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

Yes. All right. Hi, everyone. Good afternoon. Thanks for joining us. For those of you who don't know me, my name's Andrew Brackmann, and I cover the diagnostics sector here at William Blair. This afternoon, we're pleased to have the team from Labcorp joining us. We have the CEO, Adam Schechter; CFO, Glenn Eisenberg; and from Investor Relations, Christin O'Donnell. Before we begin, just a quick couple of pieces of housekeeping. First, the breakout for this session will be in the Maher room following this formal presentation time. And then for a full list of research disclosures, please see williamblair.com. With that, I'll turn it over to Adam.

All right. Thank you, Andrew. Good afternoon. Pleasure to be here today. What I want to do is give you a sense of who is Labcorp, what do we do and why do I see such tremendous growth opportunities before us. After that, we'll have time for just a brief Q&A in this room, and then we'll have any questions you may want answered upstairs. So let me start off with our cautionary statement. You've all seen it before. You can go to our website to review it. And I want to start off by giving you a sense of who is Labcorp. Labcorp is the largest laboratory service provider in the world. We use science, innovation, technology in everything that we do. We have the latest scientific methods, the latest technological advances, and we try to innovate in every part of whether it be diagnostic testing or biopharma testing. We have 2 businesses. I'll talk about those in just a moment, but they have substantial overlap and synergies, efficiencies in the way in which we work across those businesses. One of the key advantages to Labcorp is our scale. We have true scale in not only the United States, but for our Biopharma Laboratory Services business around the world, and I think that the scale gives us very significant capabilities and opportunities. And our goal is to continue to generate profitable growth while we give shareholder returns that are consistent over time. The good news is the underlying trends in the marketplace support the growth strategy that we have. I think everybody in the world knows that the population is getting older, and you see that in every part of the world. We see therapeutic advances in very important diseases like Alzheimer's disease, cancer, women's health, and I think that bodes well for diagnostic testing and for our Biopharma Laboratory Services business as we continue to focus on those new areas of science. I think every country in the world is struggling with healthcare costs as a percent of their GDP. In the United States, it's almost 20%. In places in Europe, it could be as high as 12% to 15%. The 2 other underlying trends that I think will help reduce healthcare costs over time in which we will be a big part of is, number one, the earlier detection and diagnosis of disease. Great way to reduce cost is to find disease early and to treat disease early. The second way is to have precision medicine to know who needs what medicine at the right time, who needs what type of device or treatment at the right time. I think between earlier detection, diagnosis and precision medicine, we can be part of the solution to reduce healthcare costs in countries around the world. And then we're seeing rapid changes in science, artificial intelligence and technologies that is just going to help us have new testing and diagnostic capabilities faster than what we've done before. So if you look at Labcorp, our mission is clear. It's to improve health and improve lives around the world, but we do it at scale. And I mentioned before, that scale gives us a competitive advantage. We have over 6,500 unique tests. We do more than 600 million -- in fact, last year, we did 650 million tests in the year. We do business in 100 countries where we get support for patients, particularly in our clinical trials that we support through our central laboratories. We have a database of over 45 billion data points. We also do business with every single large pharma and the vast majority of medium-sized biotech companies, and we are very active in our publications. For those of you here in Chicago, you saw ASCO was occurring this week here in Chicago, which is the largest oncology meeting in the world. We had a very significant presence. We launched several new test publications data at that meeting. So we continue to be very active in the science that we do. If you look, we have 2 business segments. We have our Diagnostic Laboratory segment, and then we have our Biopharma Laboratory Services business. I'll talk more about how we subsegment Biopharma Laboratories. But if you were to walk into one of our diagnostic labs and then walk into one of our central laboratories, diagnostics is on the left. This Biopharma Central Laboratories is on the right. You couldn't distinguish between the 2 labs. They have very similar equipment, very similar footprint, very similar capabilities, very similar people that actually run the equipment in those laboratories. So you can see how having our scale and the synergies across those businesses make sense. And then we also have global operations. So we have a very large presence, particularly for our Diagnostic business, in the United States and in Canada. For our central laboratory, our Biopharma Laboratory business, we are in Europe, and we're in Asia. And you'll see why this becomes important when I talk about scale and I talk about our longer-term strategies. If you look at our Diagnostic Laboratories, it's a very fragmented market. And if you look, we have about 10% share