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

All right. Thank you, everybody. I'm Casey Woodring from Life Science Tools and Diagnostics team here at JPMorgan. I'm pleased to introduce the management team of Labcorp. We have CEO, Adam Schechter; and CFO, Glenn Eisenberg. They're going to make some opening remarks, and then we're going to shift over to a fireside chat for the next 40 minutes. If you'd like to ask a question, please feel free to raise your hand. We have mic runners around the room. Or if you're on the webcast, feel free to submit via the conference portal. So with that, I'll hand it over to Adam.

All right. Thank you, Casey. Good afternoon, everybody. For those of you joining us by WebEx, it's a pleasure to be here today. It's nice to be back in person after 3 years. 2022 was a pivotal year for Labcorp. We made significant strategic decisions. For example, we decided to spin our Clinical Development business. We made progress on our strategy. For example, we have augmented our oncology pipeline. We've made significant progress on our hospital laboratory acquisitions. And at the same time, we continue to do well and execute well on our base business, where in 2022, we saw the base business begin to grow on a CAGR basis versus 2019 prior to COVID. So as we enter the 2023, we have significant momentum and we have to really make sure now that we execute well on our strategy. So hopefully, you saw that late last week we announced a new CEO for our Clinical Development spin business. His name is Tom Pike. He has significant CRO experience. He's been a CEO with CRO. He knows our shareholders. He knows our customers and a lot of our employees as well. So we welcome Tom, and we're looking forward to working with Tom as we continue with the spin of the Clinical Development business. At the same time, you see we've made a lot of progress when you look at our hospital acquisitions. And late last year, we actually rebadged about 5,000 employees from Ascension, where we are now running the laboratories for almost 100 hospitals across the Ascension hospital system. And I would say that's going extraordinarily well. As I look to 2023, I'm excited about 2 strong independent businesses, our Clinical business as we spin it. It has historically grown at about 8%, and we expect it to grow in the high single digits. And if you look at RemainCo, which will now be the largest laboratory business in the world. We expect -- that business historically has grown about 4% to 5%, and we expect that business to grow in the mid-single digits. So we're excited about the future. We're excited about 2023. And with that, we're glad to answer any questions that you may have.

Great. Well, I guess to start on the spin, what allowed you to move up the spin time lines?

Yes. So when we originally announced the spin, we gave a time line that we felt very comfortable that we could be within. Since that time, we put together a spin management office where we have dedicated people solely working on how we can effectuate the spin as quickly as possible. We've also brought in some external partners to help us with this spin. Based upon that, we feel very confident that we can effectuate the spin in the middle of this year, and that enabled us to move up the time line from the original time line.

Any additional commentary following the announcement of Tom Pike as the leader of the Clinical Development team?

Yes. So we did an internal external search. We were looking for somebody that we thought would be an extraordinary leader, somebody who understood the marketplace, preferably somebody who had been the CEO of a publicly traded company, somebody that understood the business, understood our customers. But equally, it's important somebody that had historically been able to add significant shareholder value. If you look at Tom and if you look at his history, he does all of those things. So we're very excited to have him as part of the team. At the same time, we have Paul Kirchgraber, who has agreed to stay with LabCorp up until the time of the spin and he'll continue to help us with the transition. He's going to continue to lead our central laboratory business and our early development business as well.

Maybe last one just on the spin. Do you have any updated thoughts as to how the stranded costs are going to shake out between the 3 businesses within Drug Development and -- that you could help the Street get a clearer picture of the margins between each of those businesses?

Yes. So we're working on that. I'll ask Glenn to provide some additional context. What -- we were expecting to provide additional information in the February, March time frame as we get the 3 years of audited data behind us. We're working on stranded costs. We realize there will be stranded cost particularly for Remainco. If you lose about $3 billion of your revenue, you have to believe that your infrastructure costs are going to have to change as well. So we're working on that very diligently. We're putting together Remainco office where we'll have dedicated people helping us understand exactly how we reduce the stranded costs. I don't know Glenn if there's anything you would add about margins?

