Laboratory Corporation of America Holdings (NYSE:LH) Q2 2023 Earnings Call Transcript

Laboratory Corporation of America Holdings (NYSE:LH) Q2 2023 Earnings Call Transcript July 27, 2023

Laboratory Corporation of America Holdings beats earnings expectations. Reported EPS is $4.96, expectations were $3.47.

Operator: Good day. And thank you for standing by. Welcome to the Labcorp’s Second Quarter 2023 Earnings Conference Call. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to Chas Cook, Vice President of Investor Relations. Please go ahead.

Chas Cook: Thank you, operator. Good morning, and welcome to Labcorp’s Second Quarter 2020 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. This morning, in the Investor Relations section of our website at www.labcorp.com, we posted both our press release and an Investor Relations presentation with additional information on our business and operations, which include a reconciliation of the non-GAAP financial measures to the GAAP financial measures discussed during today’s call. Additionally, we are making forward-looking statements.

These forward-looking statements include, but are not limited to, statements with respect to the estimated 2023 guidance and the related assumptions, the impact of various factors on the company’s businesses, operating and financial results, cash flows and/or financial condition, including the spin-off of Fortrea and its treatment as discontinued operations and general economic and market conditions, future business strategies, expected savings and synergies, including from the LaunchPad initiative, acquisitions and other transactions and opportunities for future growth. Each of the forward-looking statements are subject to change based upon various factors, many of which are beyond our control. More information is included in our recent annual report on Form 10-K and subsequent quarterly reports on Form 10-Q and in the company’s other filings with the SEC.

We have no obligation to provide any updates to these forward-looking statements even if our expectations change. Now I’ll turn the call over to Adam.

Adam Schechter: Thank you, Chas. Good morning, everyone. Before I cover our second quarter results, I want to first thank Chas for his leadership in Investor Relations over the last several years. Chas will be moving into the role of Vice President of Financial Planning and Analysis effective in August. I also want to take this opportunity to welcome Kristin O’Donnell, an accomplished leader in our finance organization, who has been appointed to Vice President of Investor Relations. Both Chas and Kristin will be in attendance at our upcoming Investor Day on September 14, and we look forward to seeing many of you in person. Beginning this quarter, Labcorp is reporting results without the inclusion of Fortrea, which is now an independent, publicly held company as a result of our successful spin on June 30.

Moving forward, we’ll report our laboratory services business under two segments, LabCorp Diagnostics Laboratories and Labcorp biopharma laboratory services. Biopharma laboratory services consists of two businesses: our Central Laboratories business, which represents about 70% of segment revenue and Early Development Research Laboratories, which although smaller, is also a leader in the market. In the second quarter, Labcorp delivered exceptional year-over-year growth in our Diagnostics Laboratories base business and generated strong growth in Central Laboratories. Early Development Research Laboratories continue to be constrained by industry-related supply chain issues that we expect to be resolved in the third quarter. We entered the second half of the year with clear operational focus and enhanced financial flexibility to advance our strategy.

We see strong momentum in the base business and are excited about the growth opportunities before us. Now let’s discuss our second quarter performance. In the quarter, revenue totaled $3 billion, adjusted earnings per share was $3.42, and free cash flow from continuing operations was $177 million. Our business is performing well with overall revenue increasing 4% compared to prior year. Base business revenue grew 13% to prior year. Diagnostics Laboratories’ base business revenue grew 16%, driven by both strong base business volume and Ascension. For Biopharma Laboratory Services, Second quarter revenue grew 3%, driven by Central Laboratories business, which grew 9%, partially offset by Early Development Research Laboratories, which was down 7% due to NHP supply constraints.

