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

Good afternoon. My name is Lisa Gill, and I am Head of Healthcare Services with JPMorgan. I am incredibly happy this afternoon to be sitting with Labcorp. I think many of you know that I followed the labs for a number of years. And in 2021, I gave them up for a 2-year hiatus. And so I'm really happy to be back. Sitting with me today, we're going to do a fireside chat. To my right is CEO, Adam Schechter; and to Adam's right is CFO, Glenn Eisenberg. So welcome, guys.

Good to have you back.

End of the conference presentation for day 2. But what I really want to do is just start by talking about the prospects as an independent lab. And I think that there are so many different challenges when we think about the pricing and the cost model today. But what do you think are your competitive advantages in the marketplace? And what do you think about the future of independent labs?

Terrific. Well, first of all, Happy New Year, everybody. It's good to be back in San Francisco. I'm going to answer your question directly in just one minute because I just wanted to give people a sense of what a transformational year 2023 was for Labcorp. It started where we finished the integration of Ascension, one of the largest deals in the history of Laboratory. And then we announced 6 or 7 other hospital deals. Then in the middle of the year, we had a spin of our clinical development business, and then we had our Analyst Day, where we talked about our strategy. And when you look at our strategy, we also provided longer-term guidance, which I think was very strong, 6% to 8% -- or 5% to 8% top line growth, margin improvement of 100 to 150 basis points and EPS growth of high single digits to low double digits. I think a big part of the reason that we're able to do that is because of what you just asked, Lisa. Being a large-scale lab is a significant advantage and here's why. Number one, we have breadth. We have over 8,000 access points where people can go to give blood, whether it be our own service centers or people we have in physicians' offices. We have depth. We have over 6,500 tests that we can perform, and we add 100 to 150 new tests every single year. And the key to having that kind of scale, it enables us to use technology, science, innovation, to invest, to reduce cost, while we increase quality, and we increase speed for turnaround time. But the real key to having scale is making sure it doesn't slow you down for decision-making. So the key is using our scale as an advantage, but we're also agile and nimble, and we make decisions quickly. But I think those types of reasons are why many other people that develop tests want to partner with Labcorp, so that we can bring their test to the market as well as our own tests.

One of the challenges Adam was the comparison for COVID tests, as we thought about 2023. But one of the things that really stood out is that your underlying organic growth of your Base Business was strong in '23. I know we're not sitting here giving guidance for '24. Glenn would kill me. But when I think about that Base Business and I think about growth in that Base Business, how do we think about how you're positioned going into 2024?

So I'll give some general statements. I'll ask Glenn to add some specifics of what we provided for longer-term guidance because it gives you a sense of how we see the strength in our business. But the first thing I'd tell you is both businesses, our Biopharma Laboratory Service business as well as our diagnostics business. And in Diagnostics, both routine and esoteric testing have come back to pre-COVID volumes. And in fact, in some instances, we're seeing a bit of an acceleration from prior to COVID. In diagnostics, some of that acceleration is because of the hospital deals that we've announced, and those are giving us increased share quicker than we historically have had. But maybe you could talk a little bit about the guidance in those numbers.

No, sure. So we'll be nice as we go into '24, not have the COVID testing comparators, if you will. But in the guidance that we gave, the 3-year outlook that we've given, it includes all in. So we're no longer going with Base Business versus how our COVID testing is, even though it still will be a little bit of a headwind for us in 2024. But overall, for our diagnostics business, we're talking about 2.5% to 4.5% organic top line growth over the next 3 years, inclusive of COVID. So it really speaks to the strength of the underlying Base Business that we have that could even overcome that. We've talked a little bit about PAMA and the issues that we have, which, again, has been deferred for a year. So as we'll talk later, maybe about a little bit about '24 benefit of not having that headwind. But in the 3 years, it's still going to be reflective in it. So diagnostics overall, strong. Our volume levels are now tracking to where we would expect them to be comparing it to prepandemic levels. So while 2023 would have had really strong growth rates year-over-year, it was driven in part because of a softer '22, not fully recovered. As we think about '23 as a normalized base year, we expect that 2.5% to 4.5% to be there. On the biopharma lab services side, we're looking at around 4.5% to 7.5% organic growth in that business. Again, call it midpoint of 6%, consistent with our historical growth rates. So again, as Adam started the conversation, really '23 really feel good because we feel like we're now in a much more normalized environment and with a lot of momentum that will take us into '24 and beyond.

You talked about the number of tests that you have today. And when we think about lab, we think about it broken down into two areas, routine and esoteric. For those of you that don't follow labs as closely, esoteric is means tissue versus blood and urine when we think about routine. Has the growth differentiated between the two, whether it's -- have you seen more routine versus esoteric or the opposite way?

