Labcorp Holdings Inc. — 2024 Q1

Yes, Jack, so they're strong assets. And we've always said that oncology is one of our core therapeutic areas, and they have a very big hereditary oncology business, much bigger than the business that we have in that area. So it certainly augments what we're doing and it accelerates it in a fairly significant way. They also have quite a bit of rare disease work that they've done, and that augments our focus on specialty testing.

Yes, Jack. So again, as Adam commented, we're very excited about the acquisition. And frankly, going out of acquiring the select assets through bankruptcy from a purchase price, obviously, relative to other deals that we see of similar focus in our therapeutic areas is quite attractive. As we think about long-term value creation, you heard in the opening comments that we expect this to exceed our cost of capital in year 3 and have a very attractive overall return on our investment.

When we talk about the 3 acquisitions that we announced in the quarter, that's adding obviously to the change in the guidance we did for diagnostics. So when you look at the change, just use the midpoint of our guidance, it improved 140 basis points, I assume roughly half of that is from those 3 acquisitions.

Yes. So I'll start overall and then I'll answer early development specifically, Erin. So overall, Biopharma Laboratory Services grew 8% and Central Labs had very strong growth at 13%. Now realizing Central Labs had a relatively easy compare versus first quarter of last year. You probably remember in first quarter of last year, there were a lot of personnel issues at investigator sites. If you look at the ED growth, it's coming back slower than we anticipated, but it's being offset by the strength in our Central Lab business.

Sure. So I'll start with the book-to-bill. So the book-to-bill was 1.0 that's lower than we would typically like. However, we've got insight to the book-to-bill for second quarter already and insight to the rest of the year. And I expect the book-to-bill to continue to grow starting next quarter throughout the rest of the year. The health of the book-to-bill still looks good across the business. It's an early development part of the book-to-bill, which frankly, is a little bit less relevant because early development, a lot of the studies start in the year and finish in the year. Typically with the book-to-bill, you look for things that go more than a year or over time.

Yes. The only thing I'd add too, Patrick, is when you put the size of the business in perspective, obviously, it's less than 10% of the company. But even within Biopharma you have 2/3 of the segment, let's say, Central Labs. And that's really where the backlog, if you will, the book-to-bill is probably more applicable because the backlog that we have in Central Lab is effectively supporting most of the revenues over the next 12 months. So to your point on visibility with early development, we have less visibility because it's a much lower percentage of the backlog with that business and much shorter lead times. So it just puts in a little bit more volatility, if you will.

So Michael, this is Glenn. When you look at the guidance that we've given, and we always kind of say the midpoint of the range is what our expectation is, and then there's always going to be pluses and minuses, which is why we put a range. So at the midpoint of our guidance, the answer is Invitae is not in those numbers.

Yes. So overall, we normally talk about our growth weighted to volume versus price mix and kind of 3:1 ratio, if you will. Obviously, it was a little different during the quarter, but strength, frankly, on both volume and on price mix. The price/mix frankly is mix related. We would normally say unit price is relatively flat. But the improvement that we saw in the quarter from a mix standpoint was the live management agreements, was the -- our test per session.

Yes. So and I'll give you -- broadly speaking, and then maybe Glenn can add some details. But broadly speaking, if you look at the hospital deals that we're doing, there's a significant number of them that we had last year, at the end of the quarter, going into this year. And when you do those, those are, by definition, getting some market share. And then when you think about what's happening in the marketplace around those hospitals, you expect that you'll pick up some market share there as well.

Yes. No, the only thing I'd add is just that we had a good quarter, and we took our full year outlook up to reflecting the stronger demand than we've been seeing. We also look back to pre-pandemic, and we're tracking well within the range that we would normally expect to be. So some of the year-over-year improvement arguably has driven a bit about and not fully recovered year -- the prior year. But to see that kind of growth, we feel very good about and expect that to continue.

Yes. So the first thing I'd say is that the LabCorp was supportive of the Valid Act, which we thought was the right way to provide oversight of the FDA of LDTs. It was legislation that was fit for purpose for our industry. We're not supportive of the current rule, although we haven't seen the final rule. We still have to see that in a whole judgment until we see exactly what's in there. What I worry about most -- and we have great quality organization. We have terrific scientists, and we do so many -- so much research and need to [indiscernible] marketplace. What I worry about is speed to market of LDTs. And patients that need these LDTs, they're typically smaller groups of patients. Other people aren't necessarily developing tests for them and they need to test as quickly as possible.

