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

All right. Good afternoon. I'm Tycho Peterson from the life science team. It's my pleasure to introduce our next company this afternoon, LabCorp. Just a quick reminder. If you want questions answered, you can submit them through the website. So with that out of the way, I'm going to turn it over to Adam to make some introductory remarks.

Thank you, Tycho. Nice to see you. Good afternoon. Thanks for joining us, everyone, today. I'm here with Glenn, who is our Chief Financial Officer. Last year at this time, we were asked whether or not we thought we'd be in-person in 2022. I was pretty emphatic to say, I think we'll be in-person. Unfortunately, here we are, once again. I just want to say, I still think it was the right decision because we all have to do our part. We had to do everything we can to alleviate any pressure that we can on the health care system. So although we're not in person, I'm looking forward to having this discussion today. And if you ask me whether I think we're going to be together again next year, I really believe we're going to be together next year because it's really important to note, we are not in the same position that we were in a year ago. In fact, with the vaccines that we have, the achievements that we have, with the amount of testing that we're able to do, we really are in a fundamentally different place than we were a year ago. And I believe by this time next year, we'll be an even better place than we are today. So I'm still optimistic, and I'm looking forward to seeing people as soon as we possibly can. What I can tell you is, everybody involved in the pandemic is doing everything they can to meet the needs of the marketplace, to meet demand. For Labcorp, what does that mean? It means that even when demand was low in the middle of last year, the middle of 2021, we continue to have our laboratories open. We continue to invest in equipment. We continue to invest in supply. And even though at that time people were questioning whether it was the right thing to do based upon the number of tests we're doing, we always said we want to be prepared for whatever could come our way. So I'm glad that we did that. And what that's enabled us to do is to have our turnaround time on average still below 2 days despite the number of tests that we're being asked to do. And in fact, we still have the equipment and supplies to go about 300,000 PCR tests a day and about 300,000 antibody tests per day. We've performed more than 65 million COVID tests since the beginning of the pandemic. And I just want to remind people that we offer those tests with no upfront, out-of-pocket costs to patients who meet the critical guidelines. The biggest issue that we're facing right now frankly of running the test is just like the rest of America. We have people that unfortunately in organization have COVID and is trying to make sure we can staff everything and staff our labs and staff the work that we do for 3 shifts a day, 24 hours a day, 7 days a week. So we're doing everything we can to maintain the health of our employee base. We also continue to make significant inroads and progress in what we do for the CDC, and we do about 10,000 of the sequences per week that we provide the data for the CDC. And I just want to let everybody know that we will continue to be diligent. We'll continue to be prepared and we'll do whatever we need to do to be successful and help the world and the United States through the pandemic if other variants come, as we go into next year and into the end of next year. So we're going to continue to be at the ready to help, in any which way we can. What I can tell you is that our work that we've done then really proves to be a case study in our ability to work together and get work done in business development but also to get work done within the company in both diagnostics and drug development. What we've seen during COVID is we're using drug development and diagnostics together to make a significant impact. So right now, in the Indianapolis, they're doing work to help us with COVID testing across the rest of the United States, and that is one of our drug development laboratories. In other parts of the world and other parts of the country, we're using our diagnostic capabilities to help in drug development. So you really see a case study of how diagnostics and drug development can work together. And now we're focused on doing the same thing in areas like oncology, in autoimmune diseases, in women's health, in Alzheimer's disease, and we want to make sure that we continue to show the power of having the capabilities that we have together. At the same time, we continue to look for new areas of growth and things like cell and gene therapy as well as things in oncology such as liquid biopsy, we're making significant progress in those areas, and we'll talk a little bit more about that in just a moment or so. But those areas are in addition to our base business that remains strong. So lot of questions, I'm sure, are what's happening to your base business as you go through these new variants? The good news is that our base business remains strong despite the