Earnings Call Transcript - LH Q2 2021

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Labcorp Second Quarter 2021 Earnings Conference Call. Please be advised that today's conference is being recorded. I'd now like to hand the conference over to your host today, Chas Cook, Vice President, Investor Relations. Please go ahead.

Chas Cook, Vice President, Investor Relations

Thank you, operator. Good morning, and welcome to Labcorp's second 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.

Adam Schechter, CEO

Thank you, Chas, and good morning, everyone. It's a pleasure to be with you this morning. We remain committed to using extensive diagnostics and drug development capabilities to advance our mission of improving health and improving lives around the world. Innovation, technology, and science remain at the forefront of what we do for patients, providers, and shareholders. To that end, the second quarter of 2021 was very strong across both diagnostics and drug development. Revenue totaled $3.8 billion, a 39% increase from the same period in 2020. Most of this growth was driven by the continued strength in our base businesses. Adjusted EPS reached $6.13 versus $2.50 from the prior year. Free cash flow was $390 million in the quarter versus $272 million in 2020. The strong performance in the quarter and the improved outlook for the year resulted in us meeting full-year guidance for revenue, EPS, and cash flow. Glenn will review the new guidance with you in a moment. Our base business continues to recover and was 51% and 32% for diagnostics and drug development, respectively. The drug development trailing 12-month book-to-bill remained strong at 1.41. This performance was aided by patients and providers returning to routine healthcare checkups and pharmaceutical clients resuming their important research activities at an even faster pace than expected.

Glenn Eisenberg, CFO

Thank you, Adam. I am going to start my comments with a review of our second-quarter results, followed by a discussion of our performance in each segment and conclude with an update on our full-year guidance. Revenue for the quarter was $3.8 billion, an increase of 38.7% over last year due to organic growth of 35.5%, acquisitions of 1.2%, and favorable foreign currency translation of 200 basis points. Our organic base business increased 42.4% when compared to our base business last year, while COVID testing revenues of $444 million were flat with last year.

Operator, Operator

Our first question comes from Brian Tanquilut with Jefferies. Your line is now open.

Brian Tanquilut, Analyst

Good morning, guys. Congrats on a strong quarter. I guess my question will be about Covance. Obviously, you're seeing some good strength there and strong performance. Just wanted to hear your thoughts on how you think about the sustainability of margins and growth outlook on your ability to maintain that high pace of growth going forward for the Covance business?

Glenn Eisenberg, CFO

Hi Brian. Thanks very much for the question. Covance had a very strong quarter, and if you look at our Labcorp drug development business in total, we had progress in all parts of the drug development business. All three segments grew strong into double digits. As I look at the margins going forward, I've always said to be careful to look at any one quarter of the margin, especially as we are going through COVID. There are certain areas where we continue to maintain people, and when we maintain those people, we’re doing it because we are going through COVID and we know we're going to need them after COVID. Some of our margins look a little bit odd from quarter to quarter. We're also seeing a slight increase in material costs and labor costs, which people are seeing in almost every industry. But we're going to continue to offset that with things like our Launchpad initiatives. I'd look at the margin on a yearly basis, and we believe that this year will be better than last year, which was better than the year before. I would expect as we go into next year in our drug development business, the margins will look better than this year. We're going to continue to find ways to expand our margins moving forward.

Operator, Operator

Thank you. Our next question comes from the line of Jack Meehan with Nephron. Your line is now open.

Jack Meehan, Analyst

Wanted to focus on capital allocation, was curious if you think the strategic review is having any influence over the timing of how you redeploy capital? You have $2 billion in cash on the balance sheet, net leverage return is below the three turns you've been at historically. Within the second half acceleration, can you provide any additional color on the pacing or magnitude of what you're looking to redeploy?

Adam Schechter, CEO

Hi Jack, and I'll ask Glenn to jump in. So first of all, two separate thoughts. We continue to execute on our strategy and do our capital allocation, and we’ve always said our allocation is focused on strategic acquisitions. You saw one of those where we purchased the remaining interest in Omni this quarter. Oncology is a strategic area. We're looking for ways to enhance our strategic capabilities. We're also looking to do more hospital resolved local laboratory acquisitions, and you saw one of those this quarter, with what we announced we were doing with one of the hospitals in the Minneapolis area, Minnesota. Those are the types of acquisitions we're going to continue to pursue. What I would say is the pipeline is as robust as I've ever seen it, and frankly, I thought we would have a couple more closed this quarter, but I feel confident we'll close more as we progress through this year. Separately, distinct from that, we continue to make progress on the strategic review. Once we reach the conclusions, we'll look forward to sharing those with you, and we expect to do that in the fourth quarter of this year.

