Labcorp Holdings Inc. Q1 FY2021 Earnings Call

Thank you for standing by, and welcome to the Labcorp Q1 2021 Earnings Conference Call. I would now like to hand the conference over to your speaker today, Chas Cook. Thank you. Please go ahead, sir. Thank you, operator. Good morning, and welcome to Labcorp's First Quarter 2021 Conference Call. As detailed in today's press release, there will be a replay of this conference call available via telephone and Internet. With me today are Adam Schechter, Chairman and Chief Executive Officer; and Glenn Eisenberg, Executive Vice President and Chief Financial Officer.

Thank you, Chas. Good morning, everyone. Thanks for joining us today. Our focus continues to be on bringing innovations to market that help improve people's health and lives. As you'll see from our first quarter results, doing so can generate strong growth and returns for our shareholders. I'm going to begin by covering our overall performance in the first quarter, which is very strong across all of our businesses. Revenue increased 47% versus the same period in 2020. While a good amount of growth can be attributed to COVID testing, we also delivered 15% year-over-year growth in our base business. In Diagnostics and Drug Development, base business revenue increased 8% and 24%, respectively, from the prior year. Our drug development book-to-bill remains very strong and reached 1.47 for the trailing 12 months. Our adjusted EPS of $8.79 represents significant growth from last year. And we generated $1.1 billion of free cash flow in the quarter. That's up from $97 million in the first quarter of 2020. Our first quarter results and our improved outlook for the year enabled us to increase our full year guidance.

Thank you, Adam. I'm going to start my comments with a review of our first quarter results, followed by a discussion of our performance in each segment and conclude with an update on our 2021 full year guidance. Revenue for the quarter was $4.2 billion, an increase of 47.4% over last year due to organic revenue growth of 45%, acquisitions of 0.9% and favorable foreign currency translation of 140 basis points. The increase in organic revenue was driven by COVID testing of 32.9% and organic base business growth of 12.2%. Operating income for the quarter was $1.1 billion or 25.4% of revenue. Okay. I think we've completed our formal remarks, and we're now ready to take questions.

I wanted to start with the Covance performance. So I was calculating new awards up 60% year-over-year, which would make Labcorp #1 so far in the quarter. So Adam, I was wondering, is that math right? Were there any chunky awards to call out? And can you maybe talk about the relative performance of each of the businesses within Drug Development?

Yes. Jack, no, your math is about right, and we're very pleased with the performance of all the businesses, frankly, Diagnostics and each of the businesses in Drug Development. Central Laboratory was particularly strong, but we saw good growth in early stage as well in late-stage. And as I mentioned on previous calls, we had recently won some larger pharmaceutical clients that are helping with our book-to-bill. So if you look at our book-to-bill, it reached a record of 1.47 for the trailing 12 months. And the total backlog, as you said, grew to $13.97 billion. And I'll just add to that, that only a very small percent of that backlog is related to COVID work. So it's really related to the other therapeutic areas.

Great. And maybe building off that, Glenn, you mentioned in the prepared remarks how the stacked growth is somewhere in the mid-teens. As you think about how this backlog growth is going to convert over the next year or a few years, how do you think the near-term trend rate for Covance is looking? Are you going to have tough comps as we're looking out a year from now? Or do you think there's just a lot of work to burn through for some time?

Yes. No, we have seen over the past several quarters a little bit of a decline in the conversion rate. We're now at around 33%. And it's, as you know, relative to the mix of business that we're doing, more oncology work that we're seeing, good growth in our backlog, as Adam commented. So right now, we continue to have a lot of good momentum. Our orders continue to be very strong. We're building up a very strong backlog, again, at $14 billion. So nothing from our view long term would change. Obviously, in the first quarter especially, you'll see kind of a really strong growth rate in part because of the COVID-related vaccine and therapeutic studies that we have that at some point will obviously start to taper off.

Great. Another one on the Covance business here. There's obviously a ton of promotion in the CRO space right now. What are you seeing in terms of opportunities from some of the potential disruption there, whether it's win rates or employee recruitment? And on the flip side of that, does the ongoing strategic review change any of your own relationships with customers? I assume it doesn't, given the latest bookings trends that you just posted. But do you see also further consolidation across the CRO space from here? Or do you see the need to add scale to the Covance business as always, a controversial topic.