new variants. And we gave our third quarter results. We look forward to sharing our fourth quarter results on February 10. But what you'll see is that our Base Business continues to perform well despite the significant increase in testing that we're doing to the variants and all the health care system issues that we're seeing due to the variants. At the same time, we continue to work on a robust pipeline of health system and tuck-in laboratory acquisitions, and that pipeline is as strong as it's ever been, and we look forward to sharing some of those as we move into next year and throughout 2022. We also continue to work on looking for things that can advance our long-term growth, strategic tuck-ins. And I think oncology is a great example of that. You probably saw that in December we announced the acquisition of Personal Genome Diagnostics, PGDx, and that's going to strengthen our leadership in oncology. It's a leader in cancer genomics that has a profile and portfolio of liquid biopsies and tissue-based products that is very strong, and it has a diagnostic kit for liquid biopsy that's already approved through the FDA. What this has done is, it's taken what we were already doing in liquid biopsy in Labcorp and it's helping to complement and accelerate our capabilities, and it helps us with our overall leading oncology portfolio of diagnostics. It will also help us in drug development. Another great example of our tuck-in acquisition strategy was the acquisition of Toxikon. Toxikon is a contract research organization. It has nonclinical testing services, and what it enables us to do is not only have a presence in Massachusetts where there's a lot of pharma and biotechnology companies, but it also enables us to enhance and to build our cell and gene therapy capabilities in early stage. So having that capacity is helpful for us as we can move things into their lab and then expand the labs that we have for cell and gene therapy internally. The last thing I would say is that we reviewed our capital allocation strategy and our structure last year. We spent a significant amount of time as a Board and a management team doing that. And we announced 5 actions in December that we believe will support our long-term growth, enable us to play a more important role in health care, but at the same time give stronger returns for our shareholders. And those 5 things were: first, we're initiating a dividend, targeted payout ratio of 15% to 20% of adjusted earnings. We expect to begin that in the second quarter. The second thing is, we authorized through the Board a $2.5 billion share repo program, $1 billion of that will be through an accelerated share repurchase program. The third thing is that we're targeting savings of $350 million over the next 3 years through a new LaunchPad initiative. It's really focused on business process improvements. The fourth thing is, we're going to give full year 2020 guidance next month on February 10. But at that time, we're also going to provide a longer-term outlook and give you a sense of why we're so excited about the future and our long-term prospects. And then the fifth thing we're going to do is, with our first quarter earnings release, we're going to give additional insights into our business performance, and we'll give additional enhanced disclosures so that you can see more deep information about our various businesses and once again give you a better insight as to what we see for our long-term growth prospects across the different business segments that we have. So we believe that these 5 things will significantly increase shareholder value, but also give you insight into things that we're excited about into the future. Finally, the Board unanimously concluded that the company's existing structure is in the best interest of customers, of patients of shareholders at this time. That allows them to benefit from the best-in-class diagnostic testing that we can do, combined with the drug development capabilities that we have, which enables us to really execute well on our 5-pillar strategy. So as we continue to execute on that strategy, we're also going to continue to evaluate opportunities to enhance shareholder value. We're going to continue, as we always do, to assess our portfolio of businesses and make decisions that are best interest of our growth, but also and our shareholders, as we move forward into the future. So at the end of the day, I believe that Labcorp is better positioned than ever to deliver on our mission to improve health and improve lives. I can tell you, the Labcorp team is excited about what we see for the future. We're entering the year with a renewed commitment to what we're trying to do as a source of advancing health across the health care through our science, our innovation and our technology. And we're excited about the growth opportunities that are before us across our businesses. The growth across our businesses remain very exciting to us. So we look forward to sharing our fourth quarter results, our guidance and our long-term outlook with you on February 10. And with that, Glenn and I are here to answer any questions that you may have. And Tycho, I'll turn it over to you.

