LH Laboratory Corp. Of America

Chas Cook IR
Adam Schechter President, CEO & Chairman
Glenn Eisenberg CFO & EVP
Jack Meehan Nephron Research
Erin Wright Crédit Suisse
Dan Leonard Wells Fargo Securities
Kevin Caliendo UBS
Ralph Giacobbe Citigroup
Ricky Goldwasser Morgan Stanley
Brian Tanquilut Jefferies
Matthew Larew William Blair & Company
Derik De Bruin Bank of America Merrill Lynch
Justin Bowers Deutsche Bank
Call transcript

Thank you for standing by, and welcome to the Labcorp Q1 2021 Earnings Conference Call. [Operator Instructions]. I would now like to hand the conference over to your speaker today, Chas Cook. Thank you. Please go ahead, sir.

Chas Cook

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. This morning, in the Investor Relations section of our website at www., we posted both our press release and in 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 our estimated 2021 guidance and the related assumptions, including the projected impact of the COVID-19 pandemic on the company's businesses, operating results, cash flows and/or financial condition, our responses to and the expected future impacts of the COVID-19 pandemic on our business more generally as well as on general economic, business and market conditions. Each of the forward-looking statements is based upon our current expectations and is subject to change based upon various factors, many of which are beyond our control that could affect our financial results.

Some of these factors are set forth in detail in our most 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 Schechter.

Adam Schechter

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. We're also encouraged to see that patients continue to return to the pre-pandemic health care teams as well as our pharmaceutical and biotechnology customers resuming their important research and development work.

Our first quarter results demonstrate Labcorp's strong position in both diagnostics and drug development.

We continue to play a central role in helping health care professionals assess a patient's health and deciding appropriate treatment options. We're also aiding in the development of treatments and cures that are critically important for the future.

Now I'm going to turn to our response to COVID.

As you know, Labcorp's capabilities in testing and drug development have been critical to the pandemic response.

Our fight against this virus is not over, but we are thankfully seeing a reduction in cases from pandemic eyes especially in the United States. And with that, our COVID testing volume has declined.

While we can't fully predict how the pandemic will evolve as the year goes on, we are confident in our ability to leverage the considerable experience and expertise that we've gained over the last year to continue to build on our leading COVID testing and treatment capabilities.

Our scientists are developing new testing solutions.

We have sufficient capacity to serve our customers, and our teams continue to support important COVID science and trials. We're also proud to be a part of getting people back to work, to school and to life.

Our employer services team offers testing and vaccination services to support workplace and community safety.

Our recently announced offering for small businesses can help employers, including restaurants reopen. Since the onset of the pandemic, we've been focused on serving all communities, including underserved populations.

This quarter, we furthered let commitment in a partnership with the State of North Carolina to provide Pixel COVID home kits at no cost to underserved communities.

Additionally, our Walgreens partnership expanded to include new integrated digital experiences available to all Walgreens customers and access to our Pixel Home Kit in over 6,000 locations. We're also helping patients securely access their results through their personal devices and apps like Common Health and Common Pass.

Finally, we're continuing our important work for the CDC to genetically sequence approximately 5,000 virus samples every week in order to identify variance.

Now I'll provide several updates to our strategy. In the quarter, as we delivered growth in our base business and we responded to the needs of our customers in a pandemic, We also made progress in advancing our strategy. In our essential laboratory business, which supports trials across many therapeutic areas, we continue to automate our processes using robotics and proprietary analytics.

Our investments in our central labs business will enable us to increase our productivity, create resiliency in our supply chain and better meet the needs of our customers. We recently opened a new automated clinical trial kit production facility in Belgium.

We expect that to eventually double our capacity. The facility will offer faster kit delivery, more flexible ordering and reduced transportation costs for biopharma clients and clinical trial investigator sites across Europe, Middle East and Africa. We're also advancing our position in oncology by strengthening our leadership team and investing in this important area where novel diagnostic testing and better treatments are needed around the world.

Our science and technology continue to be critical to Labcorp's success and future growth. We made continuing strides during the first quarter and developing future tests for cancer, Alzheimer's disease, autoimmune and liver disease.

We also increased access to testing and trials through telemedicine, pharmacies, employers, home kits and our decentralized clinical trial capabilities.

