Labcorp Holdings, Inc. — FY 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. The filing also reports unaudited fourth-quarter results. Unless otherwise noted, financial amounts are in millions of dollars.
Business context and reporting period
LabCorp operates two segments: LabCorp Diagnostics (LCD), clinical laboratory testing, and Covance Drug Development (CDD), contract research and drug development services. They represented 70.3% and 29.7% of FY 2017 net revenue, respectively. The company completed the Chiltern acquisition in September and acquired PAML and other laboratory businesses during the year.
Financial performance and liquidity
| Metric | FY 2017 | FY 2016 | Change |
|---|---|---|---|
| Net revenue | $10,205.9 | $9,437.2 | +8.1% |
| Gross profit | $3,464.0 | $3,180.5 | +8.9% |
| Operating income | $1,364.2 | $1,312.4 | +3.9% |
| Net earnings attributable to LabCorp | $1,268.2 | $732.1 | +73.2% |
| Diluted EPS | $12.21 | $7.02 | +74.0% |
| Operating cash flow | $1,459.4 | $1,175.9 | +24.1% |
Gross margin was approximately 34.0% versus 33.7% in 2016; operating margin was approximately 13.4% versus 13.9%. FY 2017 net earnings included a provisional $519.0 million net tax benefit from the Tax Cuts and Jobs Act (TCJA), so the increase in net income and EPS is not a like-for-like indicator of operating growth. The reported effective tax rate was -12.3% versus 33.7% in 2016.
LCD revenue rose 8.7% to $7,170.5 million; requisitions increased 5.8% and revenue per requisition rose 2.9%. LCD operating income grew 9.3% to $1,298.6 million, with an 18.1% margin versus 18.0%. CDD revenue increased 6.8% to $3,037.2 million, primarily reflecting Chiltern; CDD operating income fell 24.4% to $206.2 million and its margin declined to 6.8% from 9.6%, amid acquisition and transaction costs, personnel costs, restructuring, and a software project termination.
Fourth-quarter revenue was $2,701.5 million versus $2,387.3 million in Q4 2016. Attributable net earnings were $706.8 million versus $184.4 million, and diluted EPS was $6.81 versus $1.75; Q4 2017 earnings included the TCJA impact.
Cash and cash equivalents were $316.7 million at year-end, down from $433.6 million. Current assets were $2,682.6 million and current liabilities $2,046.1 million. Investing cash outflow was $2,228.7 million, including $1,882.6 million of net acquisition spending and $312.9 million of capital expenditures. Financing cash flow was positive $631.9 million.
Total debt, including current maturities and capital leases, was approximately $6,762.1 million, compared with $5,849.5 million a year earlier. The company reported a 3.2x total-debt-to-pro-forma-EBITDA ratio and compliance with debt covenants. Its $1.0 billion revolving credit facility had no borrowings outstanding at year-end; $72.2 million of letters of credit reduced availability. Management said operating cash flow and revolver availability were sufficient for expected short- and long-term needs.
Material changes versus the prior comparable period
- Revenue growth was supported by 5.8% acquisition growth and 2.3% organic growth. Chiltern contributed $188.4 million of 2017 revenue after closing September 1; acquisitions also included PAML.
- Operating income grew more slowly than revenue. LCD margin was nearly flat, while CDD margin contracted substantially.
- Operating cash flow increased by $283.5 million, which management attributed mainly to higher earnings and improved working capital; cash balances nevertheless declined.
- FY 2017 acquisition spending rose to $1,882.6 million from $548.6 million in 2016. Goodwill and intangible assets reached $11,870.8 million, up from $9,824.9 million.
- Debt increased, including issuance of $1.2 billion of 2024 and 2027 senior notes and a $750 million term loan, partly associated with financing Chiltern.
- Share repurchases totaled $338.1 million for 2017; $401.4 million of authorization remained at year-end.
Outlook, management commentary, risks, and unusual items
- Management expected a full year of Chiltern to increase CDD revenue by approximately 13%–14% in 2018, excluding the effect of the new revenue-recognition standard.
- The company expected a 2018 consolidated effective tax rate of approximately 25%. The $519.0 million TCJA benefit was provisional and could be revised during 2018. LabCorp also announced a one-time employee payment to be made in 2018.
- For 2018, management estimated that PAMA fee schedule changes would reduce LCD revenue from affected payers by approximately 8%, or $70 million. ACLA challenged CMS’s data methodology; the outcome and any legislative changes were uncertain.
- LabCorp expected approximately $130 million of additional net savings from extending its LaunchPad efficiency program to CDD over the three years through 2020. It also expected 2018 capital expenditures of approximately 3.5% of net revenue.
- The company planned to adopt the new revenue-recognition standard retrospectively in 2018. Preliminary estimates suggested 2017 reported revenue would be 2%–5% higher on restatement, primarily from CDD presentation changes, partly offset by lower LCD revenue presentation. These estimates were not final.
- Key risks include reimbursement and test-utilization pressure, payer changes and patient collection exposure, acquisition integration and CDD profitability, competition, debt and interest costs, foreign-currency exposure, cybersecurity and privacy threats, and regulatory compliance. The filing describes multiple pending lawsuits and investigations, including False Claims Act and consumer class actions; management could not estimate reasonably probable losses for several matters.
- Unusual 2017 items included $70.9 million of restructuring charges, $23.5 million of asset impairment losses, acquisition and integration expenses, and the substantial TCJA-related tax benefit.
Important facts investors should verify
- How much of reported earnings growth reflects the one-time TCJA benefit, and what the normalized tax rate and earnings base are.
- Actual revenue and margin effects from PAMA, including the progress and outcome of the ACLA challenge.
- Whether CDD margins recover and whether Chiltern integration and the CDD LaunchPad program deliver expected savings.
- Whether operating cash flow continues to cover acquisitions, capital spending, debt service, and shareholder returns, while leverage remains within management’s targets.
- The final retrospective revenue-recognition adjustments and any material developments in the disclosed legal matters.