Great. Thanks, Adam. Great -- great overview. I'm going to start with a few on COVID. And I know there's a lot of COVID fatigue in the market now, and we're all ready to be done with the pandemic, but you guys have been a critical part of the solution here. So I think it's worth hitting on a few points. I appreciate on the testing side, the color you've given. Obviously, with Omicron, there's a lot of questions on what does that mean here in the near term? Curious if you could talk about implications for volumes, turnaround times for PCR and serology and also the work you're doing around COVID sequencing, any revenue contributions you could quantify there might be helpful.

Sure, Tycho. No, those are all important questions. And we've certainly seen a significant increase in the number of PCR tests that we're doing towards the end of December, more than the beginning of December and the beginning of January, even as more than what we saw at the end of December. Just to give you a rough sense, on a weekend, the volume that we get is lower than the weekdays, mostly because of shipping and a lot of our tests are done through doctors' offices, urgent care pharmacies. So the weekends, the hours are different. Sundays are a little bit lower than other days of the week. . On a weekend right now, we're same between 25,000 and 50,000 tests per day. But during the week, we're seeing somewhere between 125,000 to 175,000 tests per day. So we're seeing significant increases in what we've seen before. The good news is, as I said before, we kept our labs open, we kept the equipment we had, we kept the people that we needed. And therefore, our turnaround time has been on average less than 2 days, which remains very strong. And we're doing everything we can to keep the turnaround time below 2 days. The biggest issue that we're facing is just getting employees to come in and making sure we keep our employee base healthy. We're seeing about the same number of employees call out that you would expect in any other business or parts of the country right now. But the good news is that we are prepared for that. Our labs are open 7 days a week. We're running them 24 hours a day, and we're keeping up with the demand. Your question on serology. There, we've not seen a very significant increase in demand. It's still very low, relatively low, maybe $10,000 to $12,000 per day, much less than that on the weekends for the same reason as PCR testing is on weekend. And we can turn those around typically within a day, but we're not seeing a significant increase in the serology testing. And then in terms of looking for the variants, it's still a very small number. It's about 10,000 per week. So it's not a significant contributor to our revenue or income but it's a significant contributor to science. And it's important that we do that to help understand what's happening with the virus. And we'll continue to do that. We can do more, if we need to do more. It's through the CDC, and we're glad to help however and wherever we can.

And how about, as we think about the evolution of testing, centralized versus decentralizing, there's been a lot of scale up lately around antigen testing, at-home testing. Can you talk a little bit about how Pixel has been able to compete? And also, what have you seen in terms of school and employer testing?

Yes. Now another very important question. And as I've said before, I believe that there's a role for all the types of testing in the market place. I think there's a very important role for antigen at-home testing. There's an important role for Pixel. It is important goal for the laboratory testing -- central laboratory testing that we do. In terms of Pixel, it still represents between 5% and 10% of the total tests that we do. So we're still doing a very significant number of Pixel tests. We -- what we hear from consumers is that the experience is very good with Pixel and people don't have to leave their house. They can just order it. We send it directly to their house. They self-collect the sample and send it back to us and get the results. So it still remains very popular in the marketplace, continues to do very well. As the total volume is growing, the number of Pixel test is growing about proportionately. And then if you look at the antigen tests, obviously, there's a lot more antigen tests in the market today than it was in the past. And my hope is that there's hundreds of millions more in the future than are today. But I think they play a more important role for screening for if you're going out to a concert, if you're trying to decide to go out today. Whereas if you have symptoms, if the doctor needs an affirmative answer to whether you have COVID or not, I think there's still going to be a very important goal for PCR tests as we go into the future. So there is a role for each of the types of tests. We aren't definitely saying that consumers are playing a more active role in their health care. We see that with Pixel, but we're also hearing that through very -- a lot of other ways, putting telemedicine and other ways that people are getting health care right now.

And reimbursement has obviously been very supportive. How long do you expect the $100 COVID reimbursement to last through 2022? And is your turnaround time impacting reimbursement at all?