Yes. So first of all, Erin, thanks for the questions. Whenever you have large-scale integrations or mergers and consolidation, you see some interruption of business. So we're going to be prepared to take advantage of whatever is out there in terms of disruption or distractions of companies that are being acquired or that are going through the significant integrations. Integrations are just hard to do. We've said all along that we believe that there was going to be additional consolidation in the industry. So it's not a surprise to us. I mean we're aware of the marketplace and all the competitors. And obviously, we know what's happening. At the same time, we've always said you need a certain level of critical mass to be successful. And the good news is we have that critical mass. And as you said, Erin, you can see it in our numbers. You can see it in the strength of our book-to-bill, you can see it in the strength of our ability to continue to grow in the Covance business. So we know the industry, we know the other players very well. And that's a great thing about Labcorp. I mean everybody comes and talks to us. At the same time, we feel like we're in a very strong position. With regard to your second question, as we go through a strategic review, we're focused on executing in the marketplace. And we're not going to lose focus and we're not going to spend time in the vast majority of our organization. They're just meeting the needs of our clients and our customers every single day. It's going to be the Board, the management team that are working together to do this thorough review. And we're not going to distract the largest parts of our organization. We're going to keep them focused on delivering. Hopefully, you see that our execution in the marketplace has been really strong across Diagnostics and Drug Development. It's been strong with everything we're doing for COVID. It's been strong in our base business. I mean our base business for the overall grew 15%, and the base business for Diagnostics was up 8%. Drug Development was up 24%. So you see that strength there. That's because we're so focused on executing on the needs of our customers. And we're going to continue to do that while we also perform the strategic review.

Okay. And switching over to the Diagnostics segment. I guess, in your view, how has the competitive landscape changed as we emerge from the pandemic here with some emerging smaller labs and other entities stepping up investments and testing capabilities? Does this change any of your outlook from a consolidation standpoint at this point across the core clinical lab space?

Yes. And a couple of parts to answer. The first thing is that if you look at people that have built capabilities to do COVID testing, those are really doing molecular testing. Molecular testing is a very, very small part of the 530 million or so tests that Labcorp does a year. So no matter how much capacity is out there for molecular testing, I don't think that there would be a significant impact to our business with new competition that can do some molecular tests. What I do believe is that some of those competitors are not going to be able to make it with just COVID testing as we've seen the number of tests per day go down. And therefore, I believe there will continue to be consolidation in the industry. And frankly, that's something that we'll continue to look at. We've always said that acquiring local laboratories or hospital laboratories, even regional laboratories are a great way for us to use our capital. We know how to integrate those. They return their cost of capital very quickly, and they're typically accretive in the first year. So we'll look for opportunities for continued consolidation, but not just in the smaller new competitors, but also in the hospitals and other laboratories.

Another question on the Drug Development business, big growth year-on-year in the new awards but off of a lower base. Can you comment on the book-to-bill ratio in the quarter? And on your upper trailing 12, but specifically for the quarter and if you felt like you were winning your pro-rata share of bookings and anything to be aware of on the monthly trend front?

Yes. Dan, it's Glenn. As you know, we do a book-to-bill on a trailing 12 number, and again, a record level of 1.47. So it's picked up nicely from the prior trailing 12 months. So obviously, it implies a very good quarter. We tend not to give the quarterly numbers because we don't want it to be focused on the quarter. Obviously, this is done over the years, but it's fair to say that we feel we had a very good quarter, and it was enough to meaningfully bump up our trailing 12-month level.

And I would also say, Dan, if you look at RFPs, they continue to be coming in strong. If you look at investment from pharma and biotech, it continues to be strong. And we continue to win at a minimum, our share, move even a bit better.

And then my follow-up, can you elaborate a bit more on the drivers of the organic growth in your base business in Diagnostics? It seems like the health care system hasn't fully normalized yet, doing 6% organic is better than the industry. So maybe if there's more granular detail you could offer on the drivers there.