Glenn Eisenberg, CFO

Jack, the only thing I’d add is that you're right. Our targeted leverage has been at 2.5 to 3 times, and a couple of things are going on. Obviously, we have the benefit of COVID testing, which has generated and helped our free cash flow this year. But also, when you look at the improvement in our EBITDA because of COVID testing, it's higher than normal. So as you look at our leverage relative to pre-pandemic, using a profile on 2019, you'd see that our leverage is currently gross debt to EBITDA towards the upper end of our range. Having said that, as Adam commented on, we expect to use our free cash flow this year for M&A and share repurchases. The midpoint of our range is a little over $2 billion. We spent around $400 million so far in the first half of the year. So this implies that in the second half you'll see more capital allocated to both share repurchases and M&A. Our M&A pipeline is strong, which gives us a lot of confidence we'll be able to deploy more towards M&A than we've done in the first half, but we'll continue to use our share repurchase program as well.

Jack Meehan, Analyst

Great. Looking forward to the updates. Thanks.

Operator, Operator

Thank you. Our next question comes from the line of Kevin Caliendo with UBS. Your line is now open.

Kevin Caliendo, Analyst

Thanks. I want to talk a little bit about Covance. Revenues were up sequentially, yet the margins fell by about 150 basis points sequentially. Is there any seasonality there? Is there anything related to COVID that would cause that? What is the right way to think about margins for that business going forward?

Glenn Eisenberg, CFO

Yeah, Kevin, Adam actually commented a little bit in the remarks about looking quarter to quarter. Obviously, you do have issues of seasonality and just timing-related things. The comparison year-over-year gives you a pretty strong view of how our margins are doing, which again, in both businesses from a base business standpoint are up nicely. When you look at Covance though, to your point, sequentially, you move from kind of the first quarter to the second quarter and margins were down, principally related to COVID testing. The level of COVID vaccine and therapeutic studies was down compared to the first quarter. We had higher pass-throughs in the second quarter versus the first, and obviously the tight labor market also impacted it. So, a lot of things that will impact a quarter-to-quarter kind of change. What we've commented on is that the second half margins within drug development, we expect to be higher than the first half and for the full year, we expect them to be up over the prior year. So we feel good about how the business is leveraging the top line growth from the base business standpoint.

Kevin Caliendo, Analyst

Just a quick follow-up to that. How much is wage pressure impacting both segments of the businesses? How are you contemplating that within the guidance, or how impactful has that been to your guidance so far?

Glenn Eisenberg, CFO

Of course, we look at that closely. We've included what we think is the range of potential things that could occur within the guidance we provided today. I think everybody's facing a tough labor market in most industries as we speak. We're just going to have to continue to find ways through Launchpad and other strategies to reduce costs to cover that in the future. So we'll continue to find ways to take out costs in other areas, through virtual clinical trials and similar initiatives.

Operator, Operator

Thank you. Our next question comes from the line of Ricky Goldwasser with Morgan Stanley. Your line is now open.

Ricky Goldwasser, Analyst

Yeah. Hi, good morning. So, a couple of questions here. First of all, when we think about the comparison for the base business for core testing versus 2019, I believe you said it was up in the second quarter was up 4.5% versus the 2Q baseline. Can you provide a little bit more detail on how it progressed on a monthly basis and what you're seeing in the July run rate, and what's embedded into second-half guidance? Then secondly, you talked about the increase in labor costs and often with Launchpad, any updates on what's going to affect Launchpad? I believe Launchpad ends in 2021. What are your plans for the next round of cost savings?

Glenn Eisenberg, CFO

Yeah. So let me start Ricky with the base business. The diagnostics business saw the base business rebound nicely. One thing is to look at revenue, which is what you stated, but the other thing is to look at volume. For the first time since the pandemic, we saw the volume increase in June of this year compared to June of 2019. So that's a good sign and shows continued recovery. As we look at July, it's still too early to provide any sense of that. But our expectation throughout this year is that we will see continued volume and revenue growth versus 2019 and that will continue throughout this year.

Adam Schechter, CEO

And Ricky, maybe just a couple of follow-on comments. As Adam said, we crossed over where our revenue and diagnostic base business in the fourth quarter of last year was favorable to 2019 levels, but that was driven off of the price mix. We were seeing more tests per session that were making up for the volume shortfall. So June was a signal month for us, if you will, as we now have crossed over with volume comparing favorably as well as price mix continuing to be higher than normal. As we progress through the rest of this year and obviously going forward, we expect those to align more with the historical patterns. As for your comment on Launchpad, with the tight labor market in particular, both businesses have Launchpad initiatives. We completed drug development one publicly last year, and this year we'll wrap up our diagnostics initiative. That's part of an ongoing business process improvement initiative for the company every single year. We know we have just high inflationary costs as we enter every year, and Launchpad is really set to offset those rising costs. So we continue to see a lot of opportunities to drive productivity through technology and labor efficiency, which will help mitigate those costs going forward.