In fact, our continued scientific and technology advancements were recognized by Fast Company, which named us one of the world's most innovative companies for 2021. This accolade is great recognition for Labcorp's talented teams who are resilient, fast and agile. It's a testament to our company's ability to adapt and thrive in a rapidly changing environment. In closing, as announced in March, the Board and leadership team are undertaking a review of the company's structure and capital allocation strategy. The goal is to ensure we are best positioned to unlock shareholder value while continuing to support the patients and the customers who rely on us around the world. This process will take time, and there will be no updates until conclusion is reached.

Our team is focused. We're focused on delivering on our mission of improving health and improving lives, which we believe drive strong shareholder returns. I want to thank our more than 70,000 employees around the world who continue to rise to the occasion. We look forward to brighter days ahead as vaccines continue to roll out. And I remain very confident in our strength across our businesses as we move forward. With that, I'll turn it over to Glenn.

Glenn Eisenberg

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.

During the quarter, we had $32 million of restructuring charges and special items, primarily due to COVID-related costs and acquisition integration charges.

We also had $92 million of amortization, which was higher than last year due to the accelerated amortization of the Covance trade name related to our previously announced branding initiative. Adjusted operating income in the quarter was $1.2 billion or 28.4% of revenue compared to $366 million or 12.9% last year. The increase in adjusted operating income and margin was primarily due to COVID testing, organic base business growth, acquisitions and LaunchPad savings, partially offset by higher personnel costs. The tax rate for the quarter was 24.6%. The adjusted tax rate, excluding restructuring charges, special items and amortization, was 24.5% compared to 25.3% last year. The lower adjusted tax rate was primarily due to the geographic mix of earnings.

We continue to expect our full year adjusted tax rate to be approximately 25%. Net earnings for the quarter were $770 million or $7.82 per diluted share. Adjusted EPS, which exclude amortization, restructuring charges and special items, were $8.79 in the quarter, up from $2.37 last year. Operating cash flow was $1.2 billion in the quarter compared to $204 million a year ago. The increase in operating cash flow was due to higher cash earnings and lower working capital requirements. Capital expenditures totaled $95 million or 2.3% of revenue compared to $107 million or 3.8% of revenue last year.

As a result, free cash flow was $1.1 billion in the quarter compared to $97 million last year.

During the quarter, we paid down $375 million of debt, invested $34 million in acquisitions and repurchased $69 million of stock. At quarter end, the company had $732 million remaining of its board authorized share repurchase program.

Now I'll review our segment performance, beginning with Diagnostics. Revenue for the quarter was $2.8 billion, an increase of 62% compared to last year, driven by COVID testing of 54.5% and base business growth of 7.5%. The base business growth was primarily driven by organic growth of 6.3%, which includes the negative impact of weather of approximately 2%. Relative to the first quarter of 2019, the compounded annual growth rate for the base business revenue was 2.7% and was primarily due to organic growth. Total volume increased 27.3% over last year, primarily due to organic volume growth of 26.6%. The increase in organic volume was due to the contribution from COVID testing volumes of 27.9%, partially offset by a reduction in organic base business of 1.3%, which was negatively impacted by weather of approximately 2%.

As a reminder, we do not include hospital lab management agreements in our volume, which would have added approximately 1.3% to organic base business volume growth. Price/mix increased 34.7% over last year, driven by COVID testing of 26.6% and a favorable mix in the organic base business of 7.5%, which was primarily due to higher test per accession. Diagnostics adjusted operating income for the quarter was $992 million or 36% of revenue compared to $254 million or 14.9% last year. The increase in adjusted operating income and margin was primarily due to COVID testing, organic base business demand and LaunchPad savings, partially offset by higher personnel costs. Diagnostics 3-year LaunchPad initiative remains on track to deliver approximately $200 million of net savings by the end of 2021.