Yes, Dan, we are very pleased with the rapid recovery in Diagnostics, which has been stronger than we anticipated. This improvement is one of the reasons we've raised our guidance for Diagnostics. When analyzing the organic revenue growth of over 6%, the volumes are still slightly down year-on-year, around 1.3%, but they would have been better if we excluded the adverse weather impact. We are beginning to see a positive trend, which is expected as we now compare the end of the first quarter to the initial pandemic effects last year. We are also glad to note that volume levels are improving, although they are still lower than pre-pandemic levels from 2019, remaining in the low single digits. While revenue continues to rise year-on-year compared to 2020 and shows compounded growth compared to 2019, volumes remain a bit down. We anticipate that volume levels will start exceeding 2019 figures by mid-year. The silver lining is that although volumes are somewhat soft compared to historical standards, we are compensating for this with our pricing and mix, particularly due to the increased number of tests being conducted. This indicates that while there may be fewer visits to physicians, more tests are being performed during each visit, indicating good momentum in our progress.

You mentioned in your prepared comments that capital allocation would accelerate over the course of the year. Was the strategic review the reason why there wasn't much capital deployed in the first quarter? Your buyback was $69 million and M&A was $34 million. How should we think about overall capital deployment, including whether there is a target for buybacks or if total allocation has been factored into these numbers?

Yes. Kevin, to your point, what we've said in our guidance overall is that the free cash flow that we're going to generate this year, call it, the $1.8 billion to $2 billion, we expect to deploy between M&A and share repurchases. We tend to start off slower in the first quarter, just historically, even with our buyback program just to let the year a little bit unfold and see what the M&A opportunities are there. We continue, as Adam said, to have really a strong pipeline of M&A transactions. The reason why we said we were accelerating especially on the share repurchase side because we can obviously unilaterally control that, is that with one quarter under our belt, three to go, we still have that midpoint of 1.9 to fully deploy. So you would normally expect that instead of it just being done all towards the end of the year, you'll start to see a pickup. But we're encouraged with the pipeline of deals that we feel we can do. We're encouraged, obviously, that we'll continue to redeploy our capital with M&A. And from our perspective, we're on track with what we were expecting to see happen.

And Kevin, just to give you a sense of how we think about it. I mean, we've always said that local hospitals, regional or laboratories, local laboratories, those would be things that we would look to acquire. And as I said before, they're accretive in the first year, return cost of capital in a couple of years, and we know how to integrate those really well. We then look for strategic acquisitions that are typically tuck-ins like we did with Global Care last year, Snap IoT that helped us with our decentralized clinical trials. There may be some things in oncology or other parts of our strategy where we want to reinforce our position, and that's the second place we look. And then, of course, we're opportunistic with the buybacks. And we look at all three of those.

Okay. And just one follow-up. Is the largest difference between the high end and low end of your guidance still attributed to PCR volumes, or is there another factor that would significantly impact earnings for the remainder of the year?

We have separated our guidance for the underlying business and COVID testing to provide distinct ranges for both. There is greater uncertainty regarding PCR testing based on the current state of the pandemic and its effects. When we shared our guidance, we indicated that it would involve various volume levels and possibly differing pricing. In the first quarter, we experienced strong PCR volumes, averaging 112,000 tests per day, but we concluded the quarter at around 80,000 tests per day. This suggests a downward trend in volume levels, though there remains the possibility of an increase in the future. At the midpoint of our guidance, we anticipate volumes will decline. Regarding pricing, we have consistently adhered to the reimbursement pricing set by CMS, which may change at some point, introducing variability to our estimates. We currently have ample capacity and our turnaround times are excellent, allowing us to fulfill existing demand.

And Kevin, I think the good news is that our base business is strong. And that's why we're able to increase the guidance in both of our base businesses. And frankly, that's the long-term success that we expect to have in the base business. If you look at the PCR testing today and you looked at our range between down 35% and down 50%, you would actually get closer to down 50% today versus the 35%. But let's see what happens because in November, there could be another outbreak of the flu, and therefore, a lot of people might come in for PCR tests. Where we have back to school and the kids are going back to school, whether there be large-scale screening. So that's why we've given ranges in both, and that's where we have a much broader range for PCR testing.