as one of the largest laboratories in the United States, but you see hospitals still have about 60% share. But that 60% share is across about 9,000 hospitals. It just shows you that even though we are one of the largest laboratories in the United States and Canada, there's still a lot of room for growth, and you're going to see continuing consolidation. This is why the hospital and the other laboratory strategy that we have to acquire and to partner with them is so successful and has so many legs for growth as we go into the future. If you look at our Biopharma Laboratory Services business, there's 2 segments. There is the central laboratory business, which is, by far, the largest part of our Biopharma Laboratory business. It's about $2 billion in revenue. That's where we do the laboratory service testing for our pharmaceutical and biopharma colleagues for their Phase I through Phase V programs. We do the back-end laboratory testing for those. The smaller part of our business is our early development research laboratories. That's where we do preclinical early-stage development work. That represents about $900 million of revenue. So then if you look at our strategy and our growth opportunities, there's 2 near-term growth opportunities that will go on for some time that are very significant. And then we have several other opportunities that we're increasing our focus on, where we think they will give us continued growth over time. So let me start with the 2 near-term growth opportunities that go across both Biopharma and our Diagnostic Laboratories. The first one is to be the partner of choice for health systems and for local and regional laboratories. And you saw the fragmented market, you saw the opportunity for growth in those areas. That has been a big part of our strategy, and that's been a big part of our growth as we look at last year, as we look into the future. The second is to lead in the development, the licensing or the scaling of specialty testing, including companion diagnostics. I'll talk about each of these areas in just a moment. As you look longer term, there are 3 other significant opportunities for growth. Number one is in cell and gene therapy. About 20% of pharmaceutical studies and clinical trials and early development are in cell and gene therapy, and we have very good capabilities in that area in our early development laboratories as well in our central laboratories. The second is we've all seen that consumers are playing a much more important and active role in their healthcare, and consumerism will continue to be important. So we're expanding consumer-centric capabilities, and we've launched a significant number of tests that consumers can order through us on demand. The last part of that longer-term strategy is to leverage our global laboratory network for targeted expansion. What I mean by that is if there are very important specialty tests or companion diagnostics that we develop with our pharmaceutical biotechnology counterparts, we would like to bring those products to market with them as they bring their products to market. So we announced at ASCO this week that we're now able to do certain liquid biopsies in China as well as in Europe. So we want to make sure those capabilities are brought to scale through our Biopharma Laboratory Services, ultimately, to use in clinical trials and, then even further in the future, to bring to market to go as a companion diagnostics with our pharmaceutical colleagues' products. So 2 short-term real growth opportunities that will go over time, and then 3 longer-term focus areas that we believe can continue to give us additional growth moving forward. So let me talk about the 2 near-term ones first. So we're seeing consolidation across the hospital industry. We continue to see that. And we've done 15 health system and/or local, regional laboratory acquisitions since 2021 alone. I've listed some of the larger ones here at the bottom of the slide. But these opportunities [ represent ] not only growth in the hospitals, but also in the geographies around the hospital systems. With the hospital systems, there's 3 parts of opportunity for growth. The first is to be the referral partners. So when there's very difficult, complicated tests, to have them referred to Labcorp to run. The second is the outreach business, which is outside of the hospital where they would send testing into the hospital. And the third part is to actually run the hospital laboratories. We do partnerships in all 3 of those areas. And the examples on this list, Jefferson and Legacy, Providence, Prisma, Ascension, Tufts, basically, we do all 3 of those. So where we can do all 3 of those, we'd like to do all 3 of those. They each have a different profile. But the reason these are good deals for us is they're typically -- well, they're always accretive in the first year. They return their cost of capital in 2 to 3 years, and we know how to integrate them, integrate them well, continue to get great service for the customers and the patients in those hospitals. In addition to that, you see 2 local deals that we've done with local, regional laboratories: one with BioReference, the other Westpac. As we see smaller local laboratories that are struggling today, especially if they don't have scale, that represents another opportunity for us to continue to show strong growth. The second part of the near-term opportunity for growth is actually focusing on specialty areas that we believe the growth will significantly outpace the growth in the overall diagnostic market. So there are 4 specialty areas that we believe will grow 2 to 3x the rate of the typical