Labcorp Holdings — Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2014. Figures are unaudited and in millions of dollars, except per-share data, percentages, and where noted.
Business context and results
Labcorp provides clinical laboratory testing through its Clinical Diagnostics Laboratory segment and operates a smaller Canadian business in its Other segment. Third-quarter growth reflected higher test volumes and fold-in acquisitions, partly offset by test and payer mix.
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Net sales | $1,551.8 | $1,462.2 | $4,498.9 | $4,371.3 |
| Gross profit | $571.2 | $547.6 | $1,656.6 | $1,697.1 |
| Operating income | $241.4 | $244.6 | $691.4 | $775.9 |
| Net earnings attributable to Labcorp | $137.2 | $148.3 | $391.6 | $447.5 |
| Diluted EPS | $1.59 | $1.63 | $4.53 | $4.81 |
| Gross margin | 36.8% | 37.4% | 36.8% | 38.8% |
| Operating margin | 15.5% | 16.7% | 15.4% | 17.8% |
Cash flow, liquidity, and debt
- For the first nine months, operating cash flow was $525.3, down from $570.0; capital expenditures were $157.2, up from $142.6. Cash and cash equivalents ended September at $575.7, versus $404.0 at year-end 2013.
- Management expected 2014 capital expenditures of approximately $205.0, primarily for laboratory platform replacements and customer-facing systems.
- Total reported debt was approximately $3,014.7, including $97.6 current and $2,917.1 long-term. The revolving facility had no borrowings; its stated capacity was $1,000.0. Debt to consolidated EBITDA was 2.5x, within the 3.0x covenant limit, and the company reported covenant compliance.
- Share repurchases totaled $229.9 in the first nine months. Labcorp suspended repurchases after announcing the Covance transaction and did not expect to resume them in the near term if the deal proceeded.
Changes and management commentary
- Third-quarter sales rose 6.1%; requisition volume increased 6.9%, while revenue per requisition fell 0.7%. Nine-month sales rose 2.9% and requisition volume increased 5.0%, but revenue per requisition declined 2.0%.
- Cost of sales rose faster than revenue. It was 63.2% of sales in Q3, versus 62.6%; for nine months it was 63.2%, versus 61.2%. SG&A was 19.7% of sales in both 2014 periods, up from 19.1% in Q3 2013 and 19.3% for the prior nine months. Management cited mix, payment reductions, cost inflation, bad debt, and consulting costs.
- Net earnings attributable to Labcorp declined 7.5% in Q3 and 12.5% for the first nine months. Results included higher interest expense following the 2013 issuance of $700.0 in senior notes. Nine-month other income included a gain on an investment sale, partly offset by an investment impairment.
- Management said payer coverage and payment delays on certain molecular pathology codes continued to affect sales and receivable write-offs, without substantial year-over-year improvement through Q3. Patient receivables had grown, though the trend was moderating; the eventual effect of ACA health plans on patient responsibility remained uncertain.
Outlook, transaction, risks, and unusual items
- No specific earnings or revenue guidance is provided in the filing. Management said operating cash flow, cash on hand, and borrowing capacity were expected to meet obligations. It expected restructuring savings to exceed related costs, which it did not expect to materially affect operations or liquidity.
- On November 2, 2014, Labcorp agreed to acquire Covance for approximately $6.1 billion, with consideration of $75.76 cash and 0.2686 Labcorp shares per Covance share. The deal was expected to close in Q1 2015, subject to conditions. Labcorp secured $4.25 billion in bridge financing and expected to arrange permanent financing. It forecast combined-company leverage of about 4.1x and planned to reduce it to 3.0x within three years, while seeking to maintain investment-grade ratings.
- Transaction risks include regulatory and shareholder approvals, delay or termination, financing and integration challenges, higher debt and lower cash, possible dilution, customer or employee disruption, and failure to realize expected benefits. A $305 million termination fee may apply in specified circumstances.
- Legal and regulatory exposures include healthcare billing investigations and False Claims Act matters, employment and consumer class actions, and professional-liability claims. The company said certain outcomes could materially affect an individual period; it could not estimate reasonably probable losses for some cases. A $50.0 jury verdict in a prenatal-testing case was under appeal; another case was remitted to a $4.4 judgment and a new trial on damages was ordered.
- An $11.7 after-tax out-of-period adjustment was recorded in Q3 to reduce a post-retirement medical liability and increase other comprehensive income; management considered it immaterial to current and prior periods. Restructuring charges were $15.4 for the nine months. The company also recorded $10.1 of consulting expenses, including process-improvement, CFO-transition, and acquisition-related costs.
Important facts for investors to verify
- Whether the Covance acquisition closed on the expected terms and timetable, and the final financing, share issuance, leverage, and integration costs.
- Subsequent trends in test volume, revenue per requisition, payer mix, government reimbursement, molecular-code collections, bad debt, and patient receivables.
- Operating cash generation, capital spending, debt levels, covenant headroom, and progress toward the stated deleveraging objective.
- Developments in material litigation and government inquiries, including the appeals and cases described in the filing, and any resulting reserve or cash impact.