I guess just when you think about the spin in the value creation, obviously, by having kind of a pure play late-stage clinical business trading more in line with the CROs that trade at a premium relative to the lab space, there's normally a 40%is kind of premium to that. With that, we're now going to incur new public company costs with that, but obviously a little bit lower on the profitability now that, that business gets burdened with those additional costs, but now at a much higher valuation, which leads to the stranded cost, if you will. From an infrastructure of LabCorp, we're supporting the full company today. Once we spin off $3 billion of our revenues, we have that cost that will either get allocated to lower revenue or we'll need to take out the cost. So we'll continue to look, especially organizationally of how will the spin affect the base business and how would we reorganize the people that have shared responsibilities that are working for multiple business units now that, that one part of the business isn't there. We'll leave that stranded cost. So we'll take those costs out, hopefully, to mitigate a lot of the added costs of the new standup public company. But we'll continue to evaluate it. We have roughly 1.5% to 2% of non-allocated costs at LabCorp that are not borne by the business. And obviously, with lower revenues from the spin, we'd still like to have that type of percentage, which means we have to take out that cost structure. And again, as Adam said, working with advisers, we'll take out the cost. From a margin perspective, while we haven't given margins for the spin company in particular, we will, as we go forward, look at what the margins will be. We're going to give audited financial statements for the prior 3 years for the new business fully burdened by the allocations as it would be part of us today, and then we'll have the additional public company costs on that. As Adam said, we should be in a position in the February to March time frame to give you the historical margins of the new business that are burdened within the cost that we have today. And then prior to going out with the new company, we'll do the roadshow, and we'll also give perspective look as well.

Got it. That's very helpful. I'll pause here in case anybody has any questions from the audience. No? All right. I guess shifting over to Diagnostics. The most recent quarter, third quarter base business, Diagnostics revenue grew close to 4% versus 3.6% in the prior quarter, so implying a potential pick up in the business fields in part by volume growth. How would you view the Diagnostic industry's volume for large labs here? And do you view LabCorp's performance tracking relatively similar to the larger industry's growth rate? Or are you growing up market here?

Yes. So we're excited about the growth prospects for RemainCo and for our Diagnostics business. If you look in the third quarter, we actually saw growth versus 2019 on a CAGR business, meaning that we're back to pre-COVID Diagnostic volumes and we're actually seeing increases. But each month of the quarter progressively got better. So it just leads us to understand that the volume is coming back in a very significant way. At the same time, with all the hospital deals that we've been able to win such as Ascension and Prisma, CJ -- [ RWJBarnabas ] and other hospital systems, that's going to help us with our volume as well. So we're going to give guidance in February for what we expect the year to be. But what I would say is that I'm optimistic about the wins that we've had, particularly in the hospital systems. And RemainCo should continue to show very good strong growth as we move forward. If you look at the end of this year, we did have some weather issues as everybody had faced. But outside of weather, we've seen continued good strong growth.

So the volume growth last quarter was 3%, mix, less than 1%. Those mix benefits came in below your largest competitor in that regard. So just curious on the mix dynamics there for LabCorp and your expectations for that metric in 2023?

Yes. I'll provide context, and I'll ask Glenn to jump in as well. If you look at our mix business, you can see that esoteric testing continues to get a larger percent to share growth versus our historical regular diagnostic -- routine diagnostic testing. But that's been growing at the same rate over time. We haven't seen that accelerate. But 2 things that we have seen. One is the number of tests per accession is still significantly higher than you would have expected based upon where we were in 2019. We don't know the exact reason for that. We hypothesize that because people aren't necessarily going for well checkups as much as they had in the past, that physicians might be doing more tests when they actually do see the patient coming to the physician's office. In addition to that, with the volume that we're going to see from the Ascension deal, which actually we measured through price, you will see differences between us and some of our competition. Overall, the mix is very good. The mix and growth in mix is consistent with what we would expect, and we're going to see larger increases in volume -- in price particularly with the Ascension deal. Anything you'd add, Glenn?

Just that when you look at the numbers in the quarter and as we project out, we're finally at the stage where we feel Diagnostics, the demand, the volume levels are kind of back to more normal levels. So when you do the comps compared to a prior period, right now, we're showing greater strength because we're comparing it to a non-fully recovered number. So our current run rate, which Adam said is tracking now greater than where we were pre-pandemic, says that the demand level now is back to where we would want, which means that year-over-year since 2022 wouldn't have been a full year -- fully recovered year, we'll have even greater than normal growth within the business. So good top line growth from a demand, a volume standpoint. Our price mix, as Adam said, between the mix impact, the test per sessions is favorable. And because of the large amount of the hospital systems deals we're doing that we treat as price will actually even get an additional benefit on pricing, which is really mix of the hospital systems coming in. So for 2023, good top line growth and obviously, the favorable news of the deferral within the PAMA impact on the business really gives us really good position to leverage that top line growth well with hopefully improve margins as we go forward.

Yes. Just to follow up on that on PAMA. The delayed cuts in 2023, how are you thinking about the progress in the SALSA legislation in relation to that?

Yes. So I think we made significant progress last year with having bipartisan support of SALSA. We had Democrats, Republicans that were very supportive of the SALSA legislation. Unfortunately, like many other legislations, it did not get passed at the end of the year. That was a bit disappointing. But at the same time, we did get the delay of PAMA again until next year. I can tell you we're going to be right back at it working with our trade organization and all of us together to reinforce the importance of SALSA as a long-term solution to what's happened with PAMA. And again, I'm cautiously optimistic, but I have been for the last couple of years, and we'll continue to fight the good fight.

