Business context and reporting period
Labcorp Holdings filed this unaudited Form 10-Q for the three months ended March 31, 2016. The company operates LabCorp Diagnostics (LCD) and Covance Drug Development (CDD); LCD and CDD contributed 69.3% and 30.7% of net revenue, respectively. The comparison with Q1 2015 is affected by Covance’s acquisition, completed February 19, 2015, so the prior-year quarter included only part of Covance’s results.
Key financial metrics
Amounts are in millions except per-share data and percentages.
| Metric | Q1 2016 | Q1 2015 |
|---|---|---|
| Net revenue | $2,295.2 | $1,772.3 |
| Total revenues, including reimbursable expenses | $2,368.0 | $1,793.2 |
| Gross profit | $777.3 | $625.1 |
| Operating income | $301.9 | $132.4 |
| Net earnings attributable to Labcorp | $160.2 | $3.1 |
| Diluted EPS | $1.55 | $0.04 |
| Cash provided by (used in) operations | $123.0 | $(86.9) |
| Capital expenditures | $71.4 | $33.8 |
Net revenue increased 29.5%. Gross margin was approximately 33.9% of net revenue (35.3% in Q1 2015); operating margin was approximately 13.2% (7.5%); net margin attributable to Labcorp was approximately 7.0% (0.2%). The 2015 comparison was weighed down by acquisition-related charges, including $166.0 of deal costs and a $37.4 debt make-whole payment, as well as other acquisition-period items.
LCD net revenue rose 8.1% to $1,590.6 and segment operating earnings increased to $277.0 from $210.4. LCD growth reflected 3.3% higher requisition volume, 2.0% price and mix, 1.1% Beacon LBS contribution and 2.2% from tuck-in acquisitions, partly offset by 0.5% currency impact. CDD net revenue increased 134.6% to $704.6 and segment operating earnings were $63.0 versus a $50.4 loss. The year-over-year CDD increase primarily reflects a full quarter of results in 2016 versus only the post-acquisition period in 2015, along with broad-based demand; an expired minimum-volume contract and currency partly offset growth.
Cash and cash equivalents were $696.3 at March 31, 2016, down from $716.4 at year-end. Current assets were $2,744.9 and current liabilities $1,642.7 (current ratio approximately 1.67). Total debt was approximately $6,394.9, including current maturities; cash-adjusted debt was approximately $5,698.6. The company reported a 3.5-to-1 total-debt-to-trailing-12-month-EBITDA ratio, no revolver borrowings, and compliance with debt covenants. Operating cash flow improved by $209.9 year over year, primarily due to higher earnings; working-capital movements included a $105.8 increase in accounts receivable.
Material changes, outlook and risks
- Net cost of revenues rose 32.3%, faster than revenue, and reached 66.1% of net revenue versus 64.8%; management attributed this primarily to the full-quarter inclusion of CDD, which has higher personnel costs as a share of revenue. SG&A fell to 17.9% of net revenue from 25.0%; excluding specified special charges, it was 17.5% versus 18.6%.
- Q1 2016 restructuring and special charges were $19.2, including facility closure costs, severance, acquisition integration-related costs, accelerated executive equity compensation and Project LaunchPad costs. A substantial portion related to planned closure of duplicative data-center operations.
- Management expects 2016 capital expenditures of approximately 3.0% of net revenue, principally for core-business growth, Project LaunchPad and Covance integration. The filing provides no full-year earnings or revenue guidance. Share repurchases remain suspended until leverage approaches the company’s 2.5-to-1 target.
- On April 4, 2016, the company announced that holders could convert zero-coupon subordinated notes during the quarter ending June 30, 2016; any cash settlement would use cash on hand and/or the revolving facility. The notes also accrue contingent cash interest for March 12–September 11, 2016.
- Risks include healthcare reimbursement and regulatory changes, billing and False Claims Act matters, litigation, privacy and cybersecurity, acquisition integration and leverage, and foreign-exchange exposure. The company said it could not estimate a reasonably probable loss range for certain proceedings; it did not believe currently known outcomes would materially harm financial condition, though period results could be affected. Its Alberta laboratory joint venture’s contract was extended through March 31, 2017; nonrenewal could substantially reduce revenue and potentially impair the investment. Management said California Medi-Cal reimbursement changes and related recoupments were not expected to materially affect consolidated results.
- Foreign-currency-denominated revenue was 19.3% of net revenue. A hypothetical 10% exchange-rate change would have affected Q1 pretax income by approximately $2.7, excluding hedging effects. Disclosure controls were reported effective, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much reported growth and profit improvement reflects the Covance acquisition and comparison-period differences versus continuing organic performance.
- Whether operating cash flow converts to earnings as receivables and other working-capital balances change.
- Debt reduction progress toward the 2.5-to-1 leverage target, and potential cash requirements from note conversions, maturities and acquisitions.
- Execution and costs of restructuring, data-center closures, Project LaunchPad and Covance integration, including expected capital spending.
- Developments in significant legal, reimbursement and government-inquiry matters, and renewal of the Alberta joint venture contract after March 2017.