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

Good afternoon, everyone, and thank you for joining us. My name is Lisa Gill, and I head up the health care services team here at JPMorgan. It is with great pleasure this afternoon that I have with me to my left, Adam Schechter, who is CEO of Labcorp. And to Adam's left is their newly appointed CFO, Julia Wang. Thank you both so much for being here. Adam, it's so great to see you.

Good to see you again, too, Lisa. It's a pleasure.

Let me start with a few things. One, when we think about performance thus far in '24, labs have been very solid. It's been a great place for investors to invest in '24. And when we think about our coverage universe, there's been many developments, both positive and some negative impacting health care services in the last year. How do you think about yourself being positioned going into '25 after being so well positioned in '24?

Yes, terrific. Well, I'll answer that question directly in just 1 second. I just wanted to take a moment before I get started and personally thank Glenn Eisenberg, who's been the CFO of Labcorp for the past 10 years. He's here in the audience. Glenn has been an outstanding CFO, has created so much shareholder value, and he's just been a great partner for me as I became CEO, worked with him the last 5 years. To the end, we have Julia. When Glenn told me about a year ago, Lisa, that he wants to think about retiring. He said he didn't have a date yet or a time yet, but it was time to actually start to think about it. He and I worked side-by-side to figure out who is the right successor. We had very strong internal candidates. So we said, if we're going to have an external candidate, they had to have -- it's almost like a unicorn. They had to have strong diagnostic skills and capabilities been in diagnostics. They have to have strong drug development skills and capabilities, and they have to be a sitting CFO for a meaningful period of time. So we found that unicorn with Julia. Julia worked for one of our competitors in North America in the diagnostics area. She's worked for 3 pharmaceutical biopharma companies, including the last company, where she was the CFO for many years. So I just wanted to -- before I answer your question, I promise I will.

I know you will.

Personally say thank you to Glenn, and welcome to Julia. And if it's okay, I'm going to see if Julia wants to say a few words.

Yes, absolutely, yes. Welcome, Julia.

Thank you, Adam. Hi, Lisa, great to see you. And I'm really excited to be here. As Adam just shared, I have had the good fortune of having worked in the broader health care space for the majority of my career, including the diagnostics industry as well as the pharmaceuticals and biotech. When this great opportunity with Labcorp initially emerged, I was immediately intrigued. Now given my past experience of working in the diagnostics industry, I appreciate firsthand how the labs can really inform the doctors and the patients in their health care decisions. But as I spend more time with Adam and the leadership team, I'm really impressed by the passion and the quality of the team in addition to the market-leading position of the company in an extremely impactful industry. I also would like to share that I like the fact that we are headquartered in North Carolina because I went to Duke University for my MBA study years ago. So when you look at in totality, I would say that joining Labcorp at this juncture in my career feels very much like homecoming. Now month #2 on the new job, the team has indeed made me feel being at home, not to mention that Glenn has been a tremendous resource as I continue to transition to the company. So thank you so much, Glenn. Once again, I'm thrilled to be here, and I look forward to working with you, Lisa, as well as the broader investor community.

Great. So now I'm going to answer your question.

Great.

Okay. 2024, we had significant momentum. If you look at the third quarter, we reported revenue growth of 9% in our Diagnostics business and more than half of that came from volume. If you look at our central laboratory business, that also grew 9%. If you look at those 2 businesses, they represent 94% of our revenue, even more than that, if you look at operating income. Our early development business was down 11% in the third quarter, but that was better than the quarter before. And as I said in the third quarter, we expect our early development business to grow in fourth quarter, which we'll report in February. So it gives us a lot of momentum and a lot of strength as we come into 2025. I feel good about the underlying dynamics and the underlying performance of our businesses. And I also feel good about the potential for additional hospital, local, regional laboratory partnerships and deals as we come into 2025. The pipeline remains strong. So we've got momentum, and we're going to continue that momentum. We'll give our guidance for 2025 when we have our earnings in February.

Great. There's a lot of talk. The inauguration is less than a week away. We're going to have a change in administration in D.C. When we think about regulatory environment, obviously, this is top of mind of many people that are here today. What are some of the things you're watching for in D.C. that potentially could impact your business?

