Brian Tanquilut: So I guess my question, Glenn, as I think about the P&L lines, the cost of sales and G&A and factory and labor and obviously Launchpad, seeing that both of those lines outpace revenue growth in Q4, how are we thinking about the — I hear you about margin improvement this year. So just curious, how you think about the labor environment and how that factors into driving margin improvement in terms of like actual dollars and the growth in those P&L lines?
Glenn Eisenberg: Yeah, so no, Brian, we normally view, well, one obviously continues to be a tight labor market, but a market that’s improved. From a nutrition standpoint, we continue to see improvement, but as a company, we’re still higher than we were pre-pandemic and that varies across the segments because actually our biopharma is back to where we’ve been and we still see some additional pressure within the diagnostic side, but again, improving. Our general premise is that the labor market inflation for labor is around 3%, you can say 3% to 4%, but within that range. We’ve always commented that our Launchpad initiative was really in place to help offset that inflationary pressure. For us, a 3%, give or take, increase in our labor, call it merit in particular, would be a little bit over $100 million and again, we target that $100 million to $125 million a year.
So again, we think things are levelling off, if you will, and that part of the margin improvement will be the Launchpad initiative to help offset those inflationary costs.
Brian Tanquilut: Understand. And Glenn, maybe just housekeeping, maybe I just missed this, but share buybacks, how much are — how much share buyback activity is based into the guidance?
Glenn Eisenberg: So what we do guide to is that the free cash flow generation that we have will be used for share repo, M&A, and dividends. So it’ll be across the board would be our expectation. We don’t comment about how much is in each of the components, if you will, because it may vary based upon the acquisition opportunities that we see. But it’ll be blended across and again, we commented as well that we have some additional balance sheet strength if we wanted to use that for additional M&A or buybacks, but the guidance that we gave and the earnings guidance, if you will, is reflected with all three of those capital allocation opportunities.
Operator: Our next question comes from Pito Chickering with Deutsche Bank. Your line is open.
Pito Chickering: Back on the ’24 guidance to diagnostic business, can you sort of quantify the margin improvements next year and any details on split between SG&A and gross margins and how much is coming from acquisitions and improving versus just pure organic improvements?
Adam Schechter: I’ll give some context on that, and I’ll ask Glenn to add on. So if you look at the diagnostic business, I’d say the first thing is if you look at fourth quarter, you saw very strong revenue growth, about 8%. If you look at margin versus prior year, it was down slightly, about 30 basis points. What drove that primarily was that there were some minor things like increased health care costs and so forth, but it was driven primarily by the hospital deals that we did, that although they’re accretive in the first year, in the first several months, they’re typically diluted and we did several of those deals at the end of last year. As we come into this year, we’re confident in the margin accretion for several reasons.
One is obviously PAMA’s been delayed. So that would have been a real headwind that we’re not facing this year. We pushed that off into 2025. If you look at our volume increases, that’s going to help us. The volume is going to be strong. If you look at the hospital deals, that we said extension would continue to give us some margin improvement over the next several years. Each of the hospital deals get a bit better as you go year-over-year. So we’ll get some improvement from the hospital deals continuing to improve. We’re also going to be looking to reduce costs across the enterprise, but a significant amount because of the size is in diagnostics of $100 million to $125 million and when you look at all those things together, we’re expecting inflation to be about 3%, which is more than a typical rate than it’s been in prior years.
So if you put all that in, that’s for our inflation of our people costs and so forth, should be around 3%, 3.5%. You put all those together and that’s why we’re confident that even though we have a headwind from COVID, that’s fairly significant, about $130 million, we’ll still be able to get some margin improvement in the diagnostic business.
Glenn Eisenberg: Yeah, no, I kind of think that’s right. Pito, that when you look this year as COVID becomes less of an impact, still an impact, it’s kind of being offset by the acquisitions that we did late in the year. Really, it’s the hospital partnerships and to your point, the margin is constrained a little bit when we do the in-hospital lab management agreements, but a typical M&A for us that would include hospital labs management tend to be more weighted to frankly the acquisition component. Ascension, as we’ve talked about, we called out one because of its sheer size, but also was disproportionately tied to the in-hospital lab. So less of an impact, a little bit of a headwind, but less of an impact. So it’s really top line growth, cost controls, Launchpad business process improvement initiatives is really what’s going to help drive the margins across both of our businesses.
Pito Chickering: Okay, great. And then back on for fourth quarter on the early stage cancellations, is it the color of why you saw that spike? Was that just a single customer or is that sort of a swath of customers? And why do you think that should normalize 2024? Thanks so much.
Adam Schechter: Sure. And it wasn’t specific to fourth quarter, although there was an increase in the fourth quarter. We saw it throughout last year and we think there were several reasons. One, when there was an NHP supply issue, people were getting in line to run their NHP trials well in advance of what they typically would. By the time it was their turn, they would look and say, you know what, we’re not going to do that trial. Either they reprioritized the pipeline, they decided the NHP costs were higher than what they had budgeted for, they decided just not to move forward at that time. The second thing is the funding in smaller biotech has been more difficult. So they’re choosing their trials very carefully in the compounds that they move forward, but as we go forward, we’re seeing, the RFPs look good as well as our win rates look good.