Yes. I'll speak about it in volume. I think that's the best way to understand the underlying dynamics. We've seen growth in both routine testing and esoteric testing. We've seen slightly faster growth in the esoteric testing. We also -- when we thought about our strategy, see 2 short-term significant opportunities. One is hospital system, local laboratory acquisitions. The second is focusing on specialty testing, but in 4 specific areas. And these 4 areas we believe are going to show disproportionate growth in the short term with oncology and women's health, and longer term in neurology and autoimmune disease. So we have significant efforts underway to have a full set of diagnostic tests for both our biopharma services laboratory business as well as our esoteric diagnostic testing business because we believe there will be disproportionate growth in those areas, and we're already starting to see that those areas are growing faster than the routine diagnostic testing areas.

So when we think about the specialties, I think many of you know that Adam came from Merck and so has a pharma background. When we think about oncology being such a big area, and we think about the future of different kinds of tests that can come to the marketplace. Can you one maybe size the potential opportunity on oncology specifically? And then maybe talk about some of the tests that you've developed or plan to develop in that area.

Yes. So when I think about oncology, about 40% of clinical trials in pharma are in oncology. So you know that, that part of the market is going to continue to grow significantly into the future. And I think about three different ways of diagnostic testing. The first one is for screening. And I think if you can develop a blood test that helps screen for cancers before people are fully diagnosed. I think that could be a very large opportunity, but that's going to take a longer time period to develop the test, to study the test, and then also get reimbursement. The second thing is about therapy selection. And we're already starting to make progress with some of the acquisitions we made, in particular, OmniSeq and PGDx where we can actually study tumors and help understand what type of therapeutic would best work for that cancer. And then the third thing is MRD, minimal residual disease. So after somebody has been treated, how do you monitor their blood to know if the cancer is coming back before you might otherwise see it. I think the second one for selecting products will be the part of the market that is recognized the fastest that's developed the quickest, and we'll work side-by-side with our pharma colleagues in Central Laboratories, early development and also in diagnostic in the marketplace over time. I think minimal residual disease, once we actually are able to have enough data and to study it enough, I think that will be the next area of growth in oncology for diagnostic testing. And then longer term, the largest potential market opportunity would be in actually using it as screening all through blood types. So in Labcorp we've had a significant investment that we've made in oncology. We acquired a company called OmniSeq, that does tissue diagnostic testing. And we acquired a company called PGDx that also does liquid biopsies. They have a kitted solution that can be distributed broadly to academic medical centers, and we have that available for our biopharma colleagues around the world, but they also have a central laboratory where they -- we can measure that. And as we go into the future, we want to develop our own tests. We want to license in tests that others develop, and we want to bring tests for others to the marketplace through licensing and/or acquisitions. And we want to just make sure we have the broadest menu for oncology as possible.

If I remember correctly, on the women's health side, you made an acquisition a number of years ago. Please, Glenn, correct me if I'm wrong, but did you buy it from Genzyme? Was that right? Although it be your -- in the women's health area?

We did the NIPT [indiscernible] Sequenom.

Right. And so when I think about the women's health segment, so if we just think about each of these segments, you highlight these specialty areas as real growth drivers. You walked through oncology. Maybe talk about some of the opportunity in women's health. When you talk about neurology, are we talking about testing around potential Alzheimer's drugs? And autoimmune, maybe if we can just kind of walk through each of those just to help us better understand what the opportunities are?

Yes. So I just explained oncology. I think that's going to be a real short- and long-term opportunity. If you look at women's health, it's more in the prenatal care or NIP testing. That is a very fast-growing part of the market. And I actually believe, in the short term, women's health will outpace the growth of all the other specialty areas. If you look at autoimmune, those are areas like rheumatology, rheumatoid arthritis, anti-inflammatory types of diseases. We see a lot of drugs in development in those areas. There's a lot of new science in those areas, in particular in things like cell and gene therapy. I think that will take longer to come to fruition. But over time, I think there'll be more needs for specialized testing in that area. And then when it comes to neurology, obviously, we launched our ATN test, which is a 3-test that helps a physician diagnose Alzheimer's in a patient. Hopefully, there will be new Alzheimer's drugs that come to market. When they do, I think new tests will be needed, and we want to be at the forefront of that. But also in other areas in neurology, whether it be Parkinson's disease or other neurologic disease, I think that as there are more products in develop, as there's more information that we learn, there's no doubt in my mind that there'll be more testing that will be necessary. But I think that will be a longer-term opportunity. So the two short-term: oncology, women's health; longer-term, neurology, immunology or autoimmune.

