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

Good morning, everyone. I'm Erin Wright, health care services analyst at Morgan Stanley. For more important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you do have any questions, please reach out to your Morgan Stanley sales representative. And with that, we're happy to have Labcorp with us today. We have CEO, Adam Schechter as well as Julia Wang, CFO. Thanks so much for coming.

Yes, it's great to see you. Pleasure to be here.

So I'll kick things off with some Q&A. I'll start off with the most recent quarter and the strength in the most recent quarter. You recently raised your revenue, EPS and free cash flow guide, what are some of those key drivers that's getting to your 7.5% to 8.6% revenue growth range, the impetus for the raise and how are things just generally playing out relative to your expectations this year?

Yes. So it's great to be here. And as Erin said, we had a really strong second quarter, but I'd say the whole first half of the year was strong for us. We have a lot of momentum. We see the momentum in both our Diagnostic business, but also our Biopharma Laboratory Services business. If you look at Diagnostics, for the full year, if you look at the midpoint of our guidance, it's about 8% revenue growth. Of that 8% growth, about half of it is from inorganic growth and the other half of it is organic. The organic growth is stronger than what we've seen in the past, but we expect that to continue through this year. We have a lot of momentum with that growth. I think we can talk about that later, if you'd like to. If you look at our Biopharma Laboratory businesses, our book-to-bill is strong. We won a couple of large Phase III trials that helps our central laboratory business, and we expect that business to continue to grow throughout the rest of this year. We had margin improvement in the second quarter, and that's despite the fact that we had a significant impact on our margin from Invitae acquisition. The good news is that we'll lap the Invitae acquisition in the second quarter, so it will no longer be a headwind as we go through the rest of this year. And that's why we expect our margins to improve in both businesses for the full year.

Okay. That's great. So you touched on some of the pieces kind of supporting the enterprise growth expectations, but I want to drill down into utilization. Can you give us some more color around core volume trends currently, how they're tracking relative to your expectations? The recent volume trends have been strong. Organic growth, 3.4% in the second quarter. How sustainable is the stronger utilization environment? What are some of those key underlying factors driving this and what's assumed for the year?

Yes. It's an important question, and I would have answered the question differently 2 or 3 years ago than I answered today. Two or 3 years ago, we started to see an increase in volume, and we thought it was due to COVID that people were not visiting their physician regularly during COVID. And when they started to go back to their physician that they were getting more services, more tests. But it's so far after COVID right now, I no longer believe that that's the reason for the increased volume, I believe that there are other things that are driving the increased volume. Number one, we certainly have an aging population. As people age, they tend to go to doctor more often, they tend to get more tests. Number two, we are seeing new tests that are available that help understand patients' diseases better. So for example, historically, if somebody had cholesterol test, they would check for total cholesterol, LDL cholesterol, triglycerides, HDL, but now they have things like ApoA and ApoB and there's additional tests that help to diagnose the disease even further than what physicians have had in the past. And then in addition to that, I do believe that we are winning market share in the marketplace. Some of that is from the hospital acquisitions that we do. They increase access to patients, but they also help us with market share. We've also seen that when we run a hospital laboratory, the geography surrounding that hospital laboratory tend to get more market share than the geographies around hospitals that were not necessarily running the laboratories. So I think for all those reasons, we've seen an increase in volume. Historically, we would have said volume will increase 1% to 2%. We're certainly seeing better volume in that, and we expect that to continue with the guidance that we gave for the full year, we expect it to be 4% growth from inorganic and 4% from organic.

And when I think about that organic piece, how much would you say is from, if you had to guess kind of true underlying halo effect of market share gains from some of these hospital deals?

Yes. So I would say, historically, the market was growing 1% to 2%. I think it's growing faster than that right now, maybe 2% to 3%. And then I would say the rest could be from market share gain.

And then price/mix has always -- I guess, it's also held up well here. Can you talk a little bit about the price/mix dynamic, what you're seeing, what you saw throughout the year and what your expectations are going forward? And mix has been that healthy contributor. Could you break down some of the pieces for us?

Yes. I'll ask Julia to jump in and help with that as well. But it is consistent with what we've seen historically overall.