So, the cancellations we believe are going to normalize. We’re also starting to see a shift in our business a bit more towards mid-size to larger pharma as some of the smaller biotech have had those cancellations. They have less cancellations typically than the smaller ones. So that’s why we think, we’re going to see improvement as we go through this year.
Operator: Our next question comes from Elizabeth Anderson with Evercore ISI. Your line is open.
Elizabeth Anderson: Hi, good morning. Thanks for the question. So I just want to follow up on that last question. So the shift towards mid-to-larger pharma in early development, is that really solely a function of this cancellation dynamic that you’re seeing over the shorter term, because I thought for maybe one of your prior comments it seems like that was also maybe more of a strategic shift moving up market there. So any additional color there would be helpful. And then secondarily on the cost improvements in BLS, I understand what you’re saying about the continued revenue improvement there. Are there any other sort of cost improvements as we move further away from the spin or should we sort of think about those cost opportunities as largely you’ve already done them and this is really just like an organic opportunity? Thank you.
Adam Schechter: Yeah, sure. So as I came up with early development business, I’ve been saying for quite some time that we would like to see a shift towards more mid to larger size and I want to be clear, it’s not significant. It’s still more in the smaller biotech than it is to the mid to larger size. It’s been something that we’ve been working on for multiple years now and we’re seeing some progress, but also a part of it is that cancellations are occurring more often in the smaller biotech companies. So we were purposely moving that direction. There is a reason that we’re able to move a little bit faster, but we still have work to do there. But over time, I would like to see that mix move more towards mid-size to larger format.
Glenn Eisenberg: Yeah, Elizabeth, also on the cost side for BLS, it’s not only the growth, but there are cost opportunities kind of in the post spin environment. We still have stranded costs that affect our Biopharma business that we’re continuing to take out and obviously that’s getting wrapped in our overall launchpad initiative as we talk to the $100 million to $125 million of savings each year. We did take out a meaningful amount of costs that were stranded. We had talked about having a $25 million dollar run rate of cost savings in the fourth quarter, which we achieved. So we’ll get the benefit of that going forward, but there’s still opportunities to consolidate. We still have a little bit of excess capacity within our early development side of the business.
So we’re managing that cost and the capacity, leaving ample room, though, because of the expectation that we’re going to start to see good growth in that business as well. But it’s not only obviously top line growth, but still opportunities to take some costs out.
Elizabeth Anderson: Got it. And maybe just one quick follow up. Anything that you can comment on the expected 2024 tax rate?
Glenn Eisenberg: Yes. So we’ve kind of guided that we think a 23% adjusted tax rate is reasonable for the company and what’s interesting, if you think about Labcorp today post spin, we actually have a higher percentage of our earnings now that are generated in lower tax rate jurisdictions than we did when we had the clinical business. In addition, we have a higher percentage of R&D. So a higher percentage of R&D benefit than we did when we had clinical. So overall, while we historically have trended and seen our tax rate decline year-to-year over the last few years, the profile of the company gives us confidence that the 23% rate now is a sustainable rate, plus or minus going forward.
Operator: Next question comes from Eric Coldwell with Baird. Your line is open.
Eric Coldwell: Good morning, guys. Of course, all of my self-proclaimed good questions have just been asked in the last couple of minutes here, but I’m going to dive into that last one on R&D tax credit. Can you tell us what specifically might have happened in the fourth quarter to drive what appears to be some additional upside and thoughts on legal or regulatory changes and in addition to Glenn’s comments here about the geographic mix and the higher proportion of revenue associated with businesses that now would get an R&D tax credit, I’m just curious on how much of a sustainable impact this might be for favorable long term tax rates.
Glenn Eisenberg: Yes. So, Eric, when you think about the focus of the company, one of the key areas of target is an oncology. And obviously with PGX, OmniSeq, other areas that we’ve acquired as well are more R&D driven than historically Labcorp was. So each year we continue to make more investments, more opportunities and with that increased investment come the tax deductibility of that. Obviously, there’s still some pending tax laws that are out there right now, where you can advertise that benefit over a number of years. From a cash standpoint, we’re kind of pre-funding it. So hopefully we’ll get — that will change and we’ll get more. There’s obviously the impact of potentially global minimum taxes that really don’t affect us that much, given as we look at where, again, geographically we generate our earnings.
Really not going to have any meaningful impact. So from a sustainability standpoint, we think that 23% plus or minus rate is a reasonable rate to go forward, but obviously, the more we grow, the more we grow internationally gives us an opportunity to structurally change that maybe a little bit more favorably as well.
Eric Coldwell: And Glenn, maybe education on my behalf, but are you seeing R&D tax credits on the CRO side as well, the BLS segment, or is it mostly or entirely associated with your internal investments in advanced diagnostics and LDTs, things of that sort?
Glenn Eisenberg: Yeah, it’s across the board. We have investments that span the entire company. I think the increase that we’ve been seeing that has been driving the more favourable amount has been driven more on the diagnostic side, but frankly, our oncology spans the enterprise. So everything that we work on and where we work on it and who’s working on it, again, we would say is across the enterprise, but more weighted to diagnostics.