And you've talked longer term that these specialty tests can drive your mix time. But when we think about 2024, is it too early for it to really have an impact on driving...

So we've seen some change in mix over time, and I think we'll continue to see that. But Glenn, why don't you talk a little bit about price/mix how we've seen esoteric impact in that?

So when you think about the diagnostics business, and again, about our 2.5% to 4.5% growth going forward, we tend to think about 1% to 2% of that coming from organic volume and then, call it, 1% from price/mix, historically, mostly from mix, but now we're actually seeing unit pricing flat to slightly up, which is encouraging. From the mix standpoint, the big drivers are, to your point, the fact that we do see esoteric testing growing faster than our routine testing. But mostly, we see that we're performing more tests per session that helped drive that. So between strong fundamental demand utilization as well favorable price/mix gives us the confidence for the, call it, that 2.5% to 4.5%, even with the constraint again of COVID that we would have in the first year of the 3-year.

And when we think about that pricing aspect, if I go back to the third quarter, you talked about managed care contracting. You talked about that you'd expect to be flat to slightly positive. Can you give any additional color on the progress in Labcorp's ability to negotiate with managed care as we think about those rates? And there's so much talk about value-based care. And I think of value-based care really in a couple of different buckets. One, the shift inside of care, which I think you can play a part of. But also, two, there's other programs, whether it's physicians taking risk and then that also shifts inside of care? Or when you think about outcomes or utilizing these tests when you think about outcomes. So maybe those -- I know that has multiple questions in a single question. But when we think about managed care, how should we think about some of those things?

So I'm going to start broad, and then I'm going to narrow down and answer the question specifically. I think one of the biggest issues that our children, grandchildren are going to face almost anywhere in the world is that health care costs are growing too fast. They're too high as a percent of GDP in almost every market, in every country in the world. And we've got to find ways to reduce costs while increasing quality and care. And I think the right way to do that is through value-based care and value-based programs. The good news about diagnostic, it represents only about 3% of total spend of any health care budget in the world, yet it's involved in almost every medical decision that people make. So we're in a good position to actually be part of value-based care. Separate and distinct from that. We have great relationships with managed care. We have for many years. We finalized all of our contracts that were up in '23. We feel great about our progress and the discussions that we have with our managed care partners. We're basically either flat to slightly accretive based on price, which is the first time we can say that in a long time. But I think a part of that is that the payers have seen the impact of us having a lot of these hospital deals. When you do a hospital deals, the price of the test in the hospital come down immediately and the payers benefit from that. And therefore, we were able to show them the benefit and say we should be able to partake in a little bit of that benefit. So I think we had a very good discussion, very strong negotiations. I feel good about where we are. The biggest issue I see is that to do value-based care is not simple. And it's no one single part of the health care system. It's multiple parts. So even though I would like to do more -- and any customer that can hear me out there, call us. We're willing to work with you. We want to find ways to do more value-based care and to reduce cost. But it's not simple, and it takes a group to come together to really try to tackle it. And there's not enough of it that's occurring in my opinion. It's not happening fast enough.

Well, I would like to think that this conference is a health care services conference. I can clearly articulate that it is more of a biopharma conference. From that perspective, when I think about biotech cancellations, we talked about this on the last quarter call where the expectation for book-to-bill in Q4 would get better. What are your expectations and time line for this to normalize would be my first question. And then secondly, I also assume that there's probably some opportunity for business development while you're here with potential small biotech companies.

Yes. So I think anybody -- this is, I think, my 19th JPM. And I always tell people, your dance card gets filled very quickly because everybody wants to sit down and meet and discuss, and there's a great opportunity for people to get together and have discussions. So we spend a lot of time doing that as I do. But I think that the important thing is, as you start to really think about the future and think about where we need to go, it really is the health care system coming together in order to make a difference. No one part has enough to make the real differences. You have to come together. So you asked about the book-to-bill and what we're doing. So we have two parts of our business in our Biopharma Laboratory Services business. One is early development. That's the smallest part of the business. By far, the largest part of our business is our central laboratory business. If you look at our central laboratory business, the kits that we send out for clinical trials and the kits that are coming back to us for clinical trials are now back to pre-COVID levels. And the business is doing very well. It's very strong, it's very healthy. We feel confident as we look at our longer-term guidance. If you -- and the mix of that business is heavily skewed towards large pharma and large biotech and it's mostly Phase II and Phase III trials. If you look at our early development business, the smaller business, much of that is in small biotechnology companies. And we've seen issues with cancellations, and there's two reasons that we saw the cancellations. The first one is for a while, there was an NHP supply shortage. So when people wanted us to do an NHP trial for them, they would call us, and we'd say it's going to be about 8 months. So people start to get in line right away. Then when we call them when we said it's time for their trial, some of them said, we're not ready yet. Some of them said, oh, we didn't think it would be this fast. So we saw cancellations for that reason. The second thing is the macro environment right now for small biotech is tough, and we see people making trade-offs making different decisions. So the cancellations were at a very high level in both businesses, but in particular, in the smaller part of our business in early development. We said in the third quarter that we expect the fourth quarter book-to-bill sequentially to be better than third quarter. I'm not giving the fourth quarter results today, I don't have all the results today, but we expect it's going to be better in the fourth quarter than it was in the third quarter. And we're seeing in our central laboratory business normalization to pre-COVID levels, our early development is not yet where it was before. There's still room for improvement there. But once again, I feel confident that when that business turns around, it's fast. Because many of those trials are very small, you get them in the same year that you run them. So once the biotechnology sector is stronger again, particularly for small companies, I believe that business will come back.