Now I'll review the performance of Drug Development. Revenue for the quarter was $1.4 billion, an increase of 25.7% compared to last year due to organic growth of 21.9%, acquisitions of 1% and favorable foreign currency translation of 290 basis points. The increase in organic revenue was due to base business growth of 19.7% and a 2.2% contribution from COVID testing performed through its central lab business. Drug Development delivered broad-based revenue growth across all businesses, including COVID vaccine and therapeutic studies. And relative to the first quarter of 2019, the compounded annual growth rate for the base business revenue was 14.7% and was primarily driven by organic growth. Adjusted operating income for the segment was $234 million or 16.3% of revenue compared to $151 million or 13.2% last year. The increase in adjusted operating income and margins were primarily due to organic base business demand, COVID testing and LaunchPad savings, partially offset by higher personnel costs. The company continues to develop and execute new LaunchPad programs to support profitable growth in Drug Development.

For the trailing 12 months, net orders and net book-to-bill remained strong at $7.6 billion and 1.47, respectively. Backlog at the end of the quarter was $14 billion, an increase of approximately $210 million from last quarter.

We expect approximately $4.6 billion of this backlog to convert into revenue over the next 12 months.

Now I'll discuss our 2021 full year guidance, which assumes foreign exchange rates effective as of March 31, 2021, for the full year.

We are raising our full year guidance to reflect the company's strong first quarter performance and improved outlook for the remainder of the year for both our Diagnostics and Drug Development base businesses.

We expect enterprise level revenue to grow 2% to 6.5% from our prior guidance of minus 1% to plus 4.5%. This includes the benefit from foreign currency translation of 70 basis points. This guidance range also includes the expectation that the base business will now grow 13.5% to 16%, up from prior guidance of 11% to 13.5%. The revenue guidance on the contribution from COVID testing is unchanged at down 35% to 50%.

However, current estimates are less favorable than the midpoint of the range.

We are raising our expectations for revenue in Diagnostics of flat to minus 5% from prior guidance of minus 0.5% to minus 7.5%. This guidance range includes the expectation that the base business will now grow 13.5% to 16%, given our first quarter performance and improved outlook, and we continue to expect COVID testing revenue again to decline 35% to 50%. We're also raising our growth expectations for revenue in Drug Development to 12% to 14% from prior guidance of 8% to 10.5%.

Our current guidance includes the benefit from foreign currency translation of 140 basis points. This guidance range also includes the expectation that the base business will now grow 14% to 16%, reflecting strong first quarter broad-based performance and an improved outlook.

Given the improved top line growth expectation of our base businesses, we're now raising our adjusted EPS guidance to $20 to $24, up from prior guidance of $19 to $23. Free cash flow is now expected to be between $1.8 billion and $2 billion, up from prior guidance of $1.7 billion to $1.9 billion.

Our earnings guidance assumes we will use our free cash flow for acquisitions and share repurchases, which we expect to accelerate in the second quarter.

We continue to expect the capital expenditures will be approximately 4% of revenue, driven by investments to support base business growth and productivity.

For additional comparison purposes, we have also included in our supplemental deck on our Investor Relations website, a view of our 2021 first quarter results and full year guidance compared to our 2019 results. In summary, the company had another quarter of strong performance. We remain focused on performing a critical role in response to the global pandemic, while also managing our base business. And as we progress through 2021, we expect to drive continued profitable growth in our base business as COVID testing volumes are expected to decline over the remainder of the year.

We expect to continue to use our free cash flow generation for acquisitions that supplement our organic growth while also returning capital to shareholders. [Technical Difficulty].


Are you there?

Glenn Eisenberg

There we go, operator. We can hear you.


Sorry about that. I don't know what happened.

You could continue.

Glenn Eisenberg


I think we've completed our formal remarks, and we're now ready to take questions.


[Operator Instructions]. And your first question comes from Jack Meehan with Nephron Research.

Jack Meehan

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?

Adam Schechter

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.

Jack Meehan

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?

Glenn Eisenberg

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.


Your next question comes from the line of Erin Wright with Credit Suisse.

Erin Wright


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.

Adam Schechter


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 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 was, 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 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.

Erin Wright

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?

Adam Schechter

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 accretive typically 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.


Your next question comes from the line of Dan Leonard with Wells Fargo.

Dan Leonard

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?

Glenn Eisenberg

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 4 7.

So it's picked up nicely from the prior trailing 12 months.

So obviously, it implies, obviously, 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.

Adam Schechter

And I would also say, Dan, is 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.