We expect Early Development Research Laboratories to grow in the second half of the year versus prior year, and we do not expect impact from NHP supply constraints for the rest of the year. Enterprise base business margin was slightly down compared to the prior year due to the impact of Ascension, which we discussed previously. Diagnostic Laboratories base business margin increased versus prior year if you exclude Ascension. And Biopharma Laboratory Services margins expanded, benefiting from Central Laboratory strong volume increases. Glenn will provide more detail on our quarterly results as well as our updated 2023 outlook in just a moment. As we mentioned at the top of the call, we completed the spin of Fortrea business on June 30. We I want to thank both the Labcorp and Fortrea teams for their tireless efforts in achieving this milestone that positions us to better meet customer needs and delivers immediate value to our shareholders.

We announced that we’ll begin an accelerated $1 billion share repurchase program. We’ll pay off $300 million in maturing debt and we’ll utilize the remainder of the $1.6 billion dividend to Labcorp from Fortrea to be returned to shareholders through additional future share purchases and/or cash dividends. The completion of the spin brings the growth opportunities of our laboratory businesses into full focus. We are poised to leverage our deep science, technology and innovative laboratory network to drive growth, and to deliver superior solutions to our customers. We are also in a very strong position operationally to advance our laboratory business. Here are several recent examples where we progressed our enterprise strategy in the second quarter.

We continue to drive growth through health care system partnerships. Earlier this month, we finalized our strategic relationship with Jefferson Health, one of the largest health systems serving the Greater Philadelphia area in Southern New Jersey. This new collaboration will focus on future research and innovations to improve health outcomes. In May, we announced the next step in our long-standing relationship with Providence Health and Services to acquire its outreach laboratory business and select assets in Oregon. This transaction builds on our more than 20-year history with the Providence family of organizations. Finally, earlier in July, we announced a comprehensive lab relationship with Legacy Health in Portland, Oregon. Under this agreement, Labcorp will acquire select assets of its outreach laboratory business, including laboratory facilities and equipment and manage Legacy’s inpatient hospital laboratories.

These relationships create immediate value for hospital systems for patients, for communities, while also providing significant growth opportunities for Labcorp. The partnerships meet our criteria of being accretive to earnings and cash in the first year. Although the margins are typically lower than the company average early on, they do improve over time. We are also pleased with our progress integrating hospital partnerships and acquisitions. For example, with Ascension, which we announced in 2022, we continue to see reduced employee turnover and improved performance due to our partnership. This scalable model connects our two mission-driven organizations to provide care teams with information to make the best possible decisions for patients.

We continue to look for regional laboratory acquisitions in geographies where we can increase access to diagnostics and expand capabilities. As an example, this week, we completed our acquisition of certain assets of Enzo Biochem’s Clinical Laboratory division in New Jersey, which serves the New York tristate health care communities. We have a very robust pipeline of potential hospital and local laboratory acquisitions and we’ll continue to focus energy and resources on this important opportunity for growth. Additionally, we’re investing in innovation and technology that supports diagnostic and drug development testing across disease areas, including cancer, Alzheimer’s and other diseases. In May, we commercially launched a new liquid biopsy test, enabling target therapy selection for patients with advanced or metastatic solid tumors.

The Labcorp Plasma Focus test allows oncologists to better evaluate tumor cells and manage the care of patients through a precision therapy plan. Additionally, our portfolio of kits [ph] solutions from the acquisition of PGDx is gaining momentum with major health systems and academic centers. Our solutions can enable operational and financial efficiencies that are making us a key partner for hospital and health systems as they execute on their precision medicine programs. Recently, we were first laboratory to launch a test for pTau-181 in plasma, an important blood test for potential Alzheimer’s patients demonstrating symptoms of dementia. Our teams are at the forefront of Alzheimer’s testing as the number of people impacted by this disease is expected to double over the next two decades.

In April, we broke ground on the expansion project of our new Central Laboratory facility in Japan. When complete at the end of 2024, the facility will enhance our Central Laboratory testing capabilities to support drug development. We also opened two new facilities in China, a new kit production facility in Suzhou and an immunology and immunotoxicology lab in Shanghai. In addition, we delivered impactful digital solutions to help our customers understand, manage and improve their health. As part of our commitment to improving the customer experience, we launched an advanced e-commerce platform to improve consumer engagement with Labcorp. The platform will support all of our businesses including Labcorp on demand, which offers consumers access to many of Labcorp’s innovative tests online nationwide.