Yes. It's so good to be with you all today. So happy to comment a bit about price/mix. As you are saying, it has been holding up. In the second quarter, it was approximately a growth of 1% contribution to our revenue growth. That's actually what we are also expecting for full year 2025. If I were to further break down the difference between price and mix, I would say that on a unit price basis, it's been relatively flat. Therefore, the benefit is really coming from mix. And there are 2 drivers behind that. One of them is the increase in test per session, the other one is the growth in our lab management agreement. And over the longer term, we do expect to continue to benefit from price/mix favorability for a couple of considerations. First of all, our increase in our partnerships with the health systems and hospitals is whereby we tend to experience a higher price mix, relatively speaking. In addition to that, we continue to observe a slight yet consistent increase in test per session, mostly driven by the factors that Adam already commented about, whether it's the aging population, it's the heightened focus on wellness and health as well as our test menu, given the whole extensive and broad it is. Last but not least, our focus on the specialty testing as well as the advancement in those categories have been a tailwind as well because what we have found is that focus not only is driving an accelerated growth in those particular categories, it's also improving our broader testing volume just because as a provider of essentially such a comprehensive offering, we are well positioned to capture essentially almost all the testing needs of the patients.

And as we think about the broader kind of pricing environment, some of the key contracts that you look at, or is there anything up for renewal this year that you would call out or upcoming? And how would you characterize some of the relationships? We're talking to a lot of payers both yesterday and today here at the conference and how would you characterize those relationships with payers right now?

Yes. I mean our relationships with payers are strong. Every year, maybe 20% of our contracts come up. They're typically 3- to 5-year contracts. We have very good relationships, and there's none of the contracts that I'm concerned about at the moment. We are a very small part of overall health care spend. Diagnostics is just 2% to 3% of health care spend, but we're involved in almost 90% to 95% of decisions that are made in health care. In addition to that, the deals that we've done with hospitals actually are great for the health care system. They're good for the hospital. They're actually good for the payers because price typically comes down when we do the deal versus the hospital running the laboratories themselves. And we've been able to show payers how much they're able to save just through the hospital deals that we're doing with them. So I would say it's a very strong relationship, and they realize the importance of Diagnostics and that we're just a very small part of the overall spend.

Yes. Okay. And then let's switch gears to Invitae. Can you speak to the rationale behind the deal, how it's progressing in terms of integration and overlap with existing offerings or integration with existing offerings and contribution in the second half and going forward, how we should be thinking about Invitae?

So I would say the Invite deal has exceeded my expectations. We were interested in the work that they do in hereditary cancer many years ago. But the market cap was about $10 billion. We would do our financial analysis. And we kind of find a way to justify an acquisition based upon what the deal would cost. As the price came down, we would continue to run the analysis, and we ultimately were able to acquire the company for less than one turn of revenue. We were able to make the numbers work and see a path to its profitability within the first year. Strategically, there's no doubt that it fits great with our strategy, with our portfolio, with the type of work that they do. If you look at the integration, it's gone extremely well. We're now up upon a year. The company will be slightly accretive for the full year this year. We're on track for that. The revenue growth about 10%, we're on track for that. And by the end of second quarter, we had fully overlapped the year since we acquired the company. So now it's going to be a tailwind versus a headwind. So I would say on all avenues, it's done exactly what we expected it to do.

And then bigger picture, just on esoteric testing, too. So growth rates, margin profile, if you could speak to that across the esoteric testing business and the focus on some of those high-growth areas, women's health, oncology, neurology, autoimmune disease, I think, is what you've called out. How are those progressing relative to your expectations? And are there any areas of innovation to call out?