Dan Leonard

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 industry.

So maybe if there's more granular detail you could offer on the drivers there.

Glenn Eisenberg

Yes. No, Dan, we've been really pleased with the pace of the recovery in Diagnostics, frankly, coming in a little stronger than what we would have expected, which, again, is one of the reasons we've increased the guidance that we have for Diagnostics. When you look at the breakup of the, call it, the 6% plus organic revenue growth, volumes are still down year-on-year. They were down around 1.3% but actually would have been favorable if you took out the negative impact from weather.

So we've really started to see the trend change. And when you think about it, not too surprising when you're comping now at the end of the first quarter to the beginning of the pandemic impact last year. But what we're equally pleased to see is that the volume levels continue to improve while still be down from 2019 pre-pandemic levels. Low single digits as well.

And so while revenue continues to be up year-on-year to '20, while revenues continue to be up compounded compared to '19, kind of a normalized year, volumes are still a little bit down. And our expectation continues to be that the volume levels will now start to kind of kick in above '19 levels, call it at the middle of the year. But the good news is that we -- while volumes are still a little bit soft compared to historical levels, we're making that up on our price/mix, which we're attributing more to the number of tests we're doing because we report volume on an accession basis.

So maybe fewer visits to the physicians, but they're doing more tests for each of those visits, but good momentum that we're continuing to see.


Your next question comes from the line of Kevin Caliendo with UBS.

Kevin Caliendo

You mentioned in your prepared comments, capital allocation would accelerate over the course of the year. Is the strategic review part -- was that the reason why there wasn't really much capital deployed in 1Q? Your buyback was $69 million. M&A was $34 million. And then I guess, the second half of that is, how should we really think about capital deployment in total, meaning is there a target in terms of buybacks? Is there a target -- total allocation been built into these numbers?

Glenn Eisenberg

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 you unilaterally control that, is that with 1 quarter under our belt 3 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.

Adam Schechter

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 3 of those.

Kevin Caliendo

Okay. And just 1 follow-up. One quick follow-up is the -- is the biggest delta between the high end and low end of your guidance still PCR volumes? Or is there something else that would sort of be the biggest net mover of earnings for the rest of the year?

Glenn Eisenberg

Well, again, if you're -- one of the reasons, again, we've broken out the guidance between our underlying base business and the COVID testing is such that we can give various ranges for the 2. And clearly, there's a little bit more uncertainty visibility, if you will, on the level of PCR testing depending on what's going on with, obviously, the pandemic and how it impacts.

So from our perspective, when we gave that range, we've said 2 things. That it's going to be a combination of different volume levels, but also potentially different levels of pricing.

So right now, we obviously had a very strong first quarter relative to PCR volumes, 112,000 tests per day. But we ended the quarter at kind of the 80,000 test per day level.

So you can see that we continue to see and expect that volume levels will continue to trail down. But again, we'll see if it picks up again, if you will. But at the midpoint, we're clearly considering that the volumes will come down. And there's also pricing. With CMS, we've always held to the pricing on the reimbursement We continue to do that. At some point, that pricing may change. CMS may change their pricing reimbursement.

So there's just a lot of variability.

So at this point, we continue to do.

We have all the capacity there.

Our turnaround times are extremely strong.

And so we're just meeting the needs that are out there.

Adam Schechter

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 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.


Your next question comes from the line of Ralph Giacobbe with Citi.

Ralph Giacobbe

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?

Glenn Eisenberg

Again, there it's -- we guide to the revenue. Obviously, we've talked a little bit about kind of the leverage that we get on that volume for PCR depending upon the pricing.

So we've talked about it being kind of north of our 65% incremental leverage on PCR volumes. Kind of comparable, but a little bit north of what we would normally have seen like on incremental volume from weather, if you will.

So as Adam said, when we gave our guidance, we give a range. Obviously, the midpoint is kind of where the most expectations. But clearly, we could see our way to getting higher at the upper end and other things that could be headwinds on the lower end. The reason we commented on the PCR one is that it's a little bit south of the center point is because, one, that's what we're currently seeing on the trends. But two, as Adam said, we could see it pick up again.