I want to probe a little more into the guidance and more around trying to figure out baseline earnings this year, excluding COVID. I know midpoint of guidance, you said COVID revenue, $1.6 billion. But it sounds like you're trending towards sort of the lower end of that. But even if I take that sort of lower end, based on my math, I'm still coming up with maybe $6 to $7 of EPS contribution. Do you think it's a fair ballpark?

We are guiding to revenue and have previously discussed the leverage we achieve on PCR volumes based on pricing. We expect to exceed our typical 65% incremental leverage on PCR volumes, similar to what we've seen with incremental volume from weather. When we provided guidance, we outlined a range, with the midpoint reflecting our main expectation. However, there is potential for better outcomes at the upper end and risks at the lower end. The reason the PCR figure is slightly below the midpoint is due to current trends, but as mentioned, there is a possibility for it to improve. We are trying to provide some insights. Depending on the ongoing public health emergency, an extension could lead to better pricing, which would be an improvement, as we anticipate scenarios where overall pricing may be lower. Looking at our earnings, we had a solid first quarter, and when compared to our guidance for the year, the percentage of earnings we achieved was notably higher than usual, with around 40% of our earnings coming from this quarter. The second quarter is likely to remain strong due to ongoing COVID testing, though it will be less than in the first quarter. The main consideration will be the second half of the year, where we expect a decline in volumes and possibly pricing. However, uncertainties remain that could lead to positive surprises if volume and pricing remain stable, resulting in a wide range of potential outcomes.

Okay. That's helpful. I have a follow-up question. Is there any update on school testing in general? Specifically regarding the K3 program that is expected to be announced soon, could you clarify whether you submitted a bid for a coordinator role in four regions or if you will only be one of the up to ten labs participating in the program? Additionally, can you provide an estimate or perspective on the potential opportunity as you see it?

No, it's a great question. We did bid on certain regions and expect to be one of the labs, regardless of whether we have one of the hubs. We anticipate being involved in both aspects, but we'll see how it develops. At the very least, it’s difficult to envision a scenario where our testing capacity and capabilities wouldn't be needed. It all hinges on how many schools choose to implement the screening. As vaccination rates increase and more parts of the country are reopening, especially in certain areas where things are almost back to normal, it’s uncertain how many schools will decide to regularly screen all their students. That’s why we provided a broad guidance range, from down 35% to down 50%. Currently, we're trending closer to the 50% end. However, if schools were to expand and conduct more testing, we might see a different outcome within that range. For now, we don’t expect a significant increase, which is why we maintained our current range.

First question on the Diagnostics side. If we think about the base business, organic growth for core business was up 70 basis points when you adjust for the weather. I suspect there was also sort of an impact of the light flu season that contributed there. So i.e., that if we normalize for that, core testing would have been even higher. Maybe you can give us a sense of those dynamics. And also, one thing that's very clear from all the details you're giving is that you are growing faster than your closest competitor, both on core testing and on PCR testing. And while some of it could be geographic, I think that core testing would grow faster geographically, PCR testing not. So can you talk a little bit about share dynamics that you're seeing?

Yes, Ricky. So a couple of things. First of all, our base business, as you say, is very strong. And it's strong across Diagnostics for Drug Development and frankly, each area of Drug Development. When you look at the diagnostics, we're seeing that people are coming back to the more routine healthcare. And if you look at the volume and you compare it to 2019, it's only down in the low single digits now versus if you look at the end of last year, it was in the mid- to upper single digits. So we've seen continued improvement in people coming back to the routine test. The other thing that we're seeing is that for each blood draw, there are more tests being run in that blood draw than historically happened. And the question is, will that be maintained? We are hypothesizing that some people have been out of healthcare for a while. So when they finally do go to their doctor or telemedicine, they're doing a lot of tests just to check on people's overall health, and therefore, that might not continue over time. But on the other hand, it may. And we're going to have to watch that closely in terms of how many tests per accession we see over time. There's no doubt that the Diagnostic team is executing extraordinarily well in the marketplace. The team is focused. They're energized. They're doing a great job. They've worked through COVID. Our sales folks were out there the entire time doing whatever they could where doctors' offices were open, doing things remotely. One of our platforms for our key pillars of our strategy was digitalization. So we were able to do a lot of things digitally through the pandemic that historically we would not have been able to do. So I agree with your assessment that we're performing well in the marketplace versus others.

