Business context and reporting period
Labcorp Holdings’ Form 10-K covers the fiscal year ended December 31, 2015; it is an annual report, not a standalone fourth-quarter filing. Labcorp operates two segments: LabCorp Diagnostics (LCD), clinical laboratory testing, and Covance Drug Development (CDD), contract research and drug development services. Covance was acquired on February 19, 2015, so 2015 results include it for only part of the year. LCD and CDD represented 72.9% and 27.1% of 2015 net revenue, respectively.
Key financial metrics
Amounts are U.S. dollars in millions, except per-share amounts and ratios.
| Metric | 2015 | 2014 |
|---|---|---|
| Net revenue | $8,505.7 | $6,011.6 |
| Gross profit | $2,903.3 | $2,203.1 |
| Operating income | $1,002.9 | $910.4 |
| Net earnings attributable to Labcorp | $436.9 | $511.2 |
| Diluted EPS | $4.34 | $5.91 |
| Cash from operating activities | $982.4 | $739.0 |
| Capital expenditures | $255.8 | $203.5 |
| Cash and cash equivalents at year-end | $716.4 | $580.0 |
| Total debt, including current portion | $6,417.0 | $3,029.8 |
Revenue rose 41.5%, driven mainly by Covance, which contributed $2,209.7 after acquisition; organic revenue growth excluding currency was 4.6%. Gross margin was approximately 34.1% versus 36.6% in 2014, operating margin approximately 11.8% versus 15.1%, and attributable net margin approximately 5.1% versus 8.5%. These percentages are calculated from reported figures. Lower earnings reflected acquisition financing costs, integration and restructuring charges, and Covance’s historically lower margins.
Interest expense increased to $274.9 from $109.5. Operating cash flow less capital expenditures was approximately $726.6, a derived measure. Investing cash outflow was $3,994.9, chiefly reflecting the Covance acquisition; financing provided $3,184.6. The current ratio was approximately 1.57, calculated from reported current assets and liabilities. Management said cash flow and available revolving credit were sufficient for anticipated needs.
At year-end, debt-to-consolidated EBITDA was 3.6x, and the company reported compliance with credit-facility covenants. Its $1.0 billion revolving facility had no borrowings outstanding, though $45.4 of letters of credit reduced availability. Management’s capital-allocation target is to reduce leverage to 2.5x before considering resumed share repurchases.
Material changes versus the prior comparable period
- Covance’s acquisition substantially expanded revenue, assets, goodwill and debt; total assets rose to $14,221.7 from $7,301.8, while long-term obligations increased to $6,417.0 from $3,029.8.
- Attributable net earnings fell 14.5% and diluted EPS fell from $5.91 to $4.34, despite higher revenue and operating income. Interest expense more than doubled, and the effective tax rate increased to 40.2% from 38.0%.
- Operating cash flow increased by $243.4, supported by acquired CDD operations and improved working capital; 2015 also included $153.5 of acquisition-related cash payments that reduced operating cash flow.
- LCD revenue increased 6.2%; requisition volume grew 3.2%, BeaconLBS contributed 0.9%, acquisitions added 2.5%, and currency reduced revenue by 0.8%. CDD revenue was $2,306.4, largely reflecting the acquisition.
- Net restructuring charges rose to $113.9 from $17.8, including $26.7 of asset impairment. The filing also reports $166.0 of acquisition deal costs, $25.6 of consulting expenses for LaunchPad and integration, and a $37.4 make-whole payment on Covance debt in interest expense.
Outlook, commentary, risks and unusual items
- Management expected Covance’s first full year of inclusion in 2016 to provide approximately 4.0% additional revenue, based on Covance’s pre-acquisition 2015 revenue. This is not presented as full-year company revenue guidance.
- Labcorp reported $45.0 of acquisition synergies in 2015 and expected annual cost synergies exceeding $100.0 within three years of closing. Project LaunchPad generated approximately $65.0 of net savings in 2015; the company expects more than $150.0 in net savings over 2015–2017.
- Reimbursement remains a material risk. The filing estimates a $10.7 reduction in net revenue from Physician Fee Schedule changes over 2016–2017 ($2.4 in 2016 and $8.3 in 2017), partly offset by a stated 0.10% Clinical Laboratory Fee Schedule increase of approximately $0.76 in 2016. The impact of proposed PAMA pricing rules was not yet clear.
- Patient-responsibility balances and collection performance warrant attention. Management reported growth in patient accounts receivable and cautioned that continued cost shifting to patients could require higher doubtful-account allowances and bad-debt expense.
- Acquisition integration, foreign-currency exposure, competition, clinical trial contract delays or cancellations, regulatory compliance, cybersecurity and privacy, and healthcare fraud-and-abuse investigations are among the disclosed risks. Covance’s purchase-price allocation remained preliminary, principally pending final deferred-tax and goodwill allocations.
- Material legal matters include False Claims Act and state Medicaid billing cases. In a Washington professional-liability case, a $50.0 jury verdict allocated 50% liability to Labcorp; the company sought further review and said insurance and reserves were sufficient. A Florida case had a $4.4 judgment after remittitur, with a damages retrial pending. Management said it could not estimate reasonably probable losses for certain proceedings.
- The Alberta joint-venture laboratory contract was extended through March 31, 2017; failure to renew could substantially reduce that venture’s revenue and potentially impair Labcorp’s investment. The filing reported no goodwill impairment in 2015.
- The unaudited quarterly table appears to label quarterly revenue as “Net earnings”: its quarterly values sum to annual revenue. It reports fourth-quarter attributable earnings of $114.2 and diluted EPS of $1.11. Verify the quarterly revenue figure and presentation against the filed financial statements before relying on it.
Most important facts for investors to verify
- How much of 2015 growth and operating income is attributable to the partial-year Covance contribution versus underlying organic performance, and whether expected synergies are being realized.
- Debt reduction, interest costs and the path from 3.6x leverage toward management’s 2.5x share-repurchase threshold.
- Final PAMA reimbursement rules and realized impacts of Medicare and other payer changes, including patient bad debt and collections.
- Covance integration costs, final purchase accounting, and the sustainability of reported margins and cash flow.
- Developments in significant billing and professional-liability matters, the Alberta contract renewal, and fourth-quarter figures given the apparent quarterly-table labeling issue.