Yes. So there's 2 things that we're watching very closely. And a lot of it is being watched by our trade group, the ACLA. The 2 things I'd say specifically are, one, LDT regulations and two, PAMA. If you look at LDT regulations, I just believe that they're trying to take legislation that was fit for purpose for one industry and apply it to another industry. And I just don't think it's the right answer. I'm not against the FDA having additional oversight of LDTs where it makes sense, but it has to be in the right way and fit for purpose for the diagnostic industry. The thing I'm most concerned about with the LDT rules is not the cost. I mean we already submit the vast -- I'd say all of our LDTs to the state of New York, which would be enough to get the LDTs approved even with the new legislation. We'd have to add some monitoring and some things that we have to do to track side effects from testing and so forth, but we can do all that. I'm much more concerned about patients. I think it will slow down the availability of LDTs. I think it will be overwhelming with the legislation where it is for all these LDTs that have to go through approval. And then the second thing is I think it creates health care disparities. So academic medical centers will be able to use LDTs in their institution. So if you're near an academic medical center and you have a child that has a disease, they could have access to an LDT that somebody in the middle of Wisconsin or someplace else where there's not necessarily a medical center with that test would not have the same access. So for me, it's more about what's the right thing to do for patients. ACLA will continue to work with the new administration to see if there's a path forward that makes more sense than the current path forward. Separate and distinct for that, PAMA has been a bane of my existence for the 5 years that I've been in this job. It is the wrong thing for the industry. I don't think that it supports innovation, and we've been trying to get good legislation in place, it has been called SALSA that would actually fix the way it's even calculated, which we don't believe is correct. Now we've had bipartisan support for a long time. You and I have talked about this 5 years in a row now, I think...

Exactly.

But we haven't been able to get the legislation over the finish line. And I think it's because anything that's been a cost add, even if it's a small cost add has been very difficult to get legislation approved. So we continue to have PAMA delayed, and it was delayed again not to come in '25. In my forecast, in my base case, I assume it comes in '26. Because I don't think hope is a strategy, and I don't think we can hope it's going to be delayed again. We have to get a long-term solution to the PAMA. And whether or not that happens is very difficult to know, but that's something that ACLA and all of us will work with the new administration to see if possible.

And you talked about there being a cost associated with moving to SALSA versus PAMA. And I think this administration is talking about trying to fill out billions of dollars. And so something that's on the cost side. But at the same time, do you feel like SALSA really solves for all the issues that initially came with PAMA? I mean we've talked so many times about the data collection and the way that they were collecting the data.

Yes. I don't think there's any perfect answer. I think there are lots of parts of SALSA that makes sense and makes it more logical and more thoughtful. I think there might be pieces that we can pull out if we can't get all of it approved, but we have to find a long-term legislative solution, continuing to hope for delays each and every year, I don't think is a sustainable strategy.

And then just going back to the LDTs for a second. When we think about potential changes there, would there be any cost from that side? So again, if we think about this administration and think about what potential changes could come on that side?

So for us, there will be some increased costs, but not enough that I would actually call it out. As I said, we already submit our tests to the New York State. So therefore, we're doing the studies and the trials and we're collecting the data that you would need to have an LDT approved. The cost would come from some additional monitoring that we would have to do, and we'll put that in place. We're preparing for it as we speak. I think there'll be other laboratories, particularly smaller laboratories that are not necessarily in New York that don't necessarily submit their LDTs. And it's going to be harder for them because they don't have the people, they don't have the capabilities to do those submissions. So they might really pick up some additional costs, which will be very difficult for them. My fear is it might prevent some of them from actually developing LDTs. And I don't think we want to do anything that prevents people having new important life-saving tests available. So I think we have to find ways to get that much more rational than it is today.

Just shifting to the Diagnostics business for a minute. Utilization has been very strong in the last couple of years. We recently did an employer survey. It's expected that medical cost will increase by 8% again in 2025. When I think about how important labs and Diagnostics are, I think for any of you that are generalists, it's only about 2% of health care costs but make up 90% of health care decisions, right? It helps to drive 90% of health care decisions. So as I think about '25, and I know you'll give guidance in February, but as I think about the setup going into '25, how do you think about setting yourself up for that 2.5% to 4.5% organic growth and the 1.5% to 2.5% inorganic growth '25, '26, et cetera?

