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

Okay. Great. Good morning, everyone. My name is Eric Coldwell. I cover pharma services at Baird, and it's our pleasure to introduce Labcorp today. We have Glenn Eisenberg, EVP and CFO of the company. And we're going to dispense with the formalities and jump straight into Q&A, I think, just do a nice fireside chat. Feel free to come in as you need to. Glenn, I'm going to let you just do that very quick intro and give us an update, and then we'll jump right into the Q&A.

Great. No, that's great. Well, first of all, great being here with everybody. Adam Schechter, Labcorp's CEO, sends his apologies. He had a conflict that he wasn't able to be able to join us today but look forward to being with you all. And as Eric said, a lot of exciting things going on with the company these days across the breadth of our businesses and really look forward to having the opportunity to have an interactive discussion with you in our fireside chat today.

Okay. That's great. Well, Glenn, let's just jump right in. So I want to probably hit on what was, I think, the biggest topic of Q2, which was the clinical development spend, the big news in the quarter. I think you've probably addressed this 100 times. But people keep asking you maybe switch your answer a little bit or things come out that we might have missed in a prior conversation. One of the biggest topics is after going through a strategic review of last year, why now? What changed? If anything changed, what was it that changed over the last 6, 7 months that led you to that announcement a couple of months ago?

Yes. No, a popular question. As you said, we spent a lot of time and were very thoughtful of going through our strategic review last year and committed to our investors that we would explain the outcome of that review at the end of last year. So at that point, we did. We announced really 5 new initiatives coming from the strategic review, including the initiation of a dividend. We announced that the Board authorized a new $2.5 billion share repurchase program, $1 billion of which we're doing on an accelerated basis. We talked about doing enhanced disclosures for our business to continue to provide some more granularity in the business. We came out and gave a long-term, a 3-year outlook for our business on various financial metrics. And we announced the new LaunchPad initiative, a 3-year, $350 million initiative. So at that point, too, we talked about the structural issues that right now, the portfolio, as we have it, is what we were going to stay with at this time. And really, we commented that we did a very thorough review. We talked to a lot of third parties. We looked at acquisitions. We looked at divestitures. We looked at spinning. We looked at spin/merging various parts of our business. And at that point, we had committed to make the announcement of where we were. We announced everything that we were prepared to do. So fast forward, call it, 7 months after we gave that conclusion to our strategic review, we announced the spin of our Clinical Development business. And effectively, it was really having the opportunity to have more time to look at all the different possibilities. And that at that time, the Board decided, with the benefit of the work that we've been doing with our advisers, that we felt it was really a great way to unlock a lot of shareholder value by putting together a pure-play clinical development business that had kind of Phase I through IV clinical trials, the market access, technology services. So a pure play that would be able to trade in line with pure-play CROs. And that represents a little over 20% of Labcorp. But then the rest of Labcorp is now the global leader in laboratory services from our routine and esoteric labs, our central labs, our early development research labs. So 2 very focused companies. And while we believe from a commercial standpoint, there's still value of having the clinical business with the rest of Labcorp, we're trying to replicate that through strategic partnership agreements with the spinco, which we can do for a period of time. We'll maintain the tax-free nature of the spin. And then both companies, obviously, over time, will chart their own directions. Hopefully, it will continue on because we believe it's a pretty compelling value proposition between the 2.

Now the follow-on to that is you are spinning clinical. Makes sense. I get it. The other business that maybe gets a little more debate is early development. I think many people can see central lab fitting in fairly well. Logistically, similar processes. Obviously, a different client base but similar processes, logistics, distribution, testing in the lab. The early development does feel to be a bit esoteric and different than the rest of Labcorp. What are the metrics you're looking for to determine whether that is a good long-term fit? Are there specific initiatives you have underway to see the fit? Is there a certain amount of time you're going to award that business before possibly making another decision here?

So again, a great question that we've looked at when we were going through the evaluation of the structural and what do we spin, to your point. The clinical business, from our standpoint, made the most sense. It's a sizable business that will compete, has size scale to compete globally and will be a pure-play business. When you look at the other large CROs, you don't see any preclinical and clinical businesses together. So from that respect, the synergies of putting those 2 together didn't make sense from our perspective. And that essentially the early development research labs is what that is. I mean it's still a lab-based business with more commonality, more synergies with the remainco of Labcorp than it would be with clinical. So that was the reason those 2 weren't put together. So we like it. It's a good business. It's a growing business. It's a global business. So it does fit. And then we also put it in the perspective that even pro forma, so after the spin is done, early development research labs will still be less than 10% of Labcorp. So from a materiality standpoint, we like the business. We think it's a good fit and we like the characteristics of it. So we'll continue to develop and grow it and be part of the company.