Lastly, I speak on behalf of the entire management team, when I say that we are excited about our upcoming Investor Day on September 14 in New York City. This event will highlight our go-forward strategy, offer business overviews and provide a longer-term financial outlook. We have a value creation road map that we are excited to share. Today marks a new chapter in our company’s history. We have a team of more than 60,000 global employees with united focus. Labcorp’s base business is performing very well. We’re executing on our growth strategy, and we’re leveraging Labcorp’s financial strength as well as operational focus to improve health, to improve lives while also increasing shareholder value. With that, I’ll turn the call over to Glenn.

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Glenn Eisenberg: Thank you, Adam. I’m 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. For reference, we’ve also included additional business information that can be found in our supplemental deck on our Investor Relations website. With the spin completed on June 30, we have treated Fortrea as discontinued operations in the second quarter. All of my comments will reflect the current business and have been adjusted to exclude Fortrea in prior periods for comparative purposes. Revenue for the quarter was $3 billion, an increase of 3.8% compared to last year, primarily due to organic base business growth and the impact from acquisitions, partially offset by lower COVID testing.

The base business grew 12.7% compared to the base business last year, while COVID testing revenue was down 88% and as we performed an average of 3,000 PCR tests per day in the quarter. Organically, in constant currency, the base business grew 10.8% and benefiting from the Ascension lab management agreement, which contributed approximately 5% of the organic growth. As a reminder, the outreach business that we acquired from Ascension is treated as an acquisition, while the lab management agreement is treated as organic growth. Operating income for the quarter was $266 million or 8.8% of revenue. During the quarter, we had $52 million of amortization and $131 million of restructuring charges and special items, primarily related to the spin of Fortrea acquisitions and LaunchPad initiatives.

Excluding these items, adjusted operating income in the quarter was $448 million or 14.8% of revenue compared to $548 million or 18.7% last year. The decrease in adjusted operating income was due to lower COVID testing. The margin decline was also negatively affected by the mix impact from the Ascension lab management agreement. Excluding these items, margins would have been up slightly as the benefit of demand and LaunchPad savings were partially offset by higher personnel expense and increased R&D investments in oncology. Our LaunchPad initiatives continues to be on track to deliver $350 million of savings over the three-year period ending 2024. In addition, the company is implementing actions in the third quarter to take out $25 million of annualized stranded costs throughout the enterprise as a result of the spin.

The tax rate for the quarter was 24.3%, the adjusted tax rate for the quarter was 23.9% compared to 25.3% last year. The lower adjusted rate was primarily due to R&D tax credits. We continue to expect our full year adjusted tax rate to be approximately 24%. Net earnings for the quarter from continuing operations were $155 million or $1.74 per diluted share. Adjusted EPS were $3.42 in the quarter, down 15% from last year due to lower COVID testing earnings as base business adjusted EPS was up approximately 18%. Operating cash flow from continuing operations was $280 million in the quarter, which was burdened by approximately $65 million of spin-related items. Operating cash flow of $280 million is down from $548 million a year ago, primarily due to lower COVID testing earnings and spin-related items.

In addition, higher working capital requirements that are timing related were partially offset by higher base business earnings. Capital expenditures totaled $103 million, down from $140 million last year. For the full year, we continue to expect that capital expenditures will be approximately 3.5% of base business revenue. Free cash flow from continuing operations for the quarter was $177 million, including approximately $65 million of spin-related items. The company invested $137 million in acquisitions and paid out $65 million in dividends. While the company did not repurchase shares in the second quarter, we announced a $1 billion accelerated share repurchase program that we expect to put in place in the third quarter and be completed by year end.