And as we think about each of those businesses, early development as well as central lab. Can you talk about your competitive positioning, help people to understand who you're competing against. You've always been big in central lab, right, Labcorp traditionally, and then post-COVID that's even bigger, but maybe help people to understand the competitive landscape.

Yes. So if you look at the central laboratory business, we are the leader in the central laboratory business. And it's a very strong business. It's global in nature. We work with almost every pharmaceutical company. If you look at our early development business, we're a leader, we're not the leader. There's 3 large companies. There's CRL, there's ourselves and the WuXi based out of China. But those are the 3 larger companies. We're 1 of 3, not necessarily the largest.

When I think about like long-term opportunities with been early development as well as the central lab business, you talked about this compound annual growth rate of 4.5% to 7.5%. Can you talk about what some of the key drivers are going to be to drive that revenue growth?

Yes. So I'll talk about that. But first, I think I talked about the two short-term opportunities with the hospital acquisitions and the specialty testing. We also said there were three longer-term opportunities. One of those three was cell and gene therapy. A big part of what we need to do in early development and ultimately in our Central Laboratories is be the best at cell and gene therapy because about 20% of trials that are starting in early development are happening in cell and gene therapy. So that's an area that we have to be a leader in. The second opportunity was international expansion. So as we develop these specialized tests and we work side-by-side with our pharma colleagues to develop those, if there's companion diagnostics that need to be with a product that they launch, we want to be able to bring that companion diagnostic to markets around the world. So as I said, for biopharma, we can now do in our liquid biopsies, we can do that in China, we can do that in Geneva, we can do it in other parts of the world. Ultimately, I want to be able to launch those tests into the market if a pharma company needs to have a companion diagnostic with them. And then the third is in consumers. And we believe consumers will play an increasingly important role in their health care decisions. And we want to make sure that we have growth in our consumer capabilities and the offerings that we have for consumers.

You touched on in cell and gene therapy, and we hear a lot about cell and gene therapy. But from your perspective, can you maybe talk a little more broadly about what their -- or maybe a little deeper on what the specific opportunities are?

Yes. So again, if you look at pharma and you look at the percent of trials, not the dollar amount, not the number of patients because they're typically smaller number of patients, but if you look at the number of trials, about 20% of them are in cell and gene therapy. If you're good in cell and gene therapy and you're working with pharma cell and gene therapy, I believe that will spill over into other therapeutic areas and actually enable us to grow in other areas. In addition to that, if you're good in cell and gene therapy in early development and you develop specific capabilities and testing capabilities, I believe you'll be the first choice that they use when they go into later trials, Phase II, Phase III for our central laboratory business. So I think that those are going to be important for us. Now to be good in cell and gene therapy, you have to have experts in the field. You have to have unique equipment, you have to have unique facilities. So if you do testing on various NHPs or other things for cell and gene therapy, the way in which you collect waste and the way in which you do things have to be very specific, different than the other areas. So there's certainly some investment that we've made over time. We're going to continue to look at that. But if you win there, I think it helps you win in other specialty areas. And if you win in early development, I think you can win more of your Central Laboratories.

Shifting to PAMA, you talked about PAMA a little bit earlier, and it's been delayed again in '24. As we think about that delay, can you talk about -- at least if I remember correctly, it drops right to the bottom line. So it should be margin accretive by being delayed. So I want to confirm that. And then secondly, while it's not necessarily a tailwind, it's a lack of a headwind. And so therefore, any cash outlay that -- or lack of cash that would have come in, may have a little bit more cash. So can you, one, talk about margins; and two, talk about if it will be a positive to cash flow versus what you were originally expecting for '24?