The -- one of the things Adam had mentioned in the past was that early development brings a geographic breadth that might be interested -- interesting to Labcorp to possibly pursue some international offerings. Is that -- can you talk -- get into that a little bit?

Yes. No, that's -- we actually like that from both the standpoint of not only the early development research labs but the central labs. Both are global businesses. Both really provided platform for Labcorp's routine esoteric to potentially expand more global given we have that infrastructure, the knowledge about the different regions that are out there. We do a little bit, especially now with the acquisition of PGDx. We're defining the opportunity to sell kits and distribute that on a more global basis, probably more of an opportunity with our esoteric businesses. We're doing some companion diagnostics as well. So I think it's fair to say that the remaining Labcorp, one will already be a global business but with opportunities to expand more globally on all the different lab parts.

Sticking with CRO operations for just a minute. Your -- if -- our interpretation of 2Q was the Street was initially concerned about the growth rate in your CTTS segment, the lab business, Clinical Trial Testing Solutions. The business was down 14% year-over-year in the second quarter. I look at it from a very different lens and see a north of 60% growth rate in the prior year, which was obviously unprecedented and driven to a large extent by what was going on in COVID and also easy comps versus the prior year when the world locked down. So very weird, lumpy quarters here over the last 3 years. But I was hoping you could dig into what dynamics drove that tough comparison in the prior year. What of that, if anything, is sustainable? And if we normalize for the lumps over the last couple of years in individual quarters, what do you see as the long-term sustainable growth rate in your central lab operations?

So with regard to central lab, you hit all the key points of what we're experiencing today. So it's always difficult to do a year-over-year comparison in isolation for all the reasons that you gave, different headwinds there. And frankly, it has more to do with not necessarily even some of the headwinds as much as the tailwinds that we had a year ago. So the first that I would comment on is that we look a lot back to 2019 prepandemic levels across all of our businesses as, again, just one data point. Are we growing? Are the levels of our revenues commensurate with the expected growth rates that we would have, even with potential headwinds in the current environment? And our CTTS or central lab business organic growth rates compounded back to 2019 would be 7%. So in line with our mid- to high single digits. And out of the 3 components of our drug development, it tends to be on the lower end of the growth than in early development research labs or in the clinical development side. So from our perspective, the '22 level of growth seems appropriate. When you look at the comparison to '21, that's where you start to get those headwinds. So clearly, currency had an impact on the business. In CTTS, we had the issue that's going on with Ukraine and Russia, had a disproportionate impact on that business versus our others. And then you get to the biggest parts, which are the COVID related. So we obviously knew that the level of vaccine and therapeutic work we were doing in CTTS would be down this year versus last year, which it is. But also what's also interesting is last year, COVID related but not from a vaccine standpoint, we saw supply chain concerns. And we saw the level of our test kits, if you will, were being sent out at a significantly higher level than what we would have expected normal demand to warrant. And in part, that was our customer base being sensitive to the concerns of supply chain. So the growth that we experienced last year in part was that overdemand or over -- more kits than demand, where this year, we're back kind of to more normalcy of it. So again, if you back out the unusual headwinds, we actually think the year-over-year growth rate makes sense. But clearly, by showing a comparison to the 2019, it really reinforces that it's more to do with what happened last year than this year other than, again, especially the Ukraine, Russia and currency.

For people not as familiar with the central lab operation and how the revenue model flows, when you get that excess demand, that overdemand that you talked about with the kits, what happens when a kit is shipped but doesn't come back, if it doesn't come back? What's the revenue, the cost profile? What happens there?

So on the positive side, when we ship kits out, we get paid. On the positive side, the ones that come back, we get paid a lot more. So obviously, when we saw that the kits were being shipped out greater than the demand, our expectation was a lot of them wouldn't come back because there is, call it, the shelf life of those kits. So if they're not used within a certain period of time, they're never going to come back. So from our perspective, we have a lot of data, a lot of history that says, here's the level of kits that would normally go out. Here's the percentage of kits that come back. There's always that fairly steady percentage correlation. What we saw last year was a significantly higher amount of kits going out and a significantly lower percentage of kits coming back that was kind of outside of the normal. So now as we come into '22, we're seeing it kind of come back more towards historical patterns so that the demand that people are asking for, the kits that are going out are more in line with what they feel they need, but all those excess kits that are out there, our customers made the determination that the incremental cost of that relative to the concern of not having that supply warranted them purchasing more kits.

