Business context and reporting period
Laboratory Corporation of America Holdings (LabCorp) filed this Form 10-K for the fiscal year ended December 31, 2014. LabCorp was the second-largest independent U.S. clinical laboratory company, operating 39 primary laboratories and about 1,750 patient service centers. Its business was primarily clinical diagnostics, including core, genomic and esoteric testing.
The reported 2014 results exclude Covance. LabCorp completed its approximately $6.2 billion acquisition of Covance on February 19, 2015, after year-end; Covance’s historical 2014 revenue was approximately $2.5 billion.
Financial performance and liquidity
Amounts below are in millions, except per-share data and percentages.
| Metric | 2014 | 2013 | Change |
|---|---|---|---|
| Net sales | $6,011.6 | $5,808.3 | +3.5% |
| Gross profit | $2,203.1 | $2,223.2 | -0.9% |
| Operating income | $910.4 | $990.9 | -8.1% |
| Net earnings attributable to LabCorp | $511.2 | $573.8 | -10.9% |
| Diluted EPS | $5.91 | $6.25 | -5.4% |
| Operating cash flow | $739.0 | $818.7 | -9.7% |
| Capital expenditures | $203.5 | $202.2 | +0.6% |
Annual gross margin was approximately 36.6% versus 38.3% in 2013; operating margin was approximately 15.1% versus 17.1%, and attributable net margin was approximately 8.5% versus 9.9%. Operating cash flow less capital expenditures was approximately $535.5 million.
At December 31, 2014, cash and cash equivalents were $580.0 million, current assets $1,692.7 million and current liabilities $976.3 million. Current and long-term debt totaled approximately $3,029.8 million; the company reported year-end total debt to consolidated EBITDA of 2.5 to 1.0 and no balance outstanding on its revolving credit facility. The reported current ratio was approximately 1.7.
Fourth-quarter snapshot
| Metric | Q4 2014 | Q4 2013 |
|---|---|---|
| Net sales | $1,512.7 million | $1,437.0 million |
| Gross profit | $546.5 million | $526.1 million |
| Net earnings attributable to LabCorp | $119.6 million | $126.4 million |
| Diluted EPS | $1.37 | $1.43 |
Fourth-quarter revenue increased about 5.3%, while attributable earnings and diluted EPS declined. The filing does not provide quarterly operating income in the supplied financial tables.
Material changes versus the prior comparable period
- Total requisition volume increased 5.3% for 2014, while revenue per requisition declined 1.7% to $43.56. Management attributed the decline primarily to test and payer mix and, to a lesser extent, foreign currency translation.
- Core testing revenue rose 6.1% to $3,656.6 million. Genomic and esoteric testing revenue was nearly flat at $2,025.6 million, with revenue per requisition down 4.0%.
- Cost of sales increased 6.2%, faster than revenue, and rose to 63.4% of sales from 61.7%. SG&A increased 6.1% to $1,198.2 million; its share of sales rose to 19.9% from 19.4%.
- Cash from operations fell by $79.7 million, primarily due to lower earnings and working-capital timing. Weather was estimated to have reduced 2014 revenue by $40.0 million, compared with $12.7 million in 2013.
- Year-end cash increased to $580.0 million from $404.0 million, while total reported debt rose modestly to approximately $3.03 billion from approximately $3.00 billion. These year-end figures precede the Covance acquisition financing.
Outlook, management commentary, risks and unusual items
- Covance transaction: The acquisition was funded with approximately $4.3 billion cash and about 15.3 million LabCorp shares. Financing included a $1.0 billion five-year term loan and $2.9 billion in notes with maturities from 2020 to 2045; management reported an approximately 3.15% weighted average rate and 12-year average maturity for $3.9 billion of long-term debt. Management expects leverage to rise, intends to maintain investment-grade credit, and plans to use free cash flow to reduce debt.
- Expected benefits and near-term impact: Management expects annual Covance cost synergies exceeding $100 million within three years. It also anticipated higher interest expense and lower Covance margins affecting 2015 results. Pro forma 2014 combined revenue was $8,532.6 million and diluted EPS $5.15, but this estimate excludes anticipated synergies and includes specified transaction and acquisition-accounting adjustments; it is not reported combined-company performance.
- Operating initiatives: Project LaunchPad is intended to improve processes and efficiency. The filing describes expected savings of more than $150 million over three years with approximately $30 million of associated one-time costs; a separate business-strategy discussion cites savings exceeding $100 million. Investors should note this difference in the stated savings estimates.
- Reimbursement and payer risk: Management cited payment reductions, delayed pricing and coverage decisions for molecular pathology tests, and increased claim requirements as pressures on revenue per requisition, margins and cash flow. PAMA requires private-market data reporting beginning in 2016 and changes Medicare lab-rate setting from 2017, with limits on annual reductions during specified phase-in periods. The potential impact was not yet clear.
- Receivables and collections: Patient accounts represented about 27.1% of gross receivables. Management noted growth in patient receivables and warned that increased patient responsibility could raise bad-debt expense. The doubtful-account provision was $276.5 million in 2014, and the allowance was $211.6 million at year-end.
- Joint venture contingency: Alberta Health Services did not select LabCorp’s Alberta joint venture as preferred proponent for a laboratory-services contract. If that award stands, joint venture revenue could fall substantially and LabCorp’s $55.2 million investment could be impaired; an appeal was pending at the filing date.
- Legal and other unusual items: The filing describes False Claims Act and other billing-related matters, employment class actions, and professional-liability verdicts, including a $50 million jury verdict in a prenatal-testing case for which LabCorp was pursuing appeal. LabCorp states it could not estimate reasonably probable losses for certain matters. 2014 also included $17.8 million of restructuring charges, $18.6 million of consulting and CFO-transition costs, and $10.8 million of Covance-related costs.
- Other outlook: Management estimated 2015 capital expenditures of $185 million to $205 million. LabCorp suspended share repurchases after announcing the Covance deal and did not expect to resume them until reaching its targeted total-debt-to-EBITDA ratio of 2.5 to 1.0. No formal earnings guidance is provided in the supplied filing text.
Most important facts for investors to verify
- Actual post-acquisition debt, leverage, interest expense, integration costs and progress against Covance synergy expectations.
- Whether volume growth can offset lower revenue per requisition, reimbursement cuts and payer coverage or coding changes.
- Patient receivable aging, collections, allowance adequacy and the trajectory of bad-debt expense.
- The result of the Alberta joint-venture contract appeal and any resulting impairment or revenue impact.
- Updates on material litigation, particularly the False Claims Act inquiries and professional-liability appeals, including any changes in loss estimates or reserves.
- Reconciliation of Project LaunchPad savings estimates and the timing and costs required to achieve them.