Yes. So there's no doubt that we're making significant progress in each of those areas. For example, in women's health, our preeclampsia test and neurology, the things that we've done for Alzheimer's disease and oncology, some of the liquid tumor things that we're working on, solid tumor things that we're working on liquid biopsies. So we're certainly making progress in each of those areas. But I would say there's 3 things to consider. First is we want to have access to the range of tests that any provider would need, including specialist providers. It's not just about the individual tests, for example, a liquid biopsy. If you actually start to help oncology patients through a liquid biopsy then you'll get all the other tests that an oncology patient would need, their WBCs, RBCs, ALPs, ALTs, all the other tests, we can be one place for the provider to go to get the test and then get it over time in just one report. I think that will be a competitive advantage for us. So it's important that we be in each of those therapeutic areas, have the leading-edge test, whether we develop them ourselves, whether we license them, whether we acquire them, we're a bit agnostic to. We just want to make sure they're available on our menu so that the specialists can order all those tests. At the same time, we've certainly seen that esoteric business is growing faster than overall diagnostic routine testing. Historically, diagnostic routine testing will grow a couple of percent per year. The esoteric testing in the 4 areas we talked about will grow about 3x that rate, so somewhere around 9%. And we'll certainly see that play out, and I expect that's going to continue over time.

And then as we think about longevity, for instance, it's a big theme for us at Morgan Stanley, and when we think about some of the consumer or direct-to-consumer kind of testing sort of initiatives, what does the growth profile look like? What are the key offerings now? Is it moving the needle yet or is at the forefront and such?

So I would look at that through a separate different ways. If you look at consumer testing, during COVID, we observed that people were looking for an answer as fast as they can get it. They weren't necessarily as concerned about the accuracy of the answer, and they were willing to pay whatever it took to get the answer. That's not how consumers typically behave. Typically, they're okay to wait a day or 2 to get their diabetes test results. They want to make sure it's absolutely accurate and they would like it to be covered by their insurance versus paying out of pocket. So we've seen for many tests, consumers go back to the historical way in which they work. At the same time, when it comes to screening, a lot of consumers would like to do that and they can do it whatever is convenient for them. When it comes to symptomatic disease, they still want to get an answer quickly, and they're more apt to do that at home. And then there are certain diseases that they prefer to test for privately, syphilis being an example that they might not want to go to the doctor. So we have our on-demand offering, which continues to grow. It's growing significantly, but it's not yet reached a point that I would pull it out because it's not a critical mass at this time. Separate and distinct from that, we have now an offering of a significant number of biomarkers for people that want to do some type of functional health and understand many different aspects of their health. We also have an offering for physicians that practice functional health so that they can order tests from us. And I'd say that's a pretty significant amount of business, but it's through the standard methods that we have all of our other business go through. If doctor is providing functional health, they can order through their electronic medical records, order directly with us, whatever test they feel are appropriate for those patients. So we are seeing an increase in functional medicine, but we've been seeing that for quite some time, frankly.

Okay. I want to switch gears to the regulatory landscape. What are your latest insights and expectations I have to ask on PAMA. We've been talking about it for, I don't know, 10 years?

Yes, it's 6 years.

It feels longer. We've heard from the new CBO scoring, they suggest that delaying PAMA may not save money in 2026. Maybe talk a bit about PAMA, PAMA reform, what your expectations are and what's the next data point we expect.

Yes. So if you look at PAMA, we've been discussing that for many years now. We still believe the way in which it's been administered and calculated is incorrect. We expect that there will be some legislation that will be announced soon that we'll try to fix the issues through a legislative process. That is the best answer. It has bipartisan support, it has for some time. Whether or not legislation gets approved, it's hard to say. But working with our trade organization, ACLA, we still believe that is the best path forward for a long-term fix. Separate and distinct from that, if it does not get passed in legislation, then we would look to see if there's a way to have it delayed again, which has been delayed for many years now. As you mentioned, we've not seen the new CBO score. I don't know, frankly, the methodology changes or what that is. So it's very difficult to try to give odds on what the chances are of it being delayed again. If the score is neutral, maybe a slight cost add or actually a cost avoidance, well, then I think there's a high likelihood it could be delayed if the legislation is not passed. If it would cost a significant amount, I think it would be harder, but not impossible. At the same time, we're going to continue to have discussions through the trade organization on other ways to make sure that the methodology is going to be better implemented than before. I think the big issue is they'd be looking for data from 2019. Trying to find a hospital that can provide data on tests by payer from 2019 is nearly impossible. I don't think I can get it for 2024 very easily. So I still think it's going to be very difficult for them to collect the data. With all that said, I've said this for the last 6 years, I'll say it again this year, I build the impact from PAMA into our base case plan, and that would be about $100 million impact next year on both the top line going directly through to the bottom line. We will use launch pad to offset as much as we can of our wage inflation, and then we'll be going after additional cost savings in order to offset some of PAMA. Obviously, we couldn't offset $100 million impact, but we would shoot to offset as much of that as possible. People have pushed me to give a number. We don't have an exact number, but I would shoot for something like $25 million to $30 million of it.