Maybe circling back on Ascension. So full year Ascension revenue is between $550 million to $600 million annually. However, these volumes are dilutive to margins. Can you maybe quantify the dilution that these volumes give you? And then just talk towards how you expect to improve operating leverage in that business over time to that low teens by year 4 number that you've given?

Yes. The Ascension deal really was a pivotal deal for LabCorp. And frankly, I think for the industry. And to rebadge that number of people and to manage that number of hospitals all beginning in October was a very significant amount of work, as you can imagine. But several things that are really important are: number one, you can't disrupt the business. Patients are counting on us to have those tests at the same type of turnaround and to be able to do it even faster at the highest quality. We have to make sure that there's a smooth transition as we go from our laboratory system -- from the existing hospital laboratory systems into our laboratory systems. So a big part of what we do is move slow and purposefully. That means that the margin in the beginning suffers a little bit. Now it will still be accretive in the first year, returns its cost of capital in about 2 to 3 years, and we're integrating it very well. But we expect the margin for that business in the first year to be in the single digits. Over time, we will find ways to combine the procurement capabilities to ensure that we have consistent systems across the hospitals that make them more efficient. We'll find ways to use our laboratory infrastructure and decide which laboratories make sense to use. And therefore, it will take us probably around 3 at most 4 years to get the margins to not where our current average margins are. I don't think that hospital inpatient laboratories ever get to that margin, but they will be significantly higher than what they are in the first year. So it's very purposeful that we're doing this slow to ensure consistency of the business and the best patient care we possibly can.

Maybe one on COVID. Just curious on how COVID volumes have tracked here with the strong respiratory season. And then just as a follow-up, how do you expect pricing and reimbursement to kind of what's that cadence for 2023 look like for you?

Yes. So the COVID testing has -- we saw third quarter higher than what fourth quarter will be even with the increase in the number of cases of COVID, hospitalization due to COVID, RSV and flu, we haven't seen a significant increase in the types of PCR tests that we do. I think a lot of patients, frankly, now just go if they believe they might have COVID and do the over-the-counter antigen test. So we are seeing a continued decline in fourth quarter versus what we saw in third quarter and before that. The price is remaining at $100, and I think it will remain there for as long as the emergency declaration is declared, but the volume is getting to a level where it's not nearly as significant now as it has been in the past. If you look at the combination test that we have, which is COVID plus either flu, RSV or all 3 COVID, flu and RSV, we've seen that test increase, but that increase isn't offsetting the overall COVID decrease-- COVID testing decrease that we've seen. Now it represents about 15% to 20% of our total COVID are the combination tests. But if you look overall across all of the COVID tests, including those combinations, they're still much lower in the fourth quarter than we saw in the third quarter.

Got it. That makes sense. Curious on how we should reflect the recent update to the specimen collection fee within our models?

Yes. So 2 things. One is we saw the delay in PAMA, and we saw an increase in specialty collection fees. Net-net, we've said that the PAMA impact is about $80 million to us. That's what we had in our plan. That was a headwind that we were facing. That headwind is no longer there. I would say that most of that 8-milligram -- or $80 million, not all of it, but most of it will show up to the bottom line. In terms of the increase in the reimbursement rate, we're not going to build upside in that. We'll monitor that. We'll see how that plays out over time. There's other pieces of legislation that kind of give additional pressure. So net-net, we think it's probably neutral. If we see some upside in the future, we'll be sure to share that. But at this point in time, I would say the majority of the $80 million from PAMA is no longer going to be a headwind. We'll build that back into our base case, but I wouldn't build anything above that. I don't know Glenn, if anything you would add?

No, I would agree that also when you look at -- from the margin standpoint, each year, diagnostics, even despite good growth they've seen margins kind of degrade a little bit because of the negative impact that PAMA's had. We've been able to mostly offset a lot of that, but there was always kind of that headwind. So as really as we go into 2023 and look at a more normalized level and not having the headwind because, again, we're talking about not having a reduction in our price, it really positions us well net-net to now see margin expansion within our Diagnostics business overall. And as Adam said, it just gives us another opportunity to continue to reinvest back in our business while still profitably growing that business.

That's helpful. I'll pause here in case anyone has any questions. Okay. Maybe shifting to Drug Development. NHPs have been a big topic of discussion. I was just with Charles River earlier. So just on the Drug Development side, to start off with, can you describe your relationship with the Inotiv as part of the Envigo asset swap? And just curious if they directly supply LabCorp with NHPs and if they do, what percentage of your NHP supply comes from them?