Yes. No, it's the right question to ask. And I feel very good about the underlying growth that we've experienced in '24 and the momentum that we have going into 2025. And there's 3 things that I would look at. Number one is we are continuing to see an increased utilization. Some hospitals have actually seen that decline. You haven't necessarily seen that in the diagnostic business. But I don't count on that. I assume that at some point in time, we'll go back to the historical rates of growth of volume of 1% to 2%. But there are 3 other ways that I expect we will continue to grow Labcorp. Number one, with the hospital acquisitions that we do and what happens in the surrounding geographies of those hospitals after you acquire their business, we should gain share and continue to gain share. Number two, we're going to continue to see the esoteric test and business grow faster than the routine business. And it's hard to see that because we do 650 million tests per year. So it takes a lot to move the needle, but we are certainly seeing our esoteric business grow faster than our routine business. And then the third thing is there's 4 therapeutic areas that we're hyper focused on: women's health, oncology, neurology and autoimmune disease. In those 4 areas, we're seeing growth rates that are 2 to 3x the typical growth rate in the market. So as I look at the future and I think about Labcorp, we should have underlying growth of 1% to 2% volume, which has happened historically. It's a little higher than that right now, but it might go back to 1% to 2%. We're going to continue to gain some market share. We're going to continue to move things from routine to esoteric as a percent of our total, and we're going to continue to look for ways to really capitalize on the fastest-growing parts of Diagnostics. And that's what gives me the confidence in the numbers that we have in our longer-term guidance.

We've heard some of the companies talk about growth in oncology. And part of that, some of the managed care companies as well as some that serve managed care companies talking about later diagnosis for oncology. Are you generally seeing that in your book of business as well? And when I think about incremental opportunities around oncology specifically, what do you see around testing and opportunities?

Yes. No, I think it's an important point. I think during COVID, people put off a lot of their routine checkups, and therefore, people were beginning to misdiagnose not misdiagnose, but not catch diagnosis of oncology as quickly as they had in the past. So everybody has kind of seen that, unfortunately. As I think about oncology for our business, we have our esoteric testing. We have things like liquid biopsies. They will be important parts of our business, but they're important for a reason that's different than what you might think. It's important on its own, but we want to be the one place you come to for all the tests that you could need for an oncology patient. And it's not just us having something like a liquid biopsy. It's the fact that when a person has a liquid biopsy, they also have their WBCs, RBCs, ALTs, ASTs, okay, there's a whole host of other tests that are run. We want to be the place that an oncologist can come to, to do all the testing for the patient. So they'll get one report with all the results in one report and have it on one report. Now with that said, when I think about the future of oncology testing, there's 4 things I look at. Number one is screening. The best way we can reduce cancer in the future is to diagnose it earlier and to screen it. I think that's going to take a long time to get reimbursement exactly the way we'd like it. The second thing is how do we determine who needs what, when? Like what's the right drug for the right patient at the right time. We're already seeing a good uptake in our business to help do that. Then the third thing would be minimal residual disease. Once a patient is cured from their cancer, how do you monitor them over time to ensure it doesn't come back. And then the fourth is people wanting to do a lot themselves with genetic testing and understanding their genealogy. And that's more in the patient paying for it out of their pocket. So in each of those 4 areas, we're developing our pipeline of products. We want to have a holistic approach, and we want to be a one-stop shop. We account for all of the oncology tests.

And same -- would you say the same for the other 4 areas that you talk about?

Yes.

There was just a panel that I came from for women's health, a big area where employers are looking at women's health, employers looking at fertility and other things. Maybe just spend a minute and talk about women's health and some of the initiatives that you have.

Yes, there's no doubt that we have to continue to develop tests for women's health. And if you look, for example, what we did, we acquired a company called Invitae. And maybe at the end, Julia, you can talk a little bit about the way we think about capital allocation. I'm sure you'll get there anyway. But when you look at Invitae, their valuation was $10 billion. We looked at the tests that they provide in women's health. We thought they were great. We looked at their patient experience. We thought it was terrific. We just couldn't find a way for their -- to justify the cost of the company. But it became $5 billion, we looked at it again. We still couldn't get from here to there. When we're able to acquire it for $239 million in bankruptcy, we said, boy, this is a great addition to our women's health franchise, and we were able to capitalize on that at the time. I don't like to do dilutive deals. It was dilutive in 2024 by $0.40, but we expect it to be slightly accretive in 2025. So it was a short term. But it actually rounded out our women's health franchise in a very good way. We have strong NIPT testing. We have very strong testing for preventive disease, BRCA testing, and we also have very strong testing for things like preeclampsia, which is a new test that we launched for women's health in the marketplace. So we have a whole team focused on women's health, and we're going to continue to develop tests. We launched in total about 80, 85 tests last year, and many of those were in the 4 therapeutic areas we talked about.