diagnostic growth rate. Those 4 areas are oncology, women's health, autoimmune and neurology. In each of those areas, we're focused on science, technology and innovation to bring new tests to market because the way to be successful in those markets is not through having one test, by having a bundle of tests. So that when a physician wants to diagnose a patient, they can come to one site and pick every test that they want in order to help understand and diagnose the patient better. So for example, in oncology, we talked a lot about that this week at the ASCO meeting. We launched a product for -- called Plasma Detect, which is a liquid biopsy for minimal residual disease, particularly for colon cancer patients. We recently announced in women's health, a product for preeclampsia screening, so we can tell what the odds of a woman developing preeclampsia while pregnant are. In terms of autoimmune, we launched several things. We launched a portfolio of tests to help with diagnosing lupus, and we also acquired a test from a company for rheumatoid arthritis called Vectra. In neurology, we are a leader in helping with the diagnosis of neurological disease. We launched an ATN profile to help understand Alzheimer's disease as well as a pTau217 in that same therapeutic area. So you'll continue to see us focus on these 4 areas for growth in addition to the fact that we bring to market almost 100, if not more than 100 new tests every single year. We also recently announced that we're acquiring select assets of a company called Invitae. Invitae is a company that has great science, cutting-edge science, state-of-the-art technologies, including the customer experience that they offer people, best-in-class interpretation of variants. They have a big product portfolio that's expanding, particularly in hereditary cancer as well as in some other orphan or smaller disease areas, and they provide a great customer experience with strong talent. We announced this because we've been watching this company as we watch many companies in specialty areas for many years. And we were able to acquire it opportunistically for a price that, I think, was very, very attractive, $239 million. With that $239 million, we expect to have revenue of $275 million to $300 million in year one. And this is another therapeutic area that is growing very fast and significantly, currently at about 10%. It's a therapeutic area that know well. We have tests in this area. It will be added to our portfolio of tests, and we are going to make sure that we're successful to make it accretive in the second 12 months. The first 12 months will be slightly dilutive of 2% to 3%. But as we look at this company and we see the talent, the capabilities and it's an area of high growth, the question is, how do we make it profitable? The way we make it profitable is by streamlining the cost infrastructure like we do when we acquire other laboratories. We know how to do this. We're very good at it. They have strong people, strong talent, great capabilities. So we have to figure out how do we preserve that while we also integrate it. We put together a state-of-the-art, very talented integration team. They're beginning the planning efforts so that when we close, we can move very quickly. And we believe that this deal will return its cost of capital in year 3. And under all the scenarios we've looked at, it'll be one of the best returns of cost of capital that we can imagine. So we're excited about this deal. We think strategically, it makes a lot of sense. Financially, it makes a lot of sense. It's slightly dilutive in the first 12 months, but it's accretive thereafter with a great return on our cost of capital. So that leads us to our guidance for 2024. If you look at our 2024 guidance, we expect revenue growth of about 5.6%. If you look at our adjusted earnings, we expect that to be about 10% and our free cash flow should grow about 20%. After our first quarter, we actually raised our revenue guidance for our Diagnostic Laboratories business based upon the strength that we're seeing across that business. When you look at the raise in the guidance, about half of that was because we did acquisitions that we closed on. We keep those acquisitions at a corporate level, and then we move them into the business once they close. The other half of the reason that we raised the Diagnostic revenue range is because we've just seen strength in the underlying business, which we expect will continue as we go through the year. For our Biopharma Laboratory Services, if you adjust for exchange, we kept that to our original guidance, and we still think that we will have strong growth. The central laboratory business continues to be very, very strong. The early development business, we expect, will rebound as we go through the rest of this year. And that leads me to my last slide, which is our longer-term guidance that we have provided. We really are making sure that we have a very attractive profile moving forward. We expect 5% to 8% revenue growth of '23 to '26. And from that, we expect to have 8.5% to 11.5% adjusted EPS growth. We expect to be able to have a margin expansion of 100 to 150 basis points and an annual cash flow, free cash flow that will grow in line with our adjusted earnings. So as we move into this year into next year, we feel confident in this profile. This profile looks very similar to the slide I just showed you for 2024, which shows you we're on track and we remain confident on the outlook that we provide. So with that, Andrew, we're glad to answer any questions. I've got my partner in finance up here with us. So feel free to ask anything on your mind.

