. I think with COVID, we've actually been able to show even more value in the relationship. But in terms of our service centers, we're a little bit behind but mostly on track.

And when we think about this opportunity to work in the future with other brick-and-mortars entities, whether it's Walgreens or others, I mean, Amazon is kind of like they're sound buys on what they want to do in services. How do you think about these opportunities?

Yes. I mean we've always welcomed and I value partnerships with retail partners and other customers as well. There's no doubt in my mind that we're going to see a growing market for at-home testing. I think patients are looking for other convenient testing methods and opportunities. They've seen what can be done with COVID, and I think they'll be open to other tests in the future. At the same time, there are certain tests, I think, that are more apt to be done at home, such as a nasal swab, where there are other tests such as a blood test or a urine sample, for example, that I think will continue to be done mostly in our service centers. What I would say is that we've got to continue to embrace innovation. We must continue to look for new technologies, new capabilities and we're going to find opportunities to grow our at-home testing business, but we're going to look to work with people like Amazon and other people like that in the future.

And along these lines, as we think about the expansion of the diagnostic market, one of the questions I received here is are there new areas in diagnostics that you can expand into that are faster growing than sort of the core routine labs?

Yes. So when I think about the future, I get very excited when I think about things like liquid biopsies. I think about cell and gene therapies. And when you think about the nexus of diagnostics and drug development and central laboratory work coming together, you can see a lot of growth potential in those types of areas. So there's a lot of innovation going on in the diagnostic areas, and you're going to see us playing a bigger and bigger role over time as those types of testing start to come to fruition. So I do believe that in the future, there's going to be new innovative, technologically advanced ways for us to find ways to grow faster than we have before.

Great. Another question here that I got is as you think about that relationship between having the exposure to these faster-growing areas of diagnostics and what you're seeing on the CRO side. Can you talk a little bit about that?

I'm sorry, can you repeat the question? I'm sorry. I missed it.

No problem. The relationship between what you're seeing on the clinical trial business versus sort of the opportunities that you are -- that are opening for you on the diagnostic side and kind of like that exposure to new diagnostics.

I see. I think the opportunities go hand-in-hand. So for example, one of our focus areas is oncology. When you think about oncology, there will be a strong role for companion diagnostics in the future. We do a significant amount of work in companion diagnostics. When you think about liquid biopsy, there will be a very strong role for liquid biopsies in cancer into the future. At the same time, the way that, that actually occurs in the marketplace in addition to the testing is to help determine which treatments are best used for which patients. So as you start to think about drug development and diagnostics together, you can see how capabilities in liquid biopsy, in companion diagnostics, in cell and gene therapy is an area for diagnostics but also a very significant area for drug development. So I think you actually see the nexus come together with the new opportunities in both the marketplace for diagnostics and drug development.

Another follow-up question that I have actually goes back to, I think, one of the comments that you made early on about the clinical trial and I'm now looking at my notes, that 70% to 80% of the sites are now open. Can you just expand on that? We got a question on that one.

Yes. So when you look at enrolling in clinical trials on a global basis, obviously, you need to get investigators that could then enroll patients. There are 2 things to look at. One is what are the number of investigators that you have; and two, how many people can each investigator enroll into a clinical trial. What we've seen is investigator sites that open typically can enroll about the same number of patients in the trials that they did before. But we still see, in some parts of the world, that the sites themselves have not all opened up, particularly where there are significant surges or outbreaks. So typically, say, let's hold off on doing clinical trials until we have patients treated and we have more capacity that we can put behind us. So the good news is that we're up to 70% to 80% of sites open. And that's -- if you would have gone at this time last year, it was much lower than that. But there's still opportunity over time for more sites to open as we continue to fight through the pandemic.

So wage inflation and attrition is yet another hot topic. And let's start with wage inflation. You're raising your minimum wage to $15. How should we think about quantifying the impact to the bottom line?