Operator, Operator

Thank you. Our next question comes from the line of Ralph Giacobbe with Citi. Your line is now open.

Ralph Giacobbe, Analyst

Thanks. Good morning. Certainly understand the fluidity of the backdrop; the guidance is pretty wide for having seen the first half. Why keep it so wide? Can you help with assumptions, particularly on the lower end that seem pretty hard to get to? Additionally, I think you mentioned the average number of COVID tests per day in the second quarter was 54,000. Can you share what the midpoint of guidance assumes for the back half in terms of average tests per day on COVID? Thanks.

Adam Schechter, CEO

Yeah, I'll start with the test question, and we can provide some context on the ranges. The average number of tests per day in the second quarter was 54,000. If you look at the month of June, it actually was lower than that average of 54,000. If you had just trended based on the June data, you would have been in the 35% to 50% reduction we had quoted earlier. We saw a slight change with the Delta variant, and we also saw the extension of the government saying that we will continue to be in an emergency situation. These two factors gave us confidence that the reduction in COVID tests would be less than what we originally planned. That's why we narrowed the guidance for COVID testing to 33% down to 38% down. We really did narrow that and provide some additional guidance there. If you look at these numbers, I know it's still a fairly wide range, going from 33% to 38%, but there are many different ways that you can actually get there based on various scenarios including the number of tests and pricing.

Glenn Eisenberg, CFO

Yeah, Ralph, I guess I would add that our ranges are wider than they would typically be in a normal year; this simply reflects the lack of visibility and uncertainty ahead of us. Having said that, with the new guidance that we provided, we've narrowed the range and increased the midpoint of all the key financial metrics that we guide to, reflecting the company's performance. When you look at the midpoint of a range, that's where we anticipate things to trend, but we provide the ranges around it because many factors could occur on both the positive and negative sides overall. As Adam said, regarding COVID testing, again, we narrowed the range and improved it. We noted for the first time, we witnessed a sequential decline in COVID testing each month. As Adam stated, June was lower than the average of the quarter, while July was the first month that we've seen the level of COVID testing higher than the prior month, indicating positivity around our COVID testing outlook.

Ralph Giacobbe, Analyst

Okay. That's helpful. Thank you.

Operator, Operator

Thank you. Our next question comes from the line of Pito Chickering with Deutsche Bank. Your line is now open.

Justin Bowers, Analyst

Hey, good morning, everyone. This is Justin Bowers on behalf of Pito. Just shifting back to the diagnostics business. How should we think about 3Q versus 4Q and the base business? It sounds like you're back to at or above pre-COVID volumes, but does the guide assume normal historic seasonality patterns or something different? We're hearing diversion messaging from hospitals and med tech companies; trying to get a sense of where you guys stand on that.

Adam Schechter, CEO

No, I think from our standpoint, and why we focus on the 2019 comparison to get close to normalcy, we're still seeing a strong recovery as we compare to 2020. But similarly, when we look at comparisons relative to last year, we saw the trough early in the pandemic, and then it improved throughout the year. We continue to expect to see good growth and favorable margins year on year compared to 2020. Diagnostics has seasonality to the business. Therefore, as you look sequentially, you need to take into account holidays and where the days lay. But our expectation is that normal seasonal patterns will occur within diagnostics, leading to positive growth expectations for the second half.

Operator, Operator

Thank you. Our next question comes from the line of Tycho Peterson with JPMorgan. Your line is now open.

Tycho Peterson, Analyst

Hey, thanks. A couple of follow-ups on the COVID outlook specifically. Are you able to quantify where you ended July on tests per day? I'm curious what that step up looks like. Secondly, does the outlook include any back-to-school testing discussions around larger programs? Lastly, curious about serology; what are your latest thoughts there, given the discussions around potential wearing off for vaccinations? How are you incorporating that into your back half expectations?

Adam Schechter, CEO

Thank you for the questions. All are important as we progress through the year. On serology, we currently have the ability to do as many serology tests as necessary. The CDC has not recommended utilizing serology to understand titers, so currently there are not many requests for this test. We can perform several thousand per day and are prepared to ramp up capacity as needed. Personally, I believe serology testing will become more critical if vaccinations are less frequent than once a year. Regarding back-to-school testing, we're discussing potential programs but haven't seen many schools ready to launch significant back-to-school testing initiatives. We have to be cautious about the competitive dynamics here.

Operator, Operator

Thank you. Our next question comes from the line of Derik De Bruin with Bank of America. Your line is now open.

Derik De Bruin, Analyst

Hi, good morning. It's tough enough to predict the second half of 2021, let alone looking at 2022. I was wondering your initial thoughts on where consensus estimates are. If we consider earnings and you grow EPS by 10% off of your 2019 base, that gives you around $15 for 2022, with the street at around $16. Are you comfortable with where consensus estimates are now? Any preliminary thoughts on 2022?