Yes, terrific. So we'll do a little bit of Q&A here before we go to the breakout in the Maher room.

Adam, I think you outlined a lot of growth potential in a lot of areas that have growth catalysts over the next handful of years. But maybe just on Diagnostics, in particular, right? In Q1, you just posted a nice quarter. You sort of talked about heightened utilization that's impacting your business. So can you maybe just sort of talk about the durability that you see from that utilization trend and how it's impacting your business?

Yes. So if you look at our growth in Diagnostics business, it's coming from several different areas. One area is that we're seeing underlying utilization a bit higher than we have previously, and you see that in hospital sector as well. The question is, how long will that last? I'm not counting on that lasting for a long period of time, although it's lasted longer than I would've expected. But the 2 other areas where we see growth, I do expect to last. One is that we're growing faster in the segment, and I believe we're capturing market share, particularly with the hospital and the local, regional laboratory acquisitions. So historically, we've said to expect 1% to 2% growth from the inorganic work that we do. We're now saying that you should expect 1.5% to 2.5%. That extra 0.5% is very meaningful. The second thing that we talked about is that the specialty areas that we're focused on are growing faster than the other parts of the Diagnostic business. And I think as we continue to focus, we're going to see mix shift. Now people say, why don't I see it in the numbers? Why don't I see your esoteric or your specialty business becoming a much larger percent faster? The reason why is we do 650 million tests a year. To move the needle, and a market share point for that, would be a lot more tests. We are seeing more esoteric or specialty business. We are seeing growth that will come from that, and we expect that to continue. But it's harder to tease out in the market share number just based upon the poor volume of tests that we have. So that's why I feel confident that with 8.5% to 11.5% EPS growth, that's going to come from 5% to 8% revenue growth.

Maybe just dovetailing off that for a minute, right? The specialty area is growing quite fast, but I think it does have a flywheel effect to the rest of your portfolio. So can you talk about its impact on routine testing as well?

Now that's a great point. I spent a lot of time in pharma before I came to Labcorp. And in pharma, you have a blockbuster product, and that can give you a significant revenue for a very long period of time. In the diagnostic testing world, typically, what a great test does is enable that you get other tests outside of that. So let me give you an example. If you have a full portfolio of test for oncology, if you have liquid biopsies, you can expect those liquid biopsies to be very good important tests. But if you're an oncologist, when you order a liquid biopsy, you're probably going to order a white blood cell count, a red blood cell count and 5 or 10 other tests in addition to the liquid biopsy test. So having those high specialty tests in a very strong portfolio of tests enables the customer to come to you and have one-stop shopping and just order everything they need that will come back to them in the same format, in the same -- from the same company. And therefore, I think that the specialty tests aren't just important tests on their own, but it's the other test that the physician will do in addition to a specialty test that you'll typically get with that.

You sort of mentioned some of the successes that you've had in the hospital network, right? And I think one of the topical things going on right now in the hospital world is sort of that cyber attack on Ascension. So can you maybe just sort of give us an update on that, how it may have impacted Labcorp?

Yes. So Ascension has been a great partner. We announced our deal with them -- I guess it was last year, and we've worked very closely with them. It's very unfortunate what's happened with their cyber attack. They're very good partner. It's not going to have a meaningful impact on Labcorp. In fact, it's going to have a very minimal impact on our business. The good news is they updated their site today and basically said that the EHR was very important to get those up and running. That they've begun to get those up and running in several markets, and they expect to have them up and running in all of their markets the week ending with June 14. So hopefully, that continues to go down their path. At any rate, there's not a significant impact to Labcorp, but we're wishing them the best. We want to do everything we can to help them as a good partner as we move forward.

Maybe just sticking on hospitals and sort of partnerships and acquisition strategy there. Can you maybe just sort of talk about the pool of assets that are available? Is that pool increasing, decreasing? And any valuation sensitivities there?