Yes. So the first thing I'd say is when you run an organization as large as ours on a global basis, and you have a lot of people on the front line where there's been considerable wage and labor shortages -- well, let's say wage pressure and labor shortages, you've got to remain competitive in order to compete in the marketplace. The good news is that people that come to Labcorp, it's partially about the money and the benefits which will remain competitive, but it's also about the mission. And we can attract people because they want to be part of trying to help to cure cancer or to figure out what we can do for Alzheimer's disease, understand how we can help people live a better, healthier life. So the starting point is you have to be competitive in the marketplace. And then the second part is you have to give people a reason to come to work every day. We're making sure that we do both of those. Obviously, there's a cost associated with increasing wages and keeping people in this type of environment. What I would say is we've been very successful at LaunchPad. We've been able to deliver what we've committed to. So we're going to deliver approximately $200 million in net savings for the 3-year Diagnostics LaunchPad initiative. And we also previously announced that we achieved our drug development LaunchPad savings. It doesn't end there. We're going to have to continue, and we will continue to find ways to reduce costs in multiple areas across our business, so we can continue to invest in our employees where we need to and at the same time, give an attractive return to our shareholders. So to me, it's not adding, adding, adding. If you're going to add some, then you've got to find ways to take out more. So we're going to continue to be very, very thoughtful about how to reduce expenses where we can, so we can be competitive in the marketplace everywhere we can.

So as we think about it, sort of the balance between -- or the degrees of freedom, right, between kind of like the higher salaries and the cost. I mean, should we kind of like think about it as the increase in the investment that you've done in increasing to $15 minimum wage is really sort of a gross number? And from a net basis, we're not going to see it necessarily flow to the bottom line because of these net savings from the LaunchPad and other areas of cost savings?

Yes, we're going to work hard to do that. I mean the short term, might there be some impact? There might be some impact. But over time, we're going to continue to reduce costs every which way we can. And we have significant effort being done to figure out exactly where that's going to come from and how do we do that in a productive manner and do it in a way in which it doesn't impact our growth opportunities. So over time, we're going to continue to improve margins in the clinical development business. And we've said in the diagnostic business, they'll be relatively flat, particularly if PAMA occurs next year, we don't know if that will or won't happen, but we're planning it to happen. So our margins on diagnostics will continue to be flat, maybe slightly down. And our margins are expected to grow in the drug development business. And we're going to find ways to take out as much cost as we can as we put some costs back in. And it's not just wage inflation, it's also material inflation. Anybody that's gone to a hardware store recently realizes that materials across almost every industry are going up. So we're going to have to offset some of that as well.

And when we think about material inflation and cost inflation, do you think that eventually, this is something that you can pass along to your customers? Or given sort of how reimbursement structures are, is that something that you will need to manage via cost saving?

We're going to plan to manage it through cost savings. That, I think, is the smart base case to do. But of course, we'll work to see if there's ways to share with others in the supply chain or in other ways that we can do that. It's not easy, particularly when you're fighting against PAMA already to do things like raise prices and so forth. But in other areas of our business, there are times that we can pass along some of those increased costs when people understand what they are and why. So base case, just assuming we've got to find a way to reduce costs to cover these things. And if it's anything better than that, that's going to be upside.

So let's talk a little bit about capital deployment. Now clearly, you're in the midst of a strategic evaluation, but let's think about that base case, where we're at now. How should we think about your capital deployment priorities? Clearly, in last year and a half, you're able to accumulate additional cash on top of what you were projecting for the base business.

Yes. So I'll give you some comments and maybe Glenn wants to jump in here. But as we've commented before, we expect to use our 2021 cash flow generation to support acquisitions and then also return capital to shareholders through our share repurchase program. What I can tell you is the pipeline for acquisition remains very, very strong. In terms of local laboratories, hospital laboratories, it's as strong as I've ever seen it, and we're continuing to make progress in those discussions. In terms of some of the strategic acquisitions that we're looking at, whether it be in oncology, cell and gene therapy, in clinical trials for hybrid and virtual trials, we see significant opportunities for strategic acquisitions that we have a smaller scale in those areas as well. So that's where we continue to focus. I don't know if, Glenn, if there's anything you'd add.