Adam Schechter, CEO

The first thing I'd say is we're still working through 2021. We're not providing guidance for 2022 right now, but the reason we're trying to break out our base business versus COVID testing is to provide clarity for 2021. We expect the base business to return to normal growth rates seen prior to the pandemic. The primary uncertainty remains around COVID testing as we approach 2022.

Derik De Bruin, Analyst

Great. A follow-up on your oncology testing—how is that segment performing? Is it responding as you expect?

Adam Schechter, CEO

The esoteric testing, including oncology, experienced a smaller decline than other routine testing at the beginning of the pandemic. Today, both segments are rebounding to expected levels. Currently, the split of our business revenue is about 60% routine testing and 40% esoteric, including oncology, both of which are coming back strong.

Operator, Operator

Thank you. Our next question comes from the line of Matt Larew with William Blair. Your line is now open.

Matt Larew, Analyst

Hi, good morning. You mentioned that test book sessions were a driver. Can you help me understand how this trended sequentially? You previously indicated that it was a driver in Q1. I’m looking to understand if things are normalizing or if there's still a patient catch-up effect happening as patients visit physicians for the first time.

Adam Schechter, CEO

I'll let Glenn provide specifics, but generally, we expect tests per session to normalize back to pre-COVID levels over time. We’re already starting to see some of that. Glenn, any additional context?

Glenn Eisenberg, CFO

Yeah, that's right. Sequentially, the test per session impact was less than in the first quarter, but naturally, the volume levels in the second quarter were much higher than the first quarter. You will ultimately see us get back to that more normalized state over time.

Operator, Operator

Thank you. Our next question comes from the line of Aaron Wright with Credit Suisse. Your line is now open.

Aaron Wright, Analyst

Great. Can you discuss what you're seeing in terms of the industry fundamentals across the Covance clinical business in terms of site accessibility, RFP flow, and the nature of new business wins in the quarter? What portion of this work remains COVID-related? Also, are you seeing any partial offset from disruptions associated with consolidation across your peers?

Adam Schechter, CEO

Sure. To provide some context, about 80% of sites are currently open. We expect this percentage to continue improving throughout the year. I anticipated some further progress than we're currently seeing, but the RFP flow is robust, and we have a strong likelihood of winning many of those opportunities. We’re pleased with our trailing 12-month book-to-bill of 1.41, and our backlog was $14.3 billion, an increase of $300 million from the first quarter, which also represents a 21% year-over-year increase. Our trailing 12-month net orders have increased almost 30% year-over-year. As for COVID orders, it’s a relatively minor part—less than 3% of our backlog and about 7.5% of our net orders over the past four quarters.

Aaron Wright, Analyst

Great, and one quick follow-up on the PLN in preferred lab networks. Can you provide an update on how that's helping steer lab volume?

Adam Schechter, CEO

We've been added to the PLN for the third consecutive year. Unfortunately, with COVID, there's not been significant progress in appeal. However, I believe this is a necessary move, and I remain confident in its eventual impact. I will provide updates when they're meaningful.

Operator, Operator

Thank you. Our last question comes from the line of Ann Hynes with Mizuho. Your line is now open.

Ann Hynes, Analyst

Great. Can you provide details on revenue per test for PCR testing and serology? Additionally, there’s speculation that the public health emergency might extend into 2022. If so, do you think labs could maintain elevated COVID pricing?

Adam Schechter, CEO

Certainly. For our domestic PCR testing, the price is still in the high eighties, just below $90. We continue to maintain this robust pricing. If the emergency extends into the next year, it may support pricing over that period. However, pricing continues to face pressure. We have consistent discussions with payers, but having an emergency declaration aids in maintaining pricing. Interestingly, despite the total number of tests declining in the second quarter, our capacity remained intact, allowing us to respond quickly to spikes in demand due to the Delta variant.

Ann Hynes, Analyst

Just one follow-up. For back-to-school opportunities, if they materialize, can you provide a revenue per test model for surveillance tests?

Adam Schechter, CEO

It depends. If it’s a pooled test, you could put 10 individuals into one test, which would vary the pricing approach based on the type of testing being utilized. Surveillance tests typically hold lower pricing than tests for individuals who are symptomatic or have been exposed. I want to thank everybody for joining us this morning and spending time with us. It's clear that the second quarter was a very strong one across the enterprise, and that enabled us to increase our full-year guidance. I thank all of our dedicated employees around the world for their tireless efforts; they truly demonstrate our mission to improve health and improve lives. As the Delta variant progresses and other variants emerge, I encourage everyone to get vaccinated if you're eligible. Let's remain vigilant as we navigate the pandemic together. I look forward to speaking with you again soon, and wish everyone a great day. Thank you.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.