Yes. So we watch our turnaround time very well and very closely. And as I said, the majority of our test and the average turnaround time is less than 2 days. So that bodes well for us getting the $100 reimbursement for many, if not all of those tests, at least most of those tests. But as we look into the future, we believe there's obviously emergency health declarations here that the price will remain stable, albeit we continue to get some pushback from managed care plans and so forth, particularly if people are using our types of tests for things like travel. But as long as they're being used for the appropriate patients, those with symptoms, those have been exposed where doctors need to know an answer, we find that we're getting good reimbursement even through managed care. And I would expect the emergency to go on for quite some time. I don't have any inside information on that. And of course, it's not within our control. But my sense is this time next year, we're going to want to be prepared, just in case there really is a seasonality to this pandemic. And in case there is another variant. So I would assume that the price is maintained for a while. But with that said, Tycho, when we provide guidance on February 10, we're going to do it like we did last year. We're going to give you guidance for our Base Business and then we're going to break out the guidance for COVID. And then we'll give you a range of what that COVID would be. It will be a little bit wider than our Base Business, but we'll give you what we think the different ways that we could be within that range are. It will be based upon what the price can be, what the volume can be, what the utilization vis-a-vis other types of tests will be. I don't know, Glenn, is there anything you'd add to that?

No, I'd just reaffirm Adam's point. It's interesting, as we went even through 2021 with how long would the public health emergency be and how long would we with the demand be there. And we would provide guidance even quarterly on that, but a wide range. And what we found was that, again, we would have been wrong on both the level of the spikes of the new variants coming in. The fact that each time the public health emergency would continue to be expanded. So it was one of the reasons why it was important for us to break out the difference of what we're doing in COVID testing versus how our Base Business is reacting to it, even though it is somewhat correlated. But again, as Adam said, in February, when we give our long-term guidance, we'll still assume different possibilities of what can occur and still break out several.

And how about the role you'll play in durable COVID testing post pandemic, if the virus ultimately resembles seasonal flu, will send out PCR tests for COVID and combo fluid, receive the bulk of the volume given the higher sensitivity indeed for accuracy? Or do you see PCR ultimately contracting to a smaller portion of the market, given scale of antigen testing?

The true answer is we don't know how that's going to play out exactly right now. And part of it is going to depend on the treatments that we have available and the types of variants are out there and how serious they are. I think the more serious, the variant, the more it could cause hospitalization, the more people are going to want PCR tests that are done at Central Laboratory. Things like flu where people aren't spreading it necessarily, unless they have symptoms. And if people get the flu, their chance of being hospitalized are still very, very low. I think you can use other types of tests in a central laboratory test at times. But if it's something that could really cause a hospitalization, where you could get very ill, where there's significant implications if you have it or don't have it, particularly, when it could spread asymptomatically, if you've been exposed, I think there is going to be a long-term need for PCR testing in a central laboratory like we have over time.

And then on the Drug Development side of COVID, can you talk toward what percentage of backlog of Covance is COVID today and what you expect the revenue contributions to be this year? We know you supported AstraZeneca's antibody combination as well as Merck's antiviral through Phase III. So what sort of work do you see continuing into 2022? And then longer term, what sort of tail does this provide?

Yes. So we obviously have done a lot of work for COVID, both for vaccines, for antivirals and for other types of treatments. In the third quarter, COVID-related trials were about less than 3% of our backlog and about 7% of our net orders for the past 4 quarters. We don't see that changing significantly. In fact, if you would have gone back for the fourth quarter of 2020, it was obviously much more as a percent of our book-to-bill and our revenue. So we've kind of seen that decline over time because the size of the vaccine trials that we were doing were just massive and the trials that we're doing for antivirals and other things, even boosters are nearly the size of what we did at the beginning of the pandemic. So to date, we won more than 600 COVID-19 opportunities across our entire development spectrum. We expect that we will continue to have good momentum with winning those types of trials. I just don't think there'll be as big a percent of our book-to-bill as they were back in the late stages of 2020.

And how about the other side of it, the COVID impact to the Base Business? How do you think about trial delays, cancellations on the drug development side? Obviously, routine diagnostics were impacted as well.

Yes. So if you look at what we have experienced through the end of the third quarter, we actually saw that for Diagnostics, organic revenue was up over 3% versus 2019 levels. So it was back to where historical growth would have been. If you look at the volume, it was kind of flat to slightly down versus 2019 levels. And then if you look at our investigator site access, it was about 85% of what it had been before. So we saw the business coming back nicely. We've been watching it very closely as we went through December, and we saw the significant impact on a global basis from the new variants. And what I can say is, we haven't seen a significant change. In the past, back in the beginning of the pandemic when the variants were really -- or when the original virus was in the marketplace, we saw our Base Business go down very significantly. We're not seeing that as we get these new variants and so forth. The Base Business maintains very, very stable as we go through those.