Yes. I'll answer that question directly in a second for moving from Diagnostics to Drug Development. The only thing I want to say additionally about Diagnostics is I'm excited about RemainCo and the opportunities before us. I'm excited about the hospital systems that are going to add to our growth. I'm excited about the innovative diagnostic testing that we're doing for oncology, for Alzheimer's, for autoimmune disease. I'm excited about the potential to bring some of those outside the U.S. into other countries around the world. So there's a lot to look forward to and be excited about for the Diagnostics business. If you look at Drug Development and specifically at NHPs, we have no direct relationship with Inotiv where we don't buy directly from them. But some of our suppliers did acquire NHPs from Inotiv. What I would say there is that if you look at across all of our business, NHP studies represents less than 2% of our total business. There may be some short-term impact, maybe a couple of months. But we've been able to secure supply. We feel very confident that it will be a very short-term impact, if any, impact that we'll see. And that we have the capability to ensure that we can continue to do the NHP trials as we move forward. So I would expect it to be several months, not more than that in terms of any impact to the NHP trials that we perform.

That's helpful. Do you expect significant price increases in sourcing NHPs or the rest of your research models for that matter as a result of the NHP shortage here?

Yes. So it's certain that NHPs, the prices have gone up pretty significantly with the shortage. But a lot of that we can pass through to our customers. So that will be more of a pass-through as we move forward. But our customers are aware of it. They understand that there's a shortage right now, that prices have gone up, and I feel confident that we'll be able to pass along those cost increases. If you look at the rest of the supply chain, we knew that there was going to be inflation. We knew that there was going to be pressure. That's why we have our LaunchPad initiative, where we reduced our cost structure by about $350 million. And we've made significant progress there, and we'll be able to offset a lot of the other pressure where we'd expect the margins to increase in our Drug Development business as we move forward.

Just on kit stocking now in the central lab, you've talked about the kits out versus kits in dynamics a little bit. Maybe first on kits out, you've talked about how there really hasn't been over-ordering given the supply chain normalization and that kits out as stable. But looking into 2023, what sort of headwind will this present?

Yes. So kits out are back to where we would expect based on 2019. What we saw for a period of time, not in 2022, but in 2021, when it was hard to find certain supplies, test tubes or other supplies that we've gone to the kits, we were making a lot of those manually. So when an investigator would order a kit, where typically it would take 2 to 3 days, it was taking maybe a week to 10 days. So investigators started to order a lot more kits than they needed when they became available, and that caused kind of a hoarding that we saw in the marketplace. As the supplies became more readily available last year, we've seen the out kits, the kits that we send to investigators, get back to pre-pandemic levels exactly where we would expect those. Kits coming back to us are still not at 2019 levels. And we think it's because some of the sites are still struggling with having the personnel to ensure that they can enroll patients as fast as they have historically. And we expect that, that will come back as we go through this year, but the kits coming back to us are still not at the pre-pandemic levels.

And then maybe one on the kits inside. You have noted that these have not been sent back in the same kind of historical rate as normal. You've seen sites still closed for COVID. So just how do you see the kits in dynamic progressing in 2023?

Yes. I mean we've seen most sites open. And we've seen that increase over time. We're now well over like 75% to 80% of sites that are open, and that's continuing. As certain parts of the world have significant impact from COVID, you have some issues around the sites, but then they come back pretty quickly once the outbreak of COVID goes down. I would expect as we go through this year, assuming that there's no significant additional outbreaks of COVID, that the kits coming back will come back to normal. But it's also not just about COVID, it's about the ability to hire people in the investigator sites to actually help enroll patients. And there's been labor issues that we've seen in almost all parts of health care. I think that's getting better, but that is still going take some more time before we get fully back to where we were historically.

Maybe shifting to book-to-bill. You reported a strong trailing 12-month book-to-bill number in 1.25 in Clinical despite some of these pressures to the business, mainly related to vaccine roll-off. So how should we expect this backlog to burn on a quarterly basis next year?

Yes. So our book-to-bill remains very strong. And I've always said that as long as you are at 1.2 or greater, then your book-to-bill is solid. And we remain over 1.2, and we continue to see strength as we go through last year. We usually burn about 30% over a year's period of time with that book-to-bill that is maybe just under 30%, and I would expect that to continue. There's some longer trials. COVID was a very fast burn because of those trials, you were able to enroll them quickly. There were so many patients with COVID. Now that we are getting back to more of our oncology trials and some of the longer trials, the burn rate should go back to what it was historically.

I guess maybe to put the book-to-bill and some of the kit stocking headwinds together, do you see the Clinical business growing high single digits next year?