At quarter end, we had $1.9 billion in cash, including the $1.6 billion dividend from Fortrea spin, while debt was $5.3 billion. Our leverage was 2.6 times gross debt to trailing 12 months adjusted EBITDA. Now I’ll review our segment performance, beginning with Diagnostics Laboratories. Revenue for the quarter was $2.3 billion, an increase of 3.8% compared to last year, driven primarily by organic growth of 1.8% and acquisitions of 2.2%. The base business grew organically by 13.5% compared to the base business last year, while COVID testing revenue was down 88%. The Ascension lab management agreement contributed approximately 7% of the growth. Total volume increased 1.4% compared to last year as acquisition volume grew 2.5%, partially offset by organic volume of minus 1.1% due to COVID testing.

Base business volume grew 8.1% compared to the base business last year, including the benefit from acquisitions of 2.7%. The strong year-over-year growth rate was also aided by lower-than-normal volume in the second quarter of 2022 due to Omicron. Price/mix increased 2.4% versus last year, primarily due to organic base business growth of 6.8%, partially offset by lower code testing of 3.9%. Base business organic price/mix was up 8% compared to base business last year, benefiting from the Ascension lab management agreement of approximately 7%. Diagnostics Laboratories adjusted operating income for the quarter was $410 million or 17.5% of revenue compared to $516 million or 22.9% last year. The decrease in adjusted operating income was due to lower COVID testing, while the margin decline was also negatively impacted by the mix impact from Ascension.

Base business margin, excluding the mix impact of Ascension was up approximately 40 basis points as the benefit of organic growth and LaunchPad savings were partially offset by higher personnel expense. Now I’ll review our segment performance of Biopharma Laboratory Services. Revenue for the quarter was $699 million, an increase of 3.1% compared to last year, primarily due to an increase in organic revenue of 2.1% and foreign currency of 1.5%. The increase in organic revenue was negatively impacted by approximately 5% due to the previously communicated NHP related supply constraints in our Early Development Research Laboratories business. Adjusted operating income for the segment was $105 million or 15% of revenue compared to $93 million or 13.7% last year.

The increase in adjusted operating income and margin was due to organic demand and LaunchPad savings, partially offset by higher personnel expense. We ended the quarter with backlog of $8 billion, and we expect approximately $2.5 billion of this backlog to convert into revenue over the next 12 months. Now I’ll discuss our 2023 full year guidance, which assumes foreign exchange rates effective as of June 30, 2023, for the full year. The enterprise guidance also includes the impact from currently anticipated capital allocation, with free cash flow targeted for acquisitions, share repurchases and dividends; in addition, the guidance includes the $1 billion accelerated share repurchase program with proceeds from the spin. Excluding Fortrea, our current enterprise guidance for revenue, earnings and cash flow remains unchanged from our prior guidance given in April.

Enterprise revenue is in line with Diagnostics Laboratories slightly up while Biopharma Laboratory Services is slightly down. We expect Enterprise revenue to grow 1.5% to 3% compared to 2022. This increase reflects the base business growing 11.3% to 12.6%, while COVID testing is expected to decline 85% to 89%. We expect Diagnostics Laboratories revenue to be up 0.5% to 1.5% compared to 2022. This is a 25 basis point increase at the midpoint from our April guidance as the base business outlook has improved, partially offset by lower COVID testing. This guidance includes the expectation that the base business will grow 13.2% to 14.2%, which includes approximately 5% growth from Ascension. The base business has improved from our April guidance based on stronger demand.

We continue to expect Diagnostics Laboratories base business margin to be slightly up in 2023 versus 2022 and including the unfavorable mix impact from Ascension. We expect Biopharma Laboratory Services revenue to grow 3% to 4.5% compared to 2022. This guidance includes the positive impact from foreign currency of 150 basis points. The midpoint of our guidance range is down approximately 75 basis points from the midpoint of our April guidance, but implies around 9.5% growth in the second half of the year as we expect favorable growth in both Central Laboratories and Early Development Research Laboratories. We also expect that the segment margin will be flat to slightly up in 2023 compared to 2022. Our guidance range for adjusted EPS and is $13 to $14, which is consistent with our April guidance, excluding Fortrea and including the impact from the accelerated share repurchase program.

