Labcorp Holdings Inc. — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011, compared with the corresponding 2010 periods. Unaudited results; amounts in millions except per-share data.
Business context and financial performance
Labcorp provides clinical laboratory testing. Management cited growth in core and esoteric testing, pricing discipline and expense control. Growth also reflects the December 2010 Genzyme Genetics acquisition; post-acquisition billing delays continued to affect collections and days sales outstanding (DSO).
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net sales | $1,404.5 | $1,276.5 | $4,176.2 | $3,708.5 |
| Gross profit | $568.5 | $527.7 | $1,725.1 | $1,568.2 |
| Operating income | $239.4 | $235.3 | $700.9 | $740.0 |
| Net earnings attributable to Labcorp | $134.3 | $140.0 | $384.3 | $426.4 |
| Diluted EPS | $1.31 | $1.34 | $3.76 | $4.05 |
| Operating cash flow | Not stated separately for the quarter | $577.0 | $624.4 |
Q3 revenue rose 10.0%; nine-month revenue rose 12.6%. Q3 sales increased in routine testing (5.4%), genomic and esoteric testing (17.7%) and Ontario (12.1%). Nine-month increases were 6.5%, 23.6% and 11.1%, respectively. Across all testing, requisition volume increased 2.1% in Q3 and 4.3% year to date; revenue per requisition grew 7.8% and 8.0%.
Gross margin was approximately 40.5% in Q3 versus 41.3% a year earlier, and 41.3% year to date versus 42.3%. Operating margin was approximately 17.0% versus 18.4% in Q3 and 16.8% versus 20.0% year to date. Lower margins at recently acquired businesses, not yet fully integrated, and higher restructuring and special charges weighed on profitability. Nine-month SG&A included the $34.5 net Hunter Labs settlement expense.
Cash, debt and liquidity
- Cash was $85.8 at September 30, 2011, down from $230.7 at December 31, 2010. Nine-month operating cash flow was $577.0; capital expenditures were $115.6.
- Total debt, including current maturities, was approximately $1,983.6, down from $2,188.4 at year-end. The revolving facility had no balance outstanding. The company used $150.6 cash to settle conversions of zero-coupon subordinated notes and paid down term debt.
- Current assets were $1,072.6 and current liabilities $982.2. Current liabilities included $140.7 for an Ontario joint-venture noncontrolling-interest put.
- Management said available cash flow and senior credit facilities should be sufficient for anticipated short- and long-term needs. The company complied with debt covenants; leverage was 1.6x and interest coverage 15.3x against limits of no more than 2.5x and at least 5.0x, respectively.
Changes, outlook and notable items
- Despite higher revenue, nine-month operating income fell 5.3% and attributable earnings fell 9.9%; diluted EPS declined from $4.05 to $3.76. Q3 attributable earnings declined 4.1%.
- Nine-month restructuring and special charges were $70.3, versus $13.2 in 2010. The 2011 total included $39.1 net restructuring costs, $16.4 of fixed-asset impairments and a $14.8 write-off of assets and liabilities related to a prior investment. Management estimated annualized savings of approximately $72.2 from the restructuring initiatives; Q3 initiatives were expected to deliver approximately $23.7 annually.
- Management expected 2011 capital expenditures of approximately $150.0. No earnings or revenue guidance was provided in the filing.
- Genzyme Genetics billing-system conversion and enrollment delays hurt collections, receivable aging and DSO. Management expected billing and collections to catch up. Severe winter weather reduced estimated nine-month volume by 0.5 million requisitions and revenue by $22.0 in 2011; the comparable 2010 impact was 0.6 million requisitions and $23.0.
- Labcorp paid $49.5 in Q3 to settle the Hunter Labs California Medicaid-billing lawsuit, without admitting liability; it had recorded $34.5 of net settlement expense in Q2 after prior reserves. The company also disclosed a newly unsealed False Claims Act suit alleging kickbacks; the government had not intervened, and Labcorp said it would defend the case. Other billing-related subpoenas and proceedings remain outstanding.
- The proposed Orchid Cellmark acquisition was for approximately $85.4. FTC review included a Second Request, and shareholder lawsuits were pending; closing was expected in Q4, subject to conditions and regulatory clearance.
- After quarter-end, Labcorp gave notice of its intent to purchase Ontario joint-venture units for C$147.8 plus adjustments, with closing anticipated November 28, 2011. The transaction was expected to increase its ownership from 85.6% to 98.2%. A put right also exposed the company to a possible purchase obligation at December 31, 2011.
- Zero-coupon noteholders could convert during Q4 2011; any cash portion was expected to be funded with cash on hand and/or the revolving facility. None of the notes was tendered for purchase on September 12.
- Key risks include reimbursement and regulatory changes, government billing investigations, litigation, integration and collection execution, competitive pricing, information-system security, and international operating and currency risks. Management reported effective disclosure controls and no material quarterly change in internal control over financial reporting.
Investor verification priorities
- Track Genzyme Genetics billing catch-up, collections, DSO and bad-debt trends, and whether acquired operations improve margins as integration proceeds.
- Assess whether the restructuring savings materialize and how recurring operating performance compares after excluding the unusually high 2011 charges.
- Review cash use and funding needs, including zero-coupon note conversions, debt maturities, share repurchases and the Ontario joint-venture purchase or put obligations.
- Monitor Orchid’s FTC review and litigation, and the status and potential financial exposure of the False Claims Act and other billing matters.
- Confirm capital spending against the approximately $150.0 full-year expectation and evaluate whether operating cash flow remains adequate for investment and capital returns.