Okay. And then on the CRO business, I mean, the one thing that I think that we're clearly seeing from the industry consolidation is that scale matters more and more. Your competitors are becoming bigger. So just kind of like any thoughts on how you think about Covance core clinical scale, excluding the Central Lab business. And just kind of like how you think that competitive environment is going to evolve.

Yes. No. So first of all, I'd say, if you look at the three pieces of our business, and I'll break them quite individually. If you look at our early-stage business, we have scale. And we're strong and we're a leader in that business, and it performs very well. If you look at our central laboratory business, we're a leader there as well. We have scale, we can compete. And I've said all along that we have the scale that we need in late-stage clinical trials. That's the area that as you get more trials, you can scale the quickest. And you can do that to some degree organically. You don't necessarily have to scale in clinical trials inorganically. So for example, we wanted to have more capabilities in China and Japan, we were able to build scale for clinical development in those countries fairly quickly. So we see what's happening in the marketplace. We understand the marketplace well. We understand the importance of scale. And to me, it's a certain level of scale you need to have to be successful. And I believe we have the level of scale across each of our three businesses that we need.

And then one last question. I wanted to follow up on what you said. You said that you're seeing more people coming back to do routine healthcare. Acuity is something that the market is very, very focused on. And you see sort of what type of tests are being ordered, which I think are positively correlated or correlated with acuity level. Any sense there in terms of what type of tests you're seeing being ordered?

Yes. So Ricky, we've seen all of the business come back, whether it be our base business or it'd be our esoteric business. In the first quarter, we saw a little bit more of the base business coming back. We think it was probably because people were getting physicals and the year was starting. It's typical to see that base business perform a bit better in the first quarter. The esoteric business continues to be pretty consistent because when people need to get one of those tests, they get it irrespective of the time of the year. So there's not a really significant difference versus what we would expect to see.

Just thinking about your comments on pricing expectations later in the year. Thinking out COVID, how are you thinking about the durability of pricing in the base business ex the COVID testing that we're seeing right now?

Brian, when I look at the business, the pricing is always under some pressure, but it's pretty stable. I feel good about our volume. I feel good about our pricing as we go into the future. Obviously, PAMA right now, we're having our base case that there'll be an impact next year. And we expect that will be about the same as it was in 2019, around the $100 million mark. But at the same time, we think that there's ways to get through that and be able to be successful through that.

Yes. The only thing, too, Brian, that I'd add is I agree that from a unit pricing standpoint, exactly as Adam has conveyed it. When we talk about price, we also do price mix. And so as you see that the volume levels are coming back, you'll see the price mix come down a little bit. Again, when you think about it and now those people are going to the physician's office more normally, you'll start to see a more normal cadence of how many tests per session they would have. So especially as we continue to grow, when we talk about a normal historical growth rate of kind of 2% to 3%, if you will, in, call it, the organic revenue with 1% to 2% coming from volume, one from price. So we normally always still do expect to have a contribution from favorable price mix. But given that the volume levels have been negative from year-on-year comparisons, we've seen an unusually high price/mix. So again, as we get more to normal, you'll see both kind of fall back into where we would normally expect it to be.

Given some goalposts around what you expect molecular look like in 2021. But do you have a sense or maybe give us some sort of wider goalposts around what it could look like in 2022? Do you think potentially down another 50%? And then the second piece of that would be, you talked about leveraging the experience and expertise you've gained through COVID. But what about the substantial footprint and capacity that you've built out to meet COVID demand? How do you leverage that moving forward?