Okay. So I've got to ask the obligatory question, which is just to the extent you're comfortable talking about current market demand, the whole biotech funding situation. We can now confirm that, at least according to the sources we've used for decades, the August biotech funding is on a run rate for $56.5 billion, which is exactly the average of the 5 years pre-COVID. It's also dramatically lower than the last 2 years, which were unprecedented. Seems to be a lot of debate amongst companies across the R&D spectrum about exactly where demand is. We're hearing terms like deliberate decision-making in some cases. We did get a preannouncement from a company this morning on lower bookings so -- which you probably aren't that familiar with given you've been in meetings all morning. But I am curious if you could give us an update on what you're seeing in the demand environment for the CRO side of the business.

Yes. So overall, demand continues to be pretty robust. Obviously, we're enjoying a strong backlog. Bookings have been -- continue to be good. We get the question a lot, especially about a niche part of our business, if you will, which is the impact of biotech funding, which again tends to be more associated with the early development research lab part of our business. But when we look at the RFPs that are out there, they continue to be very robust. We're not seeing any unusual cancellations from that. We check with our business pretty regularly just because of the sensitivity and we do go through cycles. But as far as what at least we've been experiencing, we haven't seen any slowdown in the level of activity.

Do you think there's possibly some mix, both business mix as well as client-type mix that impacts you? Were the impacts to you maybe different than what other CROs that are more heavily biotech weighted or less lab weighted perhaps? I'm just curious if you sense any -- I still want to call it Covance after all these years. Drug development -- are there any drug development nuances that you would highlight that might separate you from, if you will, a risk profile in terms of market demand?

I wouldn't say so. Again, other than when you look at the part of our business, again, the early development research labs, the size of it, from a scale standpoint, even if we were to see some slowdown, how it would impact the overall business would be muted maybe relative to others. But having said that, even for that niche part of the business, when we look at the RFPs, we're not seeing it. So I can't imagine that we're having a different profile because they would tend to be smaller biotech-related businesses that would comprise or at least the most that we would have would be associated with that part of the business. And we're still seeing a very strong level of RFP activity.

I'm going to -- we're about at the halfway mark. And I want to wrap up with one more CRO question and spend the rest of the time on lab. The -- where you've had challenges in drug development over the last year, let's call it, to me, it feels mostly exogenous, transitory, timing comparison-related, things like FX. The war in Ukraine, obviously, not something that you would capitalize in the thought process of the value of the CRO. It just -- it happened. Stepping back from all of these various issues, rates, supply chain, labor, whatever, what is the underlying long-term view of your CRO growth, the retained parts, the early development in the CTS segment? If you could just talk about that. And to what extent would you say that where there have been challenges, it truly was exogenous or transitory versus maybe something you look in the rearview mirror and say, yes, we could have done something different here?

Yes. No, I think it's frankly more of the former. Again, as we look back again to 2019 because it really puts things in perspective, should our businesses be where they are. So we already talked about the one that had been most affected by kind of the certain headwinds or unique situations that were more COVID related or Ukraine-Russia related. And even our, again, CTTS business had that 7% growth rate. If you look at the other 2 parts of the business, so the early development research labs and take the current environment and you look back to 2019, you're looking at a 12% compound annual growth rate over that period of time. So clearly, that business isn't really seeing the headwinds. And if anything, they have a little bit of tailwinds because when you think about the inflationary environment and the research products that we use, there's been a high inflationary component. And therefore, our revenues are reflected that in there. When you look at the CDCS business, the one -- the clinical development that we will be spinning, again, and do a similar profile, you're looking at an 8% compound annual growth rate from 2019 to where we are today. So again, even that business that's negatively impacted by currency has some impact from Ukraine-Russia and so forth. It's still, again, in that mid- to high single digits. We would expect an early development research and a clinical development business to be at the higher end of that revenue scale, which they kind of are, and that the CTTS or central lab would be towards the lower end of the mid- to high. But still they're all between 7%, 8% and ED higher than that but, again, buoyed a little bit because of the inflationary environment we're in. So as we think going forward, we've kind of set the expectation of mid- to high single digits. The backlog supports it. Our current level of activity supports it. And our expectation going forward -- and again, we've given our long-term outlook for the different segments. And that mid- to high single digits is consistent with what we shared with our long-term guidance.