The other interesting part too is that, even as we've gone through the pandemic from the -- call it, the diagnostics, frankly, both businesses, as we look at the revenue stream relative to 2019, we've actually been tracking it pretty historical norms. The difference is, is that the demand level, let's say, for diagnostics, the volume levels were actually tracking below 2019 levels as we were going through the pandemic, but our price/mix was offsetting that. So our revenues were staying relatively stable with historical growth as we were doing more tests per session as people were visiting physician offices at a lower level. So as we're ending up the year, we've now started to see the change that the volume levels now that we're experiencing are now back to, call it, 2019 levels and that we would expect that price/mix to now still grow, but grow at a lower level. So again, especially as we look forward, we would expect that trend to continue, volumes continuing to improve, but the revenues being still at the historical growth or hopefully even a little bit higher.

And obviously, the pandemic accelerated a lot of underlying changes, more direct to consumer. We talked about Pixel at-home collection, but telehealth, health care digitization have accelerated. We know you're involved with Ovia Health, you've got your Labcorp [ DX assist ]. Can you maybe talk about some of the investments you're making along some of those trends, telehealth and health care digitization particularly?

Yes. Absolutely. And if you go back over the last year, one of the things that I have said time and time again is that health care costs in this country and around the world are too high. And we've all got a work together to figure out how do we give better quality at a lower cost health care. I think this move to consumerism actually is helpful. And I think it will accelerate in some ways the ability to get health care costs as a percent of GDP to a lower level over time. So I think the changes due to technology are exciting. And I think giving people access to more things they can understand their health care better is important. And we've invested in things like Ovia Health, which is a digital platform, in order to help women -- women that are going through either fertility issues or pregnancy, have more information and be able to track things on their own, better than they could, otherwise. And we're continuing to focus on ways to bring technology to the forefront of everything that we do. Other investments that we've made, for example, are the customer experience. If you go to our service center now, you're able to go on your iPhone, you can make an appointment. When you get there, you can text to say you're there. When -- you'll get a text to say, it's time for you to come in. And then you get results, electronically. We're trying to find ways that we can make sure we use technology in every which way, shape or form that we can. And Tycho, many people have asked me, is this here to stay or do you think that in the future, we'll go back to telehealth being state by state as opposed to being across state-wide. I actually think it's here to stay. And I think that the more we use technology, the more we use advances in technology, the better we'll be able to control health care costs over time and get better quality.

Yes, that makes a ton of sense. I'm going to pull in my colleague, Casey, to bring us home with some questions. I've got to hop on to a panel. Casey, do you want to jump in?

Yes. Sure.

Thank you for staying, Tycho. Thank you.

Thank you.

Yes. So yes, our next question here is, what areas of the non-COVID diagnostics are you operating above prepandemic levels? And can you just elaborate on what is driving growth in some of those areas?

Yes. So I'm always careful looking at every quarter and so forth because you do see variations that are quarterly. But if you look over time and as we've gone through the last 6 months, we're seeing year-over-year growth in our esoteric categories weighted towards things like infectious disease, endocrinology, toxicology. If you look at routine categories, the year-over-year growth was related more towards its general medicine, infectious disease, maybe chronic disease. But I would say, overall, the health care system is acting very similarly to what it did prior to the pandemic in terms of testing for people, for routine and esoteric disease. Do you see some differences by geography and so forth? Maybe a little bit, but not enough to actually call out or to really get to any deep discussion on.

Got it. Maybe you can talk a little bit about the oncology testing side. It's been an area of strength for you guys. What differentiates you here? And then I'd also like to pick your brain on the rationale behind the PGDx deal. How that kind of fits into your portfolio there?