Yes. Thank you, Matt. So it's hard to predict where 2021 is going to end up. That's why we have such a broad range. It makes it even more difficult to predict 2022. What I would say is part of it is going to depend on how long the vaccines work for. Are we going to need a booster shot every year? Is it going to last for several years? Part of it is going to depend on how tough the flu seasons are. So there's still a lot of unknowns as we go to 2022. I mean, I would expect there will still be testing for COVID in 2022 that we'll be doing. The level of which will be determined to some degree by the vaccines. But on the other hand, if the vaccines last a longer period of time, will we need to do more serology tests? Will we need to do more T-cell testing? I think that the story is still going to be written as we learn more scientifically. And PCR testing will play a role, but serology and/or T-cell, another test may play a very different role as we go into 2022 and beyond. With regard to the testing capabilities that we've built, the machinery, we can still use a lot of that. I mean we use it for our other tests. There might be some excess capacity that has to be written off over time. But for us, it wouldn't be a significant issue where others that all they do is COVID testing and all they've done is build capacity for that, I think they'll have a significant issue. We're in very good shape there, frankly.

So I wanted to follow up on the longer-term COVID testing you were just discussing. So I wanted to say where do you think the testing for reference labs in the long term given the vaccine rollout but also more variants coming in. And also the testing decentralization happening right now? And then a follow-up for related question for that is for the excess capacity in the future from all of this testing roll-off. I wanted to see if you could comment more on what sort of maybe strategic tuck-ins in the testing side that you'll be focusing on?

Yes. So again, with the longer-term COVID testing, it's early to understand exactly how that's going to play out. Part of it is going to depend on vaccines, but part of it will also depend on if we have good therapeutics. So for example, if we get to next year and it's a big flu season, and if somebody gets COVID, they still have a high likelihood of being hospitalized and/or dying from COVID. I think people are going to want to use a molecular PCR test and have it done by us. If there's great therapeutics and if people get COVID, they end up not being hospitalized and they can be managed from their home and it's more like the flu, then I think you might find more testing that's done in physicians' offices. So really, it's going to depend on how the science plays out. I assume there will be some testing needed in the long term that we'll be doing. But obviously, it will be significantly less over time than what we've done in the past. To me, the real question continues to be, will there be a role for serology? Will we need to know if people are still immune to the disease or are vaccinated and have titers at the right level for the disease. And there might be other tests in the future that play a more important role than they do today, and we'll have to continue to watch that. The last thing I'd say is with regard to capacity in the future, I've seen some countries that are going to use that capacity to do significantly more screening for things like HCV or HIV, things where molecular tests are done routinely today, but they're routinely done to diagnose versus the screen. So there might be some opportunities to do those types of things. But in general, as I said, molecular testing is a very small amount of the 530 million tests or so that we do every year. And therefore, for us, it's not going to be a significant issue. I feel very optimistic as I look at our base businesses moving forward.

This is Justin Bowers on for Pito. And nice strength across both segments this quarter. But digging into diagnostics a little more, can you give us a sense of what you saw across different regions of the country? And then as you look at your different customer base, whether it's like physician order test or reference labs, can you tell us what inform us what trends are like in the quarter there? And then lastly, where are you guys tracking now on daily PCR tests versus kind of where you exited in March?

Yes. So some of the first thing I'll answer the last question first. We exited the quarter averaging around 80,000 tests per day. We averaged for the quarter about 113,000 tests per day. So you saw a continued decline. With regard to geographical differences, weather was probably a bigger impact than other things. So when we saw the Northeast get hit by weather, there was a 2% impact. A lot of it came from where the weather was, obviously. In Texas, we saw a significant issue with what was occurring there at some point when electricity was out for a week. So it was more driven, I believe, by that than it was differences in other testing. Obviously, you're going to see some differences by geography as different parts of the country open up in different ways at different times. But frankly, you saw strength pretty much across all parts of the country when you compare it to where we were at the end of last year. Okay. So thank you, everybody, for joining us today. I'll end by saying we remain optimistic about the progress against the virus, albeit certain parts of the world continue to be impacted significantly, and our thoughts are with them as they continue to go through the devastation from the virus. But in the U.S., we are very optimistic about where we are and how things are progressing. We are very pleased to see our base businesses perform well across every single area of our business. And we're seeing that as people go back to their normal lives and their normal healthcare routines in the United States, but we're also seeing pharma and biotech colleagues begin to perform their important research and development, particularly in therapeutic areas outside of COVID. As you can see, our first quarter was very strong. It was a strong quarter of performance. I think we executed in the marketplace very well. We look forward to continuing to execute on our mission to improve health and improve lives, and we look forward to talking with you soon. Thanks for the time today.

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