Free cash flow from continuing operations, excluding spin-related items, is expected to be between $800 million to $1 billion, in line with our prior guidance, excluding Fortrea. In summary, we expect to drive continued profitable growth in our base business. We expect to continue to use our free cash flow generation for acquisitions that supplement our organic growth, while also returning capital to shareholders through our share repurchase program and dividends. Operator, we’ll now take questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] One moment for our first question. And our first question will come from the line of Jack Meehan with Nephron Research. Your line is now open.

Jack Meehan: Thank you. Good morning.

Adam Schechter: Good morning, Jack.

Jack Meehan: My questions are on the new Biopharma Lab Services segment. So number one, was curious if you could comment on just how much visibility you have into the improvement you’re looking for in the second half of the year for Early Development Research Labs? And just give us an update in terms of the supply situation for NHPs.

Adam Schechter: Yes. So, first of all, I’ll answer the second part first. So, we’re in good shape for the rest of the year with NHP. We don’t expect any additional impact as we go through the second half. And then to answer the first question, if you just look at the midpoint of our guidance, it would imply about a 9.5% increase year-over-year. And that’s going to come from both segments, the NHP segment as well as from the Clinical Laboratory – the Early Development Research Laboratory as well as the Clinical Research Laboratory segments.

Jack Meehan: Great. Okay. And then maybe for Glenn, just for the segment overall, could you talk about expectations for the second half margin ramp in Biopharma Lab Services and just how we should be – if you can hear me any thoughts on the leaping off point for 2024?

Glenn Eisenberg: Yes, hi Jack. So, when we think about margins, again, specifically for Biopharma, obviously, we expect to see a second half margin year improve over the first half and improve year-over-year. So, again, benefiting from the top line growth that Adam said was kind of in the implied revenue growth of 9.5% for the segment, we’ll get good leverage over that as well as benefiting from LaunchPad. We said that for the full year for Biopharma, margins will be flat to slightly up, again, consistent with, frankly, Diagnostics margins being up a little bit and for the enterprise as well, including the negative impact from Ascension. So, we feel good about margins driven off of the top line. When you look at the quarter, we felt actually very good with a 15% margin in the quarter for Biopharma, realizing that we had very strong growth coming from Central Lab that really helped it, but also we had negative growth from Early Development Research, which constrained it.

So, we feel good about where we are kind of as a run rate. And if we can maintain that level of margin, that will get us, again, higher margins for the full year as well as year-over-year.

Jack Meehan: Thank you, Glenn.

Operator: Our next question comes from Lisa Gill with JPMorgan. Your line is now open.

Adam Schechter: Good morning, Lisa.

Lisa Gill: Good morning. It’s nice to talk to you guys again. Thanks for taking my questions. When I look at your expectations and I look at the revenue growth rate, can you talk about utilization trends? Do you think that there is still some level of pent-up demand? How do I think about this versus 2019 baseline would be kind of my utilization question? And then secondly, how do I think about reimbursement trends, especially on the managed care side. I know two years ago we talked a lot about shifts towards some type of value-based economics. Are we finally there? And if so, can you maybe talk about some of the things that you’re seeing in the market?

Adam Schechter: Yes. I’ll let Glenn answer the first question. I’ll take the second one. Lisa, if you look at the reimbursement trends, what I would say is that it continues to be a relatively stable environment. And I feel good about our interactions with the payers, I feel good about our contracts that we have in place. I wouldn’t say yet we’re there for value-based contracts and so forth. I think there’s still a lot of experimentation that happens, but we don’t see a lot of significant progress. With all that said, I believe that we’re in a very good position moving forward with the payers, and there’s nothing that I would expect to be unexpected. What we’re watching closely obviously is PAMA to see what happens there and government reimbursement on certain areas. But overall, it remains a pretty healthy environment.