Business context and reporting period
Laboratory Corporation of America Holdings (Labcorp) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2011. The company provides clinical laboratory testing. Results reflect the December 2010 Genzyme Genetics acquisition, organic testing-volume growth, and a continued shift toward higher-priced genomic and esoteric tests. Interim results are not necessarily indicative of full-year performance.
Key financial metrics
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $1,403.3 million | $1,238.4 million | $2,771.7 million | $2,432.0 million |
| Operating income | $225.7 million | $270.5 million | $461.5 million | $504.7 million |
| Net earnings attributable to Labcorp | $122.9 million | $153.7 million | $250.0 million | $286.4 million |
| Diluted EPS | $1.20 | $1.46 | $2.44 | $2.70 |
| Cash provided by operating activities | Not presented separately | Not presented separately | $400.2 million | $448.2 million |
- Revenue and volumes: Sales rose 13.3% in Q2 and 14.0% for the first half. Total requisitions increased 4.8% and 5.4%, respectively; total revenue per requisition increased 8.1% and 8.2%. Genomic and esoteric testing revenue grew 26.1% in Q2 and 26.8% for the first half, with acquisition contributions, volume growth, and mix/pricing effects.
- Profitability: Q2 gross margin was approximately 41.9%, versus 43.1% a year earlier; operating margin was approximately 16.1%, versus 21.8%. For the first half, gross margin was approximately 41.7%, versus 42.8%, and operating margin was approximately 16.7%, versus 20.8%. Higher costs at acquired businesses not yet fully integrated, labor costs, and special charges weighed on margins.
- Cash flow and capital spending: First-half operating cash flow fell 10.7% year over year, to $400.2 million. Capital expenditures were $75.2 million, compared with $59.0 million. Cash and cash equivalents were $118.9 million at June 30, down from $230.7 million at year-end 2010.
- Debt and liquidity: Current and long-term debt totaled $2,003.3 million at June 30, compared with $2,188.4 million at December 31, 2010. The company spent $149.1 million in cash to settle conversions of zero-coupon subordinated notes and repaid $37.5 million of term-loan principal. The company reported compliance with debt covenants; leverage and interest-coverage ratios were 1.6-to-1 and 14.9-to-1, respectively. Management said available facilities and operating cash flow were sufficient for anticipated needs.
- Share repurchases: Labcorp repurchased approximately 3.5 million shares for $325.8 million in the first half; $408.5 million remained authorized at June 30.
Material changes versus the prior comparable period
- Revenue growth did not translate into higher earnings: Q2 operating income declined 16.6% and attributable net earnings declined 20.0%; first-half operating income declined 8.6% and attributable net earnings declined 12.7%.
- Interest expense increased 44.8% in Q2 and 54.6% for the first half, primarily reflecting the $925 million senior-notes issuance used to help finance Genzyme Genetics.
- SG&A increased 31.5% in Q2 and 23.2% for the first half. It included a $34.5 million net charge for the California Hunter Labs settlement, legal costs related to the proposed Orchid acquisition, and acquired-business expenses.
- First-half operating cash flow was lower, with management citing Genzyme Genetics billing and payer-enrollment delays and the timing of vendor payments. Receivables and days sales outstanding were also affected.
Outlook, commentary, risks and unusual items
- Management expected Genzyme Genetics billing and collection delays to be resolved and brought up to date during Q3 2011. It forecast approximately $150 million of capital expenditures for 2011.
- Restructuring initiatives were expected to produce approximately $48.5 million in annualized savings during the first half; Q2 initiatives alone were expected to produce approximately $35.2 million. First-half charges included $24.2 million net restructuring costs, $7.2 million of fixed-asset impairment, and a $14.8 million write-off related to a prior-year investment.
- The company agreed in principle to pay $49.5 million to settle the California Medicaid-billing lawsuit, without admitting liability; it recorded $34.5 million of expense after a previously recorded $15.0 million reserve. Settlement documentation remained to be completed.
- Other legal and regulatory matters included Medicaid-billing subpoenas and a wrongful-termination judgment of approximately $10 million under appeal. Management said it could not estimate reasonably possible losses for certain proceedings and did not expect currently known matters to materially adversely affect financial condition, though individual-period results could be affected.
- The Ontario joint-venture partner could put its units to Labcorp on December 31, 2011; $153.4 million was classified as a current liability. The company also faced a required offer to repurchase zero-coupon notes on September 12, 2011 and possible additional conversions.
- The proposed Orchid Cellmark acquisition, for approximately $85.4 million, was expected to close in Q3 subject to conditions. The FTC issued a second information request, extending the antitrust review period; related shareholder suits were also pending.
- Stated risks include reimbursement and regulatory changes, government audits and billing investigations, price competition, acquisition integration, collections and bad debt, litigation, information security and technology, and increasing international operating and foreign-exchange exposure. Management reported effective disclosure controls and no material quarter-end change in internal control over financial reporting.
Important facts for investors to verify
- Whether Genzyme Genetics billing delays were resolved in Q3 and receivables and days sales outstanding improved as expected.
- Whether acquired-business integration and restructuring deliver the projected savings and help restore margins.
- The final terms, timing, and cash impact of the Hunter Labs settlement, and developments in other billing investigations and litigation.
- The outcome of the Orchid FTC review and acquisition, and any resulting costs or liabilities.
- Cash requirements from the Ontario put and zero-coupon note repurchase/conversion provisions, alongside ongoing debt, capital spending, and share repurchases.