LABCORP HOLDINGS INC. annual report, FY2016

Business context and reporting period

LabCorp Holdings’ Form 10-K covers the fiscal year ended December 31, 2016; it also provides unaudited fourth-quarter results. The company operates LabCorp Diagnostics (LCD), its clinical testing business, and Covance Drug Development (CDD), its drug-development services business. The 2015 comparison includes Covance only from its February 19, 2015 acquisition date, limiting year-over-year comparability.

Financial and operating metrics

Unless noted, amounts are in millions of dollars.

Fourth-quarter 2016 revenue was $2,387.3, gross profit $788.0, attributable net earnings $184.4, and diluted EPS $1.75. Fourth-quarter 2015 comparatives were $2,244.8, $740.7, $110.0, and $1.07, respectively.

• Segments: LCD revenue was $6,593.9, up 6.4%; CDD revenue was $2,844.1, up 23.3%. Segment operating earnings were $1,187.6 for LCD and $272.7 for CDD. CDD’s growth reflects a full year of Covance results in 2016 versus a partial year in 2015.
• Liquidity: Cash and equivalents were $433.6 at year-end, down from $716.4. Current assets were $2,478.7 and current liabilities $1,827.6. Accounts receivable, net, rose to $1,328.7 from $1,217.9.
• Debt: Reported short-term/current and long-term debt totaled $5,849.5, including capital leases. The company reported a 3.1-to-1 total-debt-to-consolidated-EBITDA ratio, no revolving-credit balance, and compliance with credit covenants. $500 million of 2.20% senior notes was current and due in 2017.
• Cash generation: Operating cash flow less capital expenditures was approximately $897 million. Investing activities used $795.7; financing activities used $649.8.

Material changes versus the prior comparable period

• Full-year revenue increased 11.0%, primarily reflecting the full-year inclusion of Covance, organic growth and acquisitions, partly offset by foreign-exchange effects.
• Attributable net earnings increased to $732.1 from $437.6; operating income increased to $1,312.4 from $996.8. Interest expense declined to $219.1 from $274.9.
• Gross margin eased to 33.7% from 34.1%; management attributed higher cost of revenue as a share of sales partly to CDD’s personnel-intensive operations and business growth. SG&A declined to 17.3% of revenue from 19.1%, reflecting acquisition/integration synergies and the LaunchPad improvement program.
• Restructuring and other special charges fell to $58.4 from $113.9. The 2016 charges primarily related to severance and facility closures, including planned closure of duplicative data-center and other facilities.
• LCD requisition volume grew 1.2%; revenue per requisition contributed 2.7% and acquisitions 2.5% to LCD revenue growth. CDD results also reflected demand and mix, partly offset by an expired minimum-volume contract and currency impacts.

Outlook, management commentary, risks and unusual items

• Management expected acquisitions completed or announced by the filing date to add less than 2% to revenue and a comparable increase to operating income. It said it remained on track for annual cost synergies exceeding $100 million by December 31, 2017. This is not comprehensive company-wide financial guidance.
• Management expected 2017 capital expenditures of approximately 3% of revenue and continued use of operating cash flow for investment, acquisitions, debt reduction and shareholder returns. Share repurchases resumed in Q4 2016; $739.5 million of authorization remained at year-end, including unsettled commitments. The company did not anticipate paying dividends in the foreseeable future.
• Reimbursement is a key risk: PAMA-based Medicare Clinical Laboratory Fee Schedule rates were scheduled to change beginning in 2018 using reported private-payer prices. Management cited uncertainty around future healthcare reform, payer coverage and utilization controls, and patient cost-sharing. The company expected a 2017 CLFS payment increase of approximately $9.9 million, while estimating PFS reductions of approximately $3.7 million.
• Management noted rising patient accounts receivable and warned that continued growth in patient responsibility could increase bad-debt expense or require a higher allowance. Patient balances represented approximately 20.0% of consolidated gross receivables at year-end.
• Sequenom was acquired in September 2016; its preliminary purchase-price allocation included approximately $206 million of goodwill. Several other 2016 acquisition allocations also remained preliminary. Goodwill and intangible assets totaled approximately $9.8 billion; management reported no impairment in 2016 but highlighted two CDD reporting units for continued monitoring.
• The company disclosed ongoing False Claims Act, billing, consumer, labor, and other litigation. It said it could not estimate reasonably probable losses for certain matters and did not expect the described proceedings to materially affect financial condition based on information then available; outcomes could still materially affect an individual period.
• Other items include a 33.7% effective tax rate, favorably affected by lower foreign tax rates, early adoption of share-based-payment accounting and tax-reserve reversals; and a $14.0 million tax benefit from that accounting adoption. Foreign-currency translation adjustments reduced comprehensive earnings.

Most important facts for investors to verify

1. Whether organic growth, including LCD test volume and CDD demand, supports continued growth after separating acquisition effects and currency movements.
2. Progress toward the stated cost-synergy target, LaunchPad savings, and integration of Covance and Sequenom, including any further restructuring or impairment charges.
3. The effect of PAMA pricing, payer coverage decisions, utilization management and higher patient cost-sharing on revenue per test, collections and bad debt.
4. Debt repayment capacity and refinancing needs, especially the 2017 note maturity, leverage, and the company’s stated investment-grade objective.
5. Developments in material litigation and the financial exposure from matters for which the company said loss estimates were not clear or reasonably estimable.
6. Final purchase-price allocations for 2016 acquisitions and the performance assumptions supporting goodwill and intangible-asset valuations.