Yes. So we've gotten quite good at being able to efficiently and effectively run the lab management agreements that we have. When you do 100 hospitals with one organization quickly, you become an expert pretty fast. So what I would say is we take our time because the most important thing is to ensure that there's no patient disruption. The second thing is to make sure that the physicians are very satisfied with the way in which they can order and the speed in which they get their results. And then over time, we find ways to use our size, our scale and our ability to synergize to reduce cost. And we've learned that the most important thing is to do it really well. And although the margins never get to our average margins, they start off low and they increase over time. I think you've seen with the announcement of several deals closing in the first quarter, multiple deals closing at the end of last year. There's a slight impact on our margin in the beginning. But over time, the margin is going to improve. And that's why we believe our Diagnostics margin will increase when you look at the totality of '24 versus '23.

Yes. So what I would say is that there's no longer a supply issue with NHP. The only thing that we're seeing with NHP is a bit of a revenue drag because the cost of NHPs when there was a supply issue were much higher. We were charging the higher price, but we weren't making a margin on that higher price. So now that the prices have come down, the actual revenue for those studies come down with the price. So you're seeing less revenue growth in that area, which I would say is probably a bit artificial because of the price of the NHPs coming down.

Yes. I would say that dynamics in the non-NHP portion you're seeing growth rates that would be a bit higher than the NHP. But again, that's more -- they're both less than what we have seen historically because of what's happening in the biotech world. We are beginning to see signs of recovery in the biotech world. So both of those parts of the business should recover over time.

Kevin, we can't hear you. You're breaking up pretty significantly.

No.

Yes. Are you talking margins in CLS or Diagnostics? I couldn't tell.

Okay, in Diagnostics. What I would say is that if you look at the Diagnostics business, the business performed very well. We had basically 7% growth in the Base Business and volume was good at almost 5%. The margin was down versus prior year was driven by three things. It was driven by COVID. There was some impact from weather. And as I previously mentioned, there was some impact from the lab management agreements as we begin to roll those out in the fourth quarter of last year, so in the first quarter, we'll see the margins get better as we go through the year. Overall, we expect the diagnostic margins in '24 to be higher than the margins in '23.

Yes. The only thing I'd add too is, as Adam said, margins up even despite COVID and weather and lab management agreements for the full year margins to be up slightly but also to see that expected beginning in the second quarter where you'll see nice growth year-over-year. We'll have the normal seasonality. So when you look at the absolute margins, they'll fluctuate based on seasonality, but the year-over-year improvement, you'll see pick up nicely beginning in the second quarter that gives us the confidence that the margins will be up for the full year.

Yes. So the first thing I would say is as we look at the businesses, they're both strong right now are routine testing as well as our specialty testing. We are seeing the specialty testing grow at a slightly accelerated rate versus the routine testing, but routine testing is still the vast majority of the business that we do. A big part of the reason that specialty testing is important is, number one, they're typically very serious diseases. Number two, when people get specialty testing, they get a lot of routine tests around those specialty tests as well.

Yes. What I would say right now, it's not a large part of our business. It's a very small part of our business. But it's an important part because there are new therapies that we believe will become available over time, it's such an important disease and it's growing in the United States and around the world. So we want to have the broadest portfolio for physicians to use to help with the diagnosis and monitoring of Alzheimer's patients. But once again, many of those patients not only need these Alzheimer's tests, but they'll use a lot of routine tests as they learn to diagnose these patients and monitor them over time.

Yes. Eric, with regard to NHP pricing, we've not given what the step down in the pricing has been. And obviously, it impacts the mix and where we get the [ primates ] from and where they're used in the studies. What we've commented is that it's been a nice reduction in the price from when we were capacity constrained and obviously, the prices were significantly higher. And I think Adam referenced this earlier as well that from our perspective, while it impacts our revenues, it's really not impacting our profitability because most of the step down in the price of NHPs were pass-through. So the positive is it shows us a lower cost for our customers to get their studies done. So they're seeing the benefit of it without a negative impact from us overall. To your point, roughly half of the studies that we do are in HP based with the other half that are not, that mix really hasn't changed very much.

Yes. I'll let Glenn answer that question, Eric, but before you guys, I think it's important to note that no two hospital deals are exactly the same, and it really it's three pieces to them, right? There's a lab management part where you run a hospital's labs. There's the outreach business and there's the referral business. Ascension was kind of an outlier to most of the deals that we do because so much of it was the lab management part of the business, and that has by far the lowest margin that starts out low and improves over time. Most of the deals that we do, they start out with a lower margin. But overall, with the kind of portfolio of the three types of business, they get to about or average margins over time. So that's the typical deal. Ascension is a bit of an outlier, but maybe you can talk about Ascension, Glenn.