Okay. $25 million to $30 million, you would be able to offset?

That's what our goal would be to offset.

Okay. I guess that was my next question. Okay. So on the one big beautiful bill and cut from a federal funding perspective, how do you think this plays out for Labcorp from a volume perspective as we could see increased uninsured population? How would you compare this to other iterations of reform? And then also, can you parse out Medicaid versus ACA in terms of if -- well, we'll see what happens from an ACA subsidy perspective, but what do you anticipate, I guess, the implications are for Labcorp?

I'll give some comments and I'll ask Julia to jump in with some of the specific analysis that we did. But I would say, in general, with the bill, there's tailwinds and there's headwinds. I think the tailwinds unfortunately, I think hospitals will be under increased pressure than they are today, which are already under a lot of pressure. That pressure tends to enable them to have quicker discussions with us about running their laboratories or acquiring their outreach business. So we've certainly seen our pipeline for hospital deals be strong. We've announced quite a few deals this year. There's more to come, and I expect that, that will continue. I think if things play out the way they may play out in the bill that will actually cause the pipeline for hospital deals to increase. The headwinds would be if we have more patients without access to health care, that tends to be difficult for payment and so forth. So those are the 2 pushes and pulls. Overall, not a significant impact to us, but I'll let Julia talk a little bit about the magnitude that we see.

Yes, sure. So if you break down the impact to start with the potential expiration of the tax credits as it relates to the ACA enrollment, we have sized that to be about 30 basis points in volume for 2026. And the key assumptions that we are making in derive at that impact is the following: First of all, we understand that for 2025 open enrollment, as it relates to the ACA marketplace plans, we had about 24.3 million insured lives. And then I believe CBO released information suggesting that about 17% of that insured population might potentially be impacted by this expiration of the credit. So obviously as Adam mentioned earlier, there are some other moving parts, too, because even if the credit gets expired, some insured lives might transition to some other alternatives, whether it's through the spouse or new employment, things like that. So all in all, when you do the puts and takes, it's getting us to a ballpark number of 30 basis points of volume impact in 2026, which obviously is relatively manageable. And the other thing as it relates to the major changes associated with Medicaid reform, most of them are not going to kick in, in 2028. So we'll continue to see how that evolves over time. The last aspect I would mention is when you think about the one big beautiful bill from an effective tax rate perspective, we do not expect anything meaningful for our company. So for this year as well as going forward, we continue to expect our effective tax rate to be approximately 23%.

And the only thing I'd add, I mean, I don't think it will be tenable for a large number of Americans to lose insurance altogether. I think whether at the federal level, at the state level, I think something would happen. We all remember before when there were 40 million Americans without insurance, it became such a political issue, whether Democrats or Republicans are running that I don't think anybody wants to get to that point again. So I think that they would find ways to ensure that there's some type of insurance for those people that would lose insurance.

And I think bigger picture to that whether it's PAMA or changes from a funding perspective across insurance or otherwise, I mean, do you think that it's still the same picture in terms of -- and this is kind of what you're getting with the hospitals, but at the end of the day, economics should prevail, volume should go to the low-cost provider.

I would think so. I mean, at the end of the day, we provide high quality at a low cost, and we are now providing a lot of innovation with that as well. So if you look at different economic environments over time, if you look at different political situations over time, the diagnostic market has always continued to perform well. And I think it's because we are so important to making health care decisions, and we're such a small overall amount of the total spend.

Okay. Let's switch to biopharma a little bit. So can you give us an update on what you're seeing in terms of cancellations, RFP flow, the biotech funding environment and how is the environment has been under the new administration. We just had the head of the FDA here yesterday talking about animal testing and talking about different components of what he's focused on. I guess, yes, how would you kind of characterize the underlying environment now?