So we were just trying to provide some color. And given where the extension of the public health emergency continues to go out, if it gets extended again, that could reinforce better pricing than what -- that would hold our pricing, which would be an improvement because we do assume in some of the scenarios we'll see lower pricing overall. But when you look at our earnings, and it's kind of interesting, we obviously had a very solid first quarter and you compare it to, call it, the midpoint of the guidance that we give for earnings for the year, we had a much higher percentage of earnings than we would historically do. We tend to try to track not this precisely, but let's say, 1/4 of our earnings would normally be -- or 1 quarter, a quarter of the year.

Here, we did around 40% of our earnings. And frankly, in the second quarter, I think it's fair to say It will be a strong quarter relative to the full year as well because we're still going to have another strong quarter of COVID testing, even though it will be less than what we saw in the first quarter. From our standpoint, the bigger question will be the second half of the year, which was really where we do expect to see a decline in volumes and potentially a declining in pricing. But there's still that uncertainty out there that could potentially be upside if the volume levels hold up greater and the pricing holds up greater. But there's just a wide range of outcomes.

Ralph Giacobbe

Okay. All right. That's helpful. And then just a follow-up question. Any update on school testing, I guess, broadly? And then more specifically on the K3 program that I think is going to be announced shortly, could you just help us -- did you guys bid for a coordinator role in 4 regions? Or will you just be 1 of the up to 10, I guess, labs to serve the program? And is there any way to sort of size or frame the opportunity as you see it?

Adam Schechter

No, it's a great question. And we did bid on certain regions, and we do expect that we would be 1 of the labs, irrespective if we have 1 of the hubs or not.

So we expect to be involved in both, but we'll see as it plays out. At the minimum, it's hard to imagine where you wouldn't need the capacity and the capabilities we have for the testing itself. It's really going to come down to how many schools want to implement the screening. And as more and more people are vaccinated, as more parts of the country are opening up, I mean, almost fully in certain parts of the country, it's hard to tell to be honest, how many schools are going to say, we're going to want to screen on a fairly often basis all of our students.

So we -- as we said, that's why we have this broad kind of guidance between down 35% and down 50%. We're turning more down towards the 50%. But if the schools were bigger and actually do a lot of testing, well, then we did go the other way in the range. But right now, we're not expecting that to be a very significant amount. And that's why we kept the range where it is.


Your next question comes from the line of Ricky Goldwasser with Morgan Stanley.

Ricky Goldwasser

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?

Adam Schechter

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 health care. 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, that there's 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 health care 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.

Ricky Goldwasser

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 of 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.

Adam Schechter

Yes. No.

So first of all, I'd say, if you look at the 3 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 and then you can be successful. And I believe we have the level of scale across each of our three businesses that we need.

Ricky Goldwasser

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 health care. 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 correlation with acuity level. Any sense there in terms of what type of tests you're seeing being ordered?

Adam Schechter


So Ricky, so 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. 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.


Your next question comes from the line of Brian Tanquilut from Jefferies.

Brian Tanquilut

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?

Adam Schechter

Brian, when I look at the business, the pricing is always under some pressure, but it's pretty asymptotic. It doesn't tend to be significantly more pressure over time than not. And the pricing is 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 $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.

Glenn Eisenberg

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-over-year comparisons, we've seen an unusually high price/mix.

So again, as we get more to normal, so you'll see both kind of fall back into where we would normally expect it to be.


Your next question comes from the line of Matt Larew with William Blair.

Matthew Larew

Given some goalposts around what you expect [indiscernible] molecular look like in 2021. But do you have a sense or maybe give us some sort of wider goalpost 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 sort of the substantial footprint and capacity that you've built out to meet COVID demand? How do you leverage that moving forward?

Adam Schechter

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.


Your next question comes from the line of Derik De Bruin with Bank of America.

Derik De Bruin

So I wanted to follow up on the longer-term COD testing you were just discussing.

So I wanted to say where do you think the testing for is for reference labs in the long term given the vaccine rollout but also more variants come 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?

Adam Schechter


So again, with the longer-term COA 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.


Your next question comes from the line of Pito Chickering with Deutsche Bank.

Justin Bowers

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?

Adam Schechter


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.


And at this time, there are no further questions.

Adam Schechter


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 the normal lives and their normal health care 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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