LabCorp Holdings Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016; unaudited. Financial amounts are in millions of dollars except per-share data. LabCorp reports LabCorp Diagnostics (LCD) and Covance Drug Development (CDD).
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net revenue | $2,372.7 | $2,269.9 | $7,049.9 | $6,260.9 |
| Operating income | $324.0 | $308.1 | $989.0 | $760.3 |
| Net earnings attributable to LabCorp | $179.5 | $154.7 | $547.7 | $327.6 |
| Diluted EPS | $1.71 | $1.50 | $5.25 | $3.29 |
| Operating cash flow | Not separately reported | Not separately reported | $727.0 | $597.8 |
- Q3 net revenue grew 4.5%; operating income grew 5.2%, attributable net earnings grew 16.0%, and diluted EPS grew 14.0% year over year. Q3 gross profit was $788.4; net cost of revenues was 66.8% of net revenue versus 66.3% a year earlier. SG&A was 16.9% of net revenue versus 17.0%.
- Nine-month net revenue increased 12.6%; operating income increased 30.1%, attributable net earnings 67.2%, and diluted EPS 59.6%. The comparison is affected by Covance being included for only part of the 2015 period and by substantial acquisition-related costs in 2015.
- LCD revenue rose 4.4% in Q3 and 5.9% year to date. CDD revenue rose 4.8% in Q3 and 31.9% year to date; the year-to-date increase largely reflects a full nine months of Covance in 2016 versus the period after the February 2015 acquisition close.
- Nine-month operating cash flow increased $129.2. Capital expenditures were $204.6, leaving operating cash flow less capital expenditures of $522.4. Working-capital use increased, including higher receivables and unbilled services.
- Cash was $567.6 at September 30, 2016, down from $716.4 at December 31, 2015. Total debt, including current and long-term debt, was approximately $6,171.4, down from approximately $6,364.2. The reported debt-to-trailing-12-month EBITDA ratio was 3.3x; the company was in compliance with debt covenants. No revolving-credit borrowings were outstanding; the facility provided up to $1,000.0, subject to its terms, and $54.7 of letters of credit reduced availability.
Changes, outlook and unusual items
- LabCorp completed its acquisition of Sequenom on September 7 for $249.1 net of cash acquired and assumed $130.0 of debt. Management expected the acquisition to be accretive in its first year; the purchase-price allocation remained preliminary. On October 6, after quarter-end, the company acquired Center for Disease Detection for $115.0.
- Management expected 2016 capital expenditures to be approximately 3.0% of net revenue, principally for growth, LaunchPad business-process improvements and Covance integration. The filing provides no specific earnings or revenue guidance.
- Nine-month restructuring and special charges were $48.6, including severance and facility-closure costs; a substantial portion related to planned closure of duplicative data-center and other facilities. The company also reported acquisition, integration, executive-transition and LaunchPad costs. Q3 included a $2.3 non-cash impairment loss on a venture-fund investment and $5.6 of interest expense tied to early retirement of Sequenom debt.
- Early adoption of share-based-payment accounting generated a $13.4 tax benefit for the first nine months, including $3.6 in Q3. The effective tax rate was 31.7% in Q3 and 33.8% year to date, down from 38.4% and 40.8%, respectively, in 2015; management cited the accounting change, tax-reserve reversals and foreign earnings mix, among other factors.
- Share repurchases remained suspended following the Covance acquisition. The company said it did not anticipate resuming them until leverage approached its 2.5x target.
Risks and contingencies
- Healthcare reimbursement and regulatory changes remain material risks. Under the PAMA final rule, new Medicare clinical-laboratory fee-schedule rates are scheduled to take effect January 1, 2018, with reductions phased in over six years. Management said the full impact would not be known until CMS releases the rates; Medicare CLFS reimbursement is less than 10% of consolidated revenue.
- The filing describes multiple government inquiries and lawsuits concerning billing, alleged False Claims Act violations, consumer claims and other matters. LabCorp said it could not estimate reasonably probable losses for certain proceedings; it did not expect currently known outcomes to materially adversely affect financial condition, though results in a particular period could be affected.
- Other stated exposures include payer pricing and utilization changes, collection and bad-debt risk, acquisition integration and leverage, foreign exchange and interest rates, data security and technology execution, and uncertainty surrounding the UK’s planned exit from the EU.
- Management reported effective disclosure controls as of September 30, 2016, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether organic testing volumes, pricing and payer mix sustain LCD growth, and whether CDD’s demand offsets the expiration of its minimum-volume service contract.
- Sequenom’s integration, realized accretion and final purchase-price allocation, as well as the performance and funding of other acquisitions.
- Debt reduction, covenant headroom and liquidity needs, including cash settlements arising from convertible-note conversions and the company’s path toward its 2.5x leverage target.
- The eventual CMS PAMA rates and their effect on reimbursement, margins and cash collections.
- Developments in the disclosed legal and regulatory matters, restructuring execution, and planned capital expenditure and integration costs.