Yes. No, absolutely, Casey. One of our pillars for growth has been oncology. And we realize oncology is important from a diagnostic testing perspective. But also if you look at drug development, the number of trials in oncology is significantly greater than any other therapeutic area. And it's a way that we can show the power of having diagnostic testing together with drug development. You develop a diagnostic test, you bring it to drug development, you developed a drug, you launched the drug in the marketplace. You need to do a diagnostic place of a diagnostic test for the drug in the marketplace. So that's why oncology is so important for us to continue to be a leader in. PGDx is the latest development in our commitment to Precision Medicine and our comprehensive oncology offering. We've already talked about OmniSeq INSIGHT that we have. We've talked about IntelliGEN our myeloid program that we have. We've got clonoSEQ. We've got the Resolution liquid biopsy that we've done for lung cancer. So we're trying to build an entire portfolio of personalized medicine because I believe that's going to be important as I mentioned before, to lower health care costs over time. The more you can personalize medicine, I think the better we can do that. The other thing I would say, Casey, is that we're not only using our scientific expertise to bring these diagnostic tests to market, but we want to use our global scale in order to bring these tests globally, which is not something that we've necessarily done before. What we've learned from COVID is that we can use some of the laboratories we have in other important parts of the world to actually do certain types of testing. And when we start thinking about oncology, we start to think about liquid biopsies and the things that we're doing with OmniSeq, we're going to push ourselves to say how can we bring that more broadly outside the United States. So I think the competitive advantage that we have is not to science and technology that we bring, includes our scale and our global capabilities that will ultimately also make a difference.

Got you. Makes sense. One follow-up on the PGDx deal. Can you talk a little bit about their decentralized model? I know that they have a kit version of their tests. Can you just walk us through -- we've heard anecdotally on some challenges that, that model kind of possesses there. So yes, any sort of color on that?

Yes. So I think it can meet both capabilities. You don't want to just have kitting capabilities. You need to have central laboratory capabilities. But kitting capabilities can be very helpful, particularly in clinical trials. So if you can develop kits for clinical trials and then be able to enroll more patients and be able to do that quicker and open up to clinical trials more broadly, I think that's going to be very helpful. So we want to make sure that we have both capabilities. But once in the marketplace, then I think you might have a combination, frankly, of kitting technology but also central laboratory technology. We're going to work on both of those. And that's why PGDx was so helpful to us because they have capabilities in both areas, not just in kitting, but we're looking at the kitting first and foremost in our clinical trials.

Got you. Jumping around a little bit. Can you talk towards what sort of progress you're making on the PLN front in 2022 sort of would abate?

Yes. So first, I'd say that our Diagnostic business remains very strong. And I think that we have the ability to continue to perform very well across diagnostics in the United States. And that's just our Base Business, but the acquisitions that I see that are before us, I think, will enhance our ability to grow that business as we go through this year into next year. But as you look at PLN, I've always said that I believe that is a way that we can increase our volume and actually grow faster. The problem is that since the announcement of PLN, it occurred just before COVID and then by the time managed -- or different employers actually adopted it, it was during COVID. It was very hard for us to see the benefits of the PLN. The thing with PLN is it makes sense to the payer, it makes sense to the patient, it makes sense to Labcorp and everything is aligned. And what we have to do is actually see if physicians will buy into it and will change their behavior. That's what we have to make sure that we show progress. It really is, is just in behavior changes. I think we have some great ideas on how to do that. But the truth is, we really haven't had the ability to focus on those things because everybody is so focused on COVID and getting through COVID right now. I do believe that in the future, it could be very helpful and important.