When I think about -- you're talking about inorganic growth with Invitae. When I think about opportunities that you're seeing in the market today, the outreach acquisition pipeline remains very strong. How do you balance integrating closed deals and continuing to deploy capital around deals going forward?

Yes. So we'll talk about that, and I'm going to ask Julia to jump in. As I think about our deal structures, most of our deals with the hospitals are regional in nature, and we have a regional infrastructure. So no one part of our company in any region is overwhelmed at any point in time, and we can do a lot of deals because we found ways to actually spread it out across the country. So I feel like we can do as many local hospital, local laboratory, regional laboratory deals as we can find. The pipeline is good. We did 10 deals last year. It's hard to know how many you'll do in any given year because sometimes they take 3 months, sometimes they take 2 years. But the pipeline looks good, and we remain excited about that. After those deals, we look at -- we're committed to our dividend. We're looking at share repurchases. And in very rare instances, we look for ways to enhance our 4 core therapeutic areas. So for example, we bought a test called Vectra last year for rheumatoid arthritis that fit into autoimmune disease very nicely. So that's how we kind of think about the capital allocation, but maybe you can add some thoughts there, too.

Yes, definitely. In terms of the capital allocation, I believe we are well positioned to pursue an attractive capital allocation strategy. So if you think about the sources of our funding, to begin with, we have been generating very strong free cash flow. In addition to that, we have a strong balance sheet. So that provides additional capacity should there be value-creating opportunities to pursue. And then in terms of the capital allocation approach, I think we have been fairly balanced. First and foremost, as Adam has already alluded to, we have been working very, very actively in the M&A space in ensuring that we do those transactions that support our strategy and augment our organic growth. And then in addition to that, we, of course, have 2 multiple ways to return the capital to the shareholders, inclusive of the share buyback program as well as the dividend. And just for perspective, in terms of the dividend, we have been really indexing that at about 15% to 20% of our adjusted earnings. So all in all, I feel very, very good about our capital allocation strategy.

Labcorp continues to pursue the specialty market growth. We talked a little bit about this. But as I think about the pipeline and I think about specialty testing going forward, any specific areas of interest as we move into '25 beyond what we talked about?

Yes. I would say the 4 core areas is where I'm really focused. But what's important to note in those areas, women's health, oncology, autoimmune and neurology, we have a very strong pipeline, and we develop tests ourselves. I'm also open to licensing tests where it makes sense because I want to have the broadest portfolio of tests that I can bring to market. And then in rare instances, I'm open to acquiring a specific test or a certain test. So we're really agnostic to some degree is how we get the best test in our portfolio. The thing that's most important is how do we have the most complete portfolio in those 4 therapeutic areas.

We touched on Invitae, and we know it was a dilutive transaction in '24. A fair expectation is that there'll still be somewhat of a headwind in the first half of '25. But should I start to think that it's accretive in the second half of '25?

Yes, it will start to -- it will be accretive for the full year, slightly accretive for the full year, but we're still working our way through. So there's 2 questions if I really said I'd be worried about with me. The first one is, are you keeping the core of what you acquired, the great tests, the innovative nature of the company, their ability to interact with customers in a way that was, frankly, better than what Labcorp was doing? And are you like kind of keeping that? And the answer is yes. We've been very deliberate to ensure that we're admiring and we're respecting the culture of the company that we think is very strong. Then the second question is, can you get the cost out? And are you going to get them out fast enough? What I would say with the cost, the reason it's taking us time for it to be accretive is we're being very thoughtful. If they have an MRD program that they were working on and Labcorp had an MRD program, we're going to do the best of best. We're going to evaluate both. We're going to say which one is furthest along, which one is scientifically best, which one has the best margin profile. And we'll be agnostic to which one we keep based upon those things. When you do an integration that way, it's a lot harder and it takes a lot more time to do it right. So for something as important as this, where we think they have really strong science, really strong data people, we want to be very thoughtful about how do we integrate this in a very different way than we would do with the typical kind of laboratory acquisition. There, we just kind of kind of swallow it up into our infrastructure. Here, it's really best of best, and that's why it's taking so long.

Earlier, we talked about esoteric testing. We talked about growth being faster in esoteric testing. You talked about that in the third quarter. Is that a shift do you think in the business? Did you continue to see that going into the fourth quarter? So is there a big shift going on here? Was it just something specific to the third quarter? How do I think about esoteric testing going into next year?