Yes. So I'll start broadly and then I'll narrow down and answer some of the questions that you raised. So broadly, if you look at our biopharma businesses, there's 2 segments. There's our Central Laboratory and there's our early development. The Central Laboratory business is the biggest business by far. Early development is frankly less than 6% of our revenue and even less than that in operating income. So it's a small piece. If you look at Central Laboratory, about 70% of our business is in large pharma. And the vast majority of that business is Phase III trials because those are going to be the largest trials. The last thing that pharma wants to cut are ongoing or new Phase III trials for important products in the pipeline. That's typically the last thing that would be cut. We've seen the essential laboratory business continued to perform well. Our book-to-bill looks strong. Our offering is strong. We are the leader in that business. So I see that business continuing to perform well as we look out to the future. Our early development business. It performed well in the second quarter. We expect that it will continue for the full year to grow this year versus last year. That business is a little bit different because about 70% of that business is in small biotech and only about 30% is in larger biotech and pharma. That's where you see more volatility when interest rates go up when funding goes down, and that's where we have to watch for cancellations very closely. When I look at that business, I look at 3 things. I look at what are the number and dollar amount of the RFPs reflects proposals coming to us. Right now, those look good and steady. I then look at what percent of those proposals do we win. That's kind of my surrogate for market share. Our market share looks good, and we're winning at a very consistent rate. I then look at do the trials start and start on time. That's the area that we're continuing to watch the closest. Right now, I would say there's a slight delay in when we see the trial starting. The cancellations are definitely less this year than they were last year. Last year, they were above the normal range. This year, they're within normal, but at the high end of normal. So that's a business that we're going to continue to watch closely. At this point, I don't see signs of an issue, but that one tends to be a little bit more volatile than the central laboratory business. And frankly, I'm glad that it's a very small part of our revenue and OI.

And maybe this is going back a little bit to the Covance days and the decision kind of the split of the business. But what was the rationale in retaining kind of the early development business? And how do you see all the different pieces playing together? I think I always ask you this question in terms of how you're taking development and then getting the companion diagnostics and ultimately taking it to market. Like how many of those opportunities are you seeing at this point?

Yes. When we decided to spin out the clinical development business, we actually looked at all possibilities. We looked at spinning out all of the biopharma laboratory services business. It made no sense to spin out the central laboratory business because it's core of what we do. In fact, we had a central laboratory business even before the acquisition of Covance, same machines, same equipment, same types of people, same reagents. If you walked into a central laboratory versus a diagnostic laboratory, you would be hard-pressed to see a difference. The biggest difference is the customer diversification, pharma versus providers, the global nature of the business and the fact that the regulators are different that come in from a global basis to central laboratories for global trials versus mostly the U.S. regulators for our U.S. laboratories. So it really made sense to keep the central laboratory business. We decided it did not make sense to keep the clinical business. It was a feet on the street business, not a lot of bricks and mortars. It was global people all around the world. We were not the leader or a leader in that business. And also to acquire another company based on the multiples at the time just didn't make sense to actually make it a leading business. That's why we decided to spin that business out. So then we had 3 alternatives for early development. One, we could spin it out with the clinical business. That made no sense because the 2 businesses are so different, especially without a central laboratory in the middle. We then said, do we spin it out on its own. Based upon the size, the scale and the margins of that business, the amount of infrastructure that you'd have to build to have your own IT departments and HR departments and CFO and CEO, it just didn't make sense to spin out as its own business. And then the question is, do you keep it or try to merge it with something else? We decided to keep it because it's more closely related to central laboratories than not. And at that point, we were doing a lot of cell and gene therapy work in early development. I think that's yet to happen, but that's where I see a lot of the benefit of having early development where cell and gene therapy work that we're doing there ultimately would make its way into our central laboratories. And then ultimately, we can bring those products to market. We also have seen an increased number of personalized medicine trials. By that, I mean, whether it's companion diagnostics or tests that are used to determine who should be treated. When we win those trials in early development, we tend to get those in the central laboratory work. But I think the big difference is the customer base is so different that it doesn't always transfer to the customers from early development to central laboratory business.

Okay. That's helpful. And then I want to switch to margins and profitability. Can you talk a little bit about the LaunchPad savings initiatives and also how we should anticipate margins to progress throughout this year? And what long-term margins ultimately look like?