Got it. Maybe shifting over to the drug development side, DCT [indiscernible] I think last quarter but represents less than 10% of total trials. Where do you see this number in potentially [indiscernible]

Yes, so Casey, we can't hear you right now. But I think your question was decentralized clinical trials and where do we see that going. If you look at decentralized clinical trials, there's no doubt that in 2021, there was significant growth. However, even with that growth, it's still not a significant portion of our overall trials that we're running. But it is becoming more and more important. The number of requests that we get from RFPs on our capabilities in decentralized trials is going up every single quarter. So I believe that COVID has accelerated the utilization of decentralized clinical trials and it's here to stay, it is going to grow. And why is it going to grow? Number one, I think you can enroll more patients that can make the trials more accessible to many patients. So therefore, you might be able to enroll the trials faster. The second thing is that it reduces cost overall. And I do think it's going to be different based upon the type of study in the therapeutic area. So for example, if you have a new chemical entity, in oncology, you might want that patient to see their doctor every month as part of their investigator every month as part of the trial. On the other hand, if you have an oncology drug that's already approved, that you're doing a Phase IV trial, that is well characterized already, you might be okay with that patient seeing their doctor once every 3 months. And if there's an issue going during those off months, so I do think that there's going to be a difference by therapeutic area and by type of trial, but there's no doubt in my mind that it's going to continue to grow and be important. And frankly, when I talk about strategic tuck-in acquisitions, that's what we did with SnapIOT, that gave us better technology to do decentralized clinical trials, and that's what we did with GlobalCare, which gave us kind of feet on the street, particularly in Europe to help ensure that we have people that can visit these patients when one are seeing their investigators are going to the sites themselves. So I think we're very well positioned in that area, but we're going to have to continue to grow and develop and be better in the decentralized clinical trials because it will be more and more important in the future. I don't know, if anything you would add to that.

Yes, just as the trends are such the tuck-in acquisitions that we've done really has given us -- enabled us both from technology and from people and resources to continue to see that grow as a bigger part of our business, but still at a small level. But good growth prospects.

Got you. If we're still on the drug development piece, I'd feel like I'd like to ask the question on just the [ levels of strategic view ] and more specifically, the reason to keep Covance, what sort of synergies ultimately does the drug development portion of your business have with the diagnostic side and ultimately -- is that sort of the reason why you decided to hold on to few.

No. Thank you, Casey. Very important question. Again, you're breaking up a little bit, but I got the gist of the question. We get a very thorough strategic review. And we looked at everything. We looked at, should we double down and buy something, should we spin out something? Should we spend in emerge, should we hold on, we look at different piece of the business. At the end of the day, when we look at all the information before us, the Board and myself as part of the Board, believe that it's in the best interest of the shareholders, the customers and our patients to keep the businesses together right now. And the reason why is, because we do see significant synergies between drug development and diagnostic testing. We saw it clearly with COVID, but we also believe we can see in other areas of oncology and Alzheimer's disease. Now with that said, we are going to continue to always look for ways to increase shareholder value. And we're going to continue to find ways to show and to prove the benefit of having the 2 businesses together. At some point, if we reach a different conclusion, of course, we would do different things. But at this point in time, we believe it is the right thing to do. And that's why we're spending so much time trying to give you additional insight, additional information to our business, a better understanding of our long-term outlook and then give you real specific examples over time outside of COVID on how these businesses work so well together. I kind of explained in oncology, but you can do the same thing with something like Alzheimer's disease and understand how diagnostic testing and drug development fits together nicely. So we'll continue to provide more information, more data. But at this point in time, we think it's definitely the right thing to do.

Got you. That's very helpful. Maybe a couple on capital structure and margins here, maybe loop Glenn in. Can you quantify any headwinds related to wage inflation next year? And maybe how this dynamic is impacting both sides of the business?

Well, clearly, wage inflation is upon us, it's upon us currently. And our expectation is that it will continue into next year. We obviously, normally, with us over half of our cost structure, if you will, our people. So when you look at just normal wage rate increases, that's normally a headwind and our LaunchPad initiative, our business process improvement is really part of the drive to help mitigate the rising costs. In the current labor market, that's tight. We are seeing some wage rate adjustments in certain areas to deal with the tight markets that we're seeing. So we do expect a little bit more of a headwind from wages, like we're currently experiencing. We are able to pass on some of those costs through pricing, but as well as our cost reduction initiatives that will help mitigate. What's nice is, we normally talk about margins for our business, we normally talk about Diagnostics margins being down little bit because of the impact of PAMA and the drug development margins improving, such net-net that the company's margins are relatively flat. As you know, PAMA for 2022, has been extended out into 2023. So we're actually in a position now, having our biggest headwind, if you will, not being there for at least 2022, where now we're in a position to potentially to see nice margin improvement across the enterprise. But at least that's one major headwind that's abated for at least this year.