Yes. So when I first started as a CEO of Labcorp, it's been about 5 years, people asked me what was the biggest surprise? And my answer at that time was one of the biggest surprises is how long it takes to have a hospital deal come to fruition, that we had a strong pipeline, but I was always surprised that, that pipeline could take years to actually come to a deal. Well, during COVID, that changed. I think what happened was hospitals realized that they didn't have the right equipment necessarily, that they weren't putting the right capital into their laboratories, and they also were struggling financially. So for those reasons, we started to do a lot more hospitals. I mentioned 15 different hospital deals since 2021. And now what's happened is people realize we're really good at it. And if we go and we pitch a deal to a hospital, they can get additional capital, we'll acquire their outreach business typically, run their laboratories in the hospital for them. And I can give them references of all 15 of those hospitals where we've done it, and they'll call and they'll say they did what they said they were going to do. They did it in a timeframe that they said they were going to do it. Yes, there might have been some blips in the road, but we work together, we solve those. And the patient satisfaction is at least as good, if not better, than it was before. And when you have that kind of credibility, it takes away the biggest reason they didn't move fast before. They didn't move fast before because they were worried about the patient and getting the physicians the data that they wanted as fast as the physicians were used to getting it. And the CFO of the hospital would say, "I want to do this." But then you have people in the hospital say, "Well, if they can't do it well and if we have any blips with the patient, the physicians are going to get upset." Well, that's been taken away to a large part because we've done so many of these, and we've done them so well that I think people get past that hurdle faster than they have before. The pipeline remains strong. I'd say the sense of urgency isn't as strong as it was last year when the hospitals were struggling more than they are this year, but we continue to have a very, very robust pipeline.

And then maybe just switching gears to the other areas of the business. Central labs has been quite a strong sort of segment for you over the last couple of quarters. So can you maybe just talk about the drivers there and the durability of that growth?

Yes. So central laboratories is a very strong business for us. We are a leader. We are a strong leader in that business. That business is -- on the slide that I showed, 70% of it comes from large pharma and 30% comes from biotechnology. Large pharma is continuing to invest, particularly in their later-stage clinical trials, which were a lot of the studies that we run in central laboratories are later-stage clinical trials. And if pharma is going to have budget changes or cuts, they're not going to cut their Phase III programs or their Phase II program. So it's a very stable business for us that has a very strong outlook. And then if you look at central laboratory plus diagnostics, that's about 93% of our business, those 2 together. So both of those business show strength. They both show continuing growth opportunities, and I feel very confident that those will be good businesses moving forward.

Maybe we can round out with that last 7% on the early development side of things. But you sort of talked about a recovery, most likely in the back half of the year. What gives you the confidence in sort of that outlook?

Yes. So the early development business has always been cyclical. And I mentioned pharma doesn't cut Phase II or Phase III trials. But when they have to make cuts, they'll typically look at their early-stage pipeline, and that's where they'll make their cuts. Then about a year or 2 years later, they'll look back and say, "Okay, how's our pipeline looking?" They don't have enough products in Phase I, so they increase their budget for their earlier-stage products. So it's always been a bit cyclical. And I feel like we've hit the trough, and we'll start to see growth there again. But there were 2 issues that were pretty unique to this time period. One, there was an NHP shortage. So an NHP shortage caused 2 issues. We weren't able to start studies as quickly as we historically did. So people would get in the pipeline to do their trials much earlier than they had in the past. So historically, they say, "6 weeks out, we need to start a trial." We can do that. When there was a shortage of NHPs, it was 6 months out. A lot of people when they get in line that early for that early stage of a product, by the time it's their turn, their product may have failed, the mechanism might not look good anymore. There's a whole host of reasons that they may cancel trials. So we've seen the cancellation rate much higher in that business than what we've seen historically. And then the second thing is NHPs became much more expensive during that time period. So there were certain companies that just couldn't afford to move forward with those trials at the expense that it would cost them. As we sit here today, that issue is no longer an issue in terms of NHPs. The pricing has come down not yet back to where it was before, but certainly lower than it was in the past. And the supply issue is no longer an issue. When I look at our RFPs, meaning the number of requests that we have to bid for a trial, they're strong. When I look at our win rate, it remains strong. The big issue has been our cancellation rate. Cancellation rate in the first quarter was still higher than historical levels. There's no doubt about it. But it was definitely lower than fourth quarter of last year. As we go through second quarter, I don't have the data there yet, but I would hope that the second quarter cancellations are better than the first quarter. So it's just going to take some time for that to catch up. With the biotechnology funding, I think, you've all seen as coming back and -- that just takes some time to work its way into a system. So with all the early signals, I think by the fourth quarter of this year, we should see strength in that business moving forward.

All right. Adam, Glenn, thank you. We'll take this to the breakout in the Maher room upstairs.

Thanks, everybody. It's good to see you.