Yes. No. I think that's right, especially given the size of the transaction overall, let alone the percentage that was live management. But we normally, and Ascension was a good example. Let's say, would be starting a mid-single-digit kind of margin, obviously, mixing us down that we've talked about. And then we normally see the margin step up over the years with that one, while we expect to see a step up, probably not as strong in just the second year of ownership as relative to others is we continue to share on a value basis, if you will, some of the synergies and the savings that we get, we're obviously passing on to that our large partner there and thereafter starting to see the step up. So positive direction, but we'll see more of an incremental improvement next year.

And the revenue for that looks very strong. It's slightly above what we had guided to originally.

This is John Kim on for Mike. So you've done a lot of deals. You have Invitae, BioReference and the 3 health system agreements that you closed in the first quarter. And Glenn, you talked about how, given the range that Invitae would be included in the top end of the guidance. So could you just update us on your thoughts on the deal funnel and your capital allocation priority, are there any other larger deals, independent labs or health systems that are still coming our way?

Yes. So when you think about -- to your point, the transactions that we've done this year and as we commented, embedded in our guidance is the assumption that we'll use our free cash flow for acquisitions, dividends and share repurchases. We have been -- this has been a good year for M&A. We've always talked about that we've had a strong pipeline of deals, and we're seeing them come to fruition this year.

Got it. I appreciate that. And if I could ask one on the Biopharma early development. So you talked about the cancellations coming down still a little high. But I wanted to ask, you previously talked about targeting perhaps medium-sized clients. Any -- has there been any shift or your win rates are good and at least in the Central Labs, has there been any shift in that direction in terms of garnering attention or RFP from the medium-size clients?

Yes. So we're trying to improve our mix to more larger to medium-sized clients. It takes some time because many of those clients have master service agreements and you have to wait for us to expire or find ways to be part of those. But over time, I'm confident that we'll continue to shift the mix more towards the medium to larger size pharma.

Yes. No, it's a good question, Brian. And it's good news that the systems are doing better and that the hospitals are performing better. I think that's good for all of health care, frankly. So I'm pleased that they are beginning to rebound and do better. The interesting thing was before the issues with the health systems, a lot of the discussion was can you do it and can you do it well? And should we take the risk that things aren't going to go well.

You've got Kieran Ryan on for Pito. I noticed you didn't touch on waiver when discussing the diagnostic margin drivers. I think one of your peers cited some modest improvement in the environment. So can you just give us an update on what you're seeing on labor as it relates to things like wage growth and turnover?

Yes. So I'll start with turnover. And I'll give a sense, overall, across LabCorp, our turnover is better now than it was last year or the year before that. In our Biopharma business, I'd say it's back to pre-COVID levels, maybe even a little bit better. So the turnover there has really improved. In our Diagnostics, we see in certain areas, there's still a higher turnover than what we would have seen prior to the pandemic, particularly in frontline employees, where they have not only other choices in health care, but in other industries. But even there, we start to see less turnover than what we've seen in the past. There's been a significant inflation of cost due to retaining employees in the past as we go forward, I think it will move back more towards the level of inflation of about 3% or so.

Got it. And then just a quick follow-up. The prior question was kind of talking about the strong demand that hospitals and some providers you're seeing now. I was just wondering, does the top line guide in Diagnostics at all contemplate a normalization in kind of broader utilization? Or are you just really not seeing anything outside of what you'd expect at this point?

Yes. I would say that we're seeing what we would expect at this point is slightly higher, we give a range because there's a range of different things that may or may not occur. But overall, we think that the environment is healthy.

Yes. When you look at the -- also, I guess, our implied guidance, so you're looking at a stronger top line growth than what we did in the first quarter with our guidance, but that's just really driven off of COVID becoming less of an issue. It was a bigger issue in the first quarter decline year-on-year, plus that's where we had the adverse impact from weather. So really when you adjust for that, as Adam's commented, the demand that we're seeing, which is came in a little bit stronger than we expected. We expect that to be similar demand going forward throughout the rest of the year.

Yes. So as I think about the early development business, I don't think that it's a share shifting. I think our share is remaining consistent within the parts of the market that we compete, we don't compete in all aspects of our -- we don't have a contract manufacturing organization, for example. But in the areas that we compete. Our win rates look good, our RFPs look good. So I believe that our market share is being maintained. I think we're seeing more that there's still a higher level of cancellations than what we've seen in the past. And in some instances, it's taking a bit longer for the companies to make their final decisions because they're still managing what I would say is a rather restricted budget even with the funding being better than it has been before.

I want to thank you all for joining us today. And hopefully, you can see we continue to advance our strategy and make significant progress, and we're going to continue our mission to improve health and improve lives around the world. Hope everybody has a good day.