Got you. And then capital allocation priorities. Those have obviously changed a bit now with the dividend and new share repurchase agreement. How should we think about M&A? And then you talked a little bit about how the M&A environment has changed post-pandemic on the hospital consolidation side. So yes, just how you're thinking about M&A more broadly here moving into 2022?

Yes. I'll give you some thoughts. I'll ask Glenn to jump in. So at the end of the day, we have confidence in our business, and that confidence in our business enabled us to do the share repurchase program, to also announce the dividend, but I feel confident that we can do the acquisitions that we need to do. The acquisitions that we are looking to do are tuck-in acquisitions, primarily in the hospital segment and work with our hospital colleagues to look for laboratories that we can acquire, to look for local regional laboratories that make sense for us to acquire. And then strategic tuck-ins such as when I talked about with PGDx, with OmniSeq, with GlobalCare, Toxikon, SnapIOT. These are all strategic tuck-in acquisitions. And we have the wherewithal to do as many of those as we think we can. So when we think about it, first and foremost, we want to make sure that we pay our dividend, and we're going to do that starting in the second quarter. Once we get past that, we're going to look at the business development opportunities that we have before us. We are very disciplined acquirers. In general, we look for things that return to cost of capital within 2 years, that are accretive typically in the first year and that we can integrate very well. There will be a few exceptions to that, like PGDx, where it's not accretive in the first year. It's slightly dilutive in the first year. But if it's something that's very important strategically, we'll look to do those types of acquisitions as well as smaller tuck-in acquisitions. And then we'll use our share buyback program to kind of make sure that we're returning cash to shareholders and that we're using our capital appropriately. But Glenn, why don't you give some additional insights and your thoughts.

Yes. No, just agree with the comments. First and foremost, investing internally. So our capital investments continue to see great opportunities to invest in our business for growth and we do roughly around, call it, 3.5% of our revenues tied to our internal CapEx needs, equivalent, frankly, for both of our businesses. And then as Adam said, we generate significant free cash flow as a company and plus have a very strong balance sheet. So M&A, obviously, is a big driver of our capital spend that we expect to make investments to complement the existing businesses we have. But we still generate excess capital well above that. So in the past, the company has always returned capital through our share repurchase program. With the Board inactive now, as Adam said, starting in the second quarter is through all the feedback that we had going through our strategic review process, a strong desire to also initiate a dividend. So from our perspective, we were always returning fairly significant capital each year in the form of share repurchases. Now the deal will be, we'll continue to return capital, but now in a combination between having a dividend and having our share repurchase. The increased level of share repurchases, the $2.5 billion that was just authorized by the Board, really reflects the fact that we've been generating, obviously, very strong cash flow, aided, if you will, because of all the COVID testing that we've done, but the balance sheet is also strong. So right now, we're more under-levered than we would normally be. We target our leverage at roughly 2.5x to 3x gross debt to trailing 12 months EBITDA. So we're below that level, if you will. And frankly, we're within the range if you look at pre-pandemic EBITDA. But still, we have a strong balance sheet. We have additional cash on our balance sheet to give us a lot of confidence that we can initiate the dividend, still return capital through buybacks but still give us all the needed capital we need for our acquisition program.

Got it. That's very helpful. The last minute here, I'll just -- I'll kick it back to you guys for any closing remarks.

Thank you, Casey, and thank you, everybody, for joining us today. I also want to thank all of the Labcorp employees and our frontline workers and our people in our laboratories that are coming in every day, doing everything they can to help the United States and the world through the pandemic. They've been real heroes on the front line. We look forward to sharing more about our performance and our outlook, both for 2022 and longer-term next month on February 10. And then I wish everybody to stay well, be careful. Get vaccinated, boosted. And hopefully, we'll be together soon. So thanks for your time today.

Thank you.

Sounds good. Thanks, guys.