Yes, I'll start, and I'll ask Julia if she wants to jump in. So if you look at our margins in LaunchPad, we continue to make a lot of progress in Launchpad. We committed to $100 million to $125 million of cost reduction per year. And we have hit that commitment and continue to make progress towards it this year. We will hit it, and then we've committed to it for next year as well. That helps to offset the increase that we see in wage inflation. So then the question is, how do we use AI and robotics and other technologies to reduce cost even further, which is what we're going to try to do to offset part of PAMA going into next year. With that said, we did see a margin increase of 20 basis points in the second quarter across Diagnostics, despite the fact that we had still a negative impact from Invitae. For this year, we expect the margins to increase for both businesses. You can talk about the progression.

Yes. I think that's right. So we are pleased with the progress we've made with margin. In the second quarter as an enterprise, we grew our margin by 20 basis points. That is after absorbing a headwind of Invitae of 30 basis points. And heading into the second half, particularly now that we have annualized Invitae as well as our efforts to continue to drive operating efficiencies across the enterprise. So we expect a step-up in the margin expansion in the second half to a degree that will translate into a full year margin expansion for 2025. And actually, that margin expansion is also a key driver for our guidance for EPS growth this year. At the midpoint, we do expect our EPS to grow approximately at 12% versus a year ago, which, of course, is going to help with our free cash flow generation as well, given our relatively high cash conversion from adjusted earnings into cash.

And on capital deployment, can you talk a little bit about the deal pipeline? I think you still say it's still robust, but how would you characterize it relative to even last year or the year before, the past 3 years in terms of the deal pipeline?

Yes. So when we think about deals and more broadly about capital deployment, we first are looking at these hospital local regional laboratory deals. The reason why is they're accretive in the first year, they return their cost of capital very quickly, 2 to 3 years. And we know how to do them, and we develop good partnerships through them. That pipeline has been strong. After COVID, I think a lot of hospitals realized that they weren't investing the capital that they needed to keep their laboratories up to date. So they really were much more open to thinking about us running their laboratories. In addition to that, they realized that we can do it very well. And they saw us, for example, with Ascension, move 100 hospitals over very quickly, very successfully without interrupting patient care. And I think that gave them comfort that they could do it with us. In addition to that, by acquiring their outreach business, it gives them an infusion of cash, which they can use to invest in surgical suite or something else that would be more beneficial to them. So we saw an acceleration after COVID. That has continued. I would say the urgency has slowed down a little bit recently with the hospitals being a bit more successful than they were in terms of generating margin. But with that said, we've actually seen it accelerate again and the pipeline start to build in the last several months. So I think as hospitals are looking at next year and they're starting to prepare what could happen with tariffs and other things that they're facing, they are looking again to us to potentially be a good partner and/or acquire their outreach business. So that pipeline right now, I'd say, is as strong as I've seen it. And I'd say the urgency is probably a little bit higher than it was at the beginning of the year, but not where it was right after COVID.

Okay. And then any incremental color on your latest announced acquisition of the community health systems business and the nature of that deal?

It's a great deal for them and for us. It's across many different states. So it will be one that will go across several of our regions. We have a very good team that we've put together to work with them on it. So we're looking forward to that. It will be a good partnership. There's no doubt about it.

How do you find the right balance between some of these hospital deals and then bolt-on lab deals and then partnerships as well as acquiring innovation?

Yes. So the first thing is that we look to deploy our capital. We're committed to our dividend, and we remain committed to the dividend. We then look for as many of these hospital local regional laboratory deals that we can do as long as they meet our financial criteria, accretive first year, cost of capital return in 2 to 3 years and good partners. And we have the capacity to do as many of those as we've been doing and even more as we go into the future. Then we look at are there other acquisitions such as key tests that we'd like to acquire. Typically, they're very small amounts of capital outlay. They return their outlay very quickly. And then we're not interested at this moment to look for a third leg of the stool or something outside of our core. We believe that the core of our central laboratory business and our diagnostics business, our biopharma business is strong enough to give us a great profile as we move forward. So at this point, we're looking at those types of deals. We're not looking at any large acquisitions outside of our cores that we're doing now.

Okay. Great. Thank you so much for the time. I really appreciate it.

Yes. Good to see you. Thanks, everybody.

Thank you.