Great. So switching to LCD, Labcorp Diagnostics. The investor community and analysts have been very focused on one public data source out there that tracks a very small subset or a relatively small subset of lab volumes on a core basis as well as COVID. But I want to focus on core to start. That data, the XIFIN data set, it does appear as though 3Q is running notably below on what they consider baseline volumes that were in negative territory. And frankly, through July, it was looking pretty bleak, running mid-80s of baseline volume according to their data set. We analyze that data. And the reality is both you and your large competitor, Quest, every quarter have beaten that implied growth rate in XIFIN and sometimes by as much as 8 points. So you've done a lot better. What might, if I could -- and I know it's a tough question to analyze somebody else's data. But what might be the difference between what they're reporting from their subset of labs that they're showing each week to the results you and your competitor are putting up, which are consistently much better?

Yes. So I agree. I mean XIFIN is just another data point worth looking at to try to get a sense of utilization levels that are out there. From our perspective -- again, we continue to focus on how are we performing back to '19 as one of our benchmarks. And in our business, especially the diagnostic, seasonality actually comes into play with holidays and different days, if you will. So by taking kind of, let's say, our quarterly performance, comparing it to the same quarter back to 2019 and looking at the growth rates, we have a good sense of is business better. XIFIN doesn't do that. I think their methodology would be to take January and February of 2020, trying to get to this pre-pandemic. But then all the growth rates relative to pre-pandemic are based upon just that one data set. So you're talking about different number of days and so forth. So I think that's a little bit of a methodology difference. The other is I know they provide weekly information. And I would say that we have a lot of volatility as we go through week to week to week as well. And so obviously, we report on ours on a quarterly basis. We do look at it relative to XIFIN. And to your point, we've consistently seen a significant increase over the level of data. And so while we would say directionally, their data is a meaningful data point, the magnitudes could be pretty significant. So a time where they're up a little bit, we could be up a lot. It could be where they're down a little bit where we can still be up. So I would caution just -- again, it's another data point to use. I think we commented on the second quarter call that the volume levels were continuing to do well. In the first quarter, because of Omicron, we knew we had a negative comp compared to 2019. It was still up for the quarter year-on-year because we were off of a low base, but we were down compared to '19. As we went into the second quarter, we not only saw the year-on-year growth, but we saw -- we were now higher compared to the comparable period in 2019. And we commented at that time that we expect to continue to see demand levels increase and that the growth rates, especially relative to 2019, would be commensurate, if you will. So demand continues from our perspective to be good. But if you would look at it from a week or even a month, I think we commented as well on our second quarter call that April was a good month. May was a little bit weaker than that. But then June was the better of them. So we don't focus on the shorter term. But quarterly, we continue to see good demand.

So -- and I don't want to put words in your mouth or put you on the spot for saying something you're not able to say at a mid-quarter conference. But would there be anything -- in that one data set that's out there, would there be anything that they're showing that you would say, yes, we're seeing that, it's a correlate but -- I'm going to ask you [ just spotly ] and you can answer however you want. Core volumes, are they -- is this data representative of a trend? Or just looks like one of those quarters where maybe you could be more towards the higher end of difference as you have been in the past?

Yes. And again, just being mindful of what we can say about the current environment. I would say consistent with what we said on the second quarter call that we expect volume levels to be higher sequentially. We expect good growth year-on-year. And we expect good growth comparing it to the 2019. That hasn't changed. So to your point, if a XIFIN data is trending in one way, it could mean we're not seeing anything change. It's just the magnitude of the change is different. And obviously, we'll update every quarter of where we are. But as a consistent theme, we continue to expect to see demand improving as we continue to move forward.

I'm going to spend just a second on COVID testing, primarily the PCR side of COVID. Again, various public data sets, all are imperfect and some have gone away over time as the pandemic has stretched out. But triangulating various sources, we still have access to it. It looks like 3Q is on pace for COVID PCR testing nationally to be down somewhere in the ballpark of 20% to 30% over Q2. Now you and also your large competitor both guided to lower volumes as the year progresses. I don't think that's a big shock to anybody. The Street has the same mindset. When we look at your competitor who does still put out monthly data, they had a very good July. They had a weaker August. But in aggregate, they're down 10%, which looks better than the market averages. So triangulating, again, various public sources and one public competitor, we're seeing a range of anywhere from down 10% to down 30% in 3Q to date. I'm curious if you can give us a sense on what you're seeing in the COVID testing marketplace. And if there are reasons why your data may vary from your large public competitor's data or trend, if you could highlight that as well?