No. Just normally, Ricky, as you know, we've always been very balanced between capital deployment between M&A and share repo over time. As Adam said, in the first half of this year, while we've been in the market on the share repo side, the M&A, we did not spend a lot on. But we commented that, as Adam said, we expect to use our free cash flow this year, which rounded will be a $2 billion-ish kind of a number for the full year. So it really speaks that in the second half of this year, we do expect to see some of that pipeline on M&A coming through in cash used for those investments as well as continuing our share repurchase program.

So when you think about M&A, Adam, you talked about local and hospital labs, you talked about oncology and cell and gene therapy. How should we really think about kind of like balancing the acquisitions between the 2 businesses? What is -- the free cash flow is $2 billion, but what is sort of kind of that sweet spot that you think about?

Yes. So first thing I'd say is, when it comes to local laboratories, hospital acquisitions, I would do as many of those as I could as fast as I could. And here's why. Number one, they return their cost of capital very quickly. Number two, they're typically accretive in the first year. And number three, we know how to integrate those and integrate them well. So that to me is something you do as many as you can. And then we're looking at strategic opportunities and there's certain areas in what's ahead of us that meets the strategy of where we are going forward. And even if we were to have to do more than just the free cash flow, we have the ability to do that. So to me, it's more about what makes financial sense strategically but also gives us the best chance for long-term growth. And by long term, I'm thinking 5 years. I'm not thinking 10 or 15 years. But what we're trying to do is balance those strategic opportunities. And most of those aren't billions and billions of dollars. You can do lots of those strategic acquisitions for less than that.

So it seems like -- and it sort of kind of like ties to the question that we got here. Another question that we got is as we think about how you're thinking of positioning the portfolio and the acquisitions that you are targeting, really, the goal is to accelerate top line growth, maybe to accelerate long-term growth targets. Is that fair?

Yes. I mean the first thing is we want to continue to have a very attractive short-term profile for revenue growth and EPS growth. And I think these hospital acquisitions and the local laboratories enable us to do that to get some accelerated short-term growth. And at the same time, I'm extraordinarily excited about the future. And when I think about the future growth opportunities, I want to make sure we're investing enough to be at the forefront of those types of opportunities in areas like oncology, rheumatoid arthritis and several other areas. And you've seen us do, for example, an Ovia Health acquisition that's going to really solidify our position as a leading diagnostic company for women's health. Those are the type of strategic opportunities that might not give you a great return immediately, but it certainly will over time and allow us to grow faster as we go into the future. So it's both short-term and long-term strategic.

Great. So I think we have time for one more question. I'll ask 2 of them so -- although they're connected. So Adam, you've been now with Labcorp for -- it's been over 2 years. Time goes by really, really quickly. And so I saw someone before 2 years and he said, well, it was already 3. So really, as you think about what you know today about Labcorp, what really kind of like surprised you the most that you didn't appreciate in the first day on the job?

Yes. So you learn a lot being a new CEO. But being a new CEO in the middle of a pandemic, where your company is at the forefront of the fight of the pandemic, you learn a lot really fast. I would say our scientific, technological and innovation capabilities are far above what I think people realize and what I had realized coming in. Our ability to innovate, to move fast in the marketplace, to develop new tests, new kinds of tests to help with the enrollment of vaccines trials, I think, exceeded our customers' expectations. But it also was remarkable to me just to see our science, technology and innovation at work. And we have great, great, great people. So with that, Ricky, I know that we're towards the end of time. I just want to thank you for your time today. Know we are focused on doing everything we can to help the country and the world through the pandemic. At the same time, we're continuing to execute well in the marketplace, and we'll continue to look for ways to provide short- and long-term shareholder growth. So it was great to be here today, and I appreciate you spending time with us.

Adam, Glenn, thank you very much for spending time with us. And for everybody on the webcast, thank you for listening in and for all your questions.