Yes. No, the one thing, obviously, is forecasting COVID testing has been a challenge for everyone, just given the uncertainty and when new spikes were to occur. And in fact, when we issued our second quarter release, we actually increased our outlook for COVID testing, just to your point. And so at that time, we were probably doing around 30,000 tests per day, which was down from a year ago, down from even the first quarter. And we said at that time, we were at a run rate that we felt kind of a 20,000 to 30,000 tests per day for the second half, we felt, was kind of the best guess at the time. And I'd love to say that's probably a continued expectation we have just because it can move quickly. But our view was that the volume levels would be down in the second half. We've kind of all said that, but a little bit higher than what we would have thought after the first quarter. So they clearly are a little bit higher and -- but we expect them still to be lower than what we experienced in the second quarter. Obviously, we have the advent of the public health emergency still in place. And so pricing continues to be favorable from that respect.

It looks like the PHE will extend into '23 at this point as well. I mean there's been no warning unless you've seen something I haven't seen.

Yes. It's one of those -- it's tough to predict. So October is where they'll have to do it. I think from our perspective, when we gave our guidance, we still expected that the public health emergency, to your point, would continue on. But we also felt that if it didn't, and October would be the next spot, and we would see the reimbursement levels come down a lot. It's still on lower volume and that we still felt within the guidance range we gave that -- even if that were to occur or happen. But to your point, yes, we're still seeing a lot of cases that are out there, a lot of demand that's out there. But obviously, we don't know whether they'll extend it or not.

Okay. Real quickly, throughout the pandemic, you ramped up capacity as quickly as you could. You got to that 300,000 tests a day capability. Here we are 2.5-plus years in, and we're not seeing 300,000 a day. When -- maybe you already have done this. But when do you pull back that capacity? When do you -- whether it's people, equipment, shelf space, inventory to support testing, when do you pull that back? And what is the financial implication when you do?

Yes. So we've already started a comment that we're pulling it back a little bit. That one of the guiding principles of the company was we were going to ramp up capacity as quickly as we could and at a high level because of all the uncertainty. And frankly, at the reimbursement rates that we're getting from it, it was dollars that we could invest in the business. And we've always felt that was wise. And frankly, a lot of the times when COVID would come back down, then we would see a spike that nobody would have envisioned. And we had capacity to continue to do that. I think from our perspective, that's still a guiding principle. We're taking it down a little bit but still what we believe would be ample capacity. I think the turning point will be mostly what happens with the public health emergency. If it's no longer out there, I think, and the reimbursement levels come down materially, then at that point, we're going to rightsize the business, with still the philosophy, the guiding principle we are going to have excess capacity than demand but not at the level -- to your point, if we have 300,000-ish of capacity and we're doing 20,000 to 30,000 a day, that seems to be a fairly wide gap. So we have a lot of room to bring it down and still have excess capacity.

Okay. Last one in the last 1.5 minutes here. You've been really active on hospital outreach deals, hospital lab management deals recently, Barnabas, AtlantiCare, Prisma. The list goes on and on. What is happening in that market? It feels like the pipeline of opportunities with hospitals are really opening up.

It has. Hospital transactions tend to take a long time because it's very much, well, a relationship, the confidence of working together because when we take over the labs, we're still servicing their customer base, if you will. But we've really seen a nice increase in the demand. And with the Ascension transaction, a very significant one that we're extremely excited about and should be closing very soon. But from our perspective, we've always believed that it was still a compelling story for the hospital systems to be part of -- with us or focused lab companies. So the outreach, when you think about it, that competes more directly with us, they can sell that to us and then redeploy that capital back into their core parts of the business. And we get a very good return, good margins, good return from that. The in-hospital lab is also interesting because that's obviously more of a strategic partnership for a period of time, a long period of time but -- where we're going into their hospitals and running their labs for them. Here, we're able to demonstrate to them that we can operate it at a low cost than they could. So they're saving dollars. So it really comes down to the partnership. Do they feel that us, as a partner, that we can deliver the same service levels, the same quality, the same turnaround times and do it at a less cost to them? And that's what they're seeing. So from our perspective, we feel from a financial standpoint, it's compelling for the hospital system. So it really now needs to be the question for them strategically, is that the direction they want to go to? But we've at least shown them a model that financially, it would support their decision to have us as a partner. And we're really excited about all the ones that we're doing.

Okay. Well, Glenn, we've run out of time. I want everyone to join me in thanking Glenn and Labcorp for being here today. And also in the next session, sorry, losing my voice, Tandem Diabetes Care coming up next. And please feel free to join us for the rest of the day, presentations. Glenn, thank you so much for being here. Really an honor to have you guys.

Yes. Eric, thanks for having us. And I appreciate everyone coming in, in attendance and appreciate being with everyone. Thank you.

Thanks very much. Yes.