LABCORP HOLDINGS INC. quarterly report, Q3 FY2017

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Business context and reporting period

Laboratory Corporation of America Holdings (LabCorp) filed this unaudited Form 10-Q for the quarter ended September 30, 2017. It operates LabCorp Diagnostics (LCD) and Covance Drug Development (CDD). Amounts below are in millions of dollars unless noted.

Financial performance and position

  • Third quarter: Net revenue was $2,597.9, up 9.5% year over year, reflecting 6.9% acquisition growth, 2.3% organic growth and about 0.3% foreign-currency benefit. Operating income rose 5.3% to $341.3; net earnings attributable to LabCorp increased to $180.6 from $179.5. Diluted EPS was $1.74 versus $1.71.
  • First nine months: Net revenue was $7,504.4, up 6.4% (4.4% acquisition growth and 2.2% organic growth, partly offset by currency). Operating income was $1,010.0, up 2.1%; attributable net earnings were $561.4 versus $547.7. Diluted EPS was $5.40 versus $5.25.
  • Margins and segments: Net cost of revenues was 67.4% of net revenue in Q3 versus 66.8% a year earlier; for nine months it was 66.0% versus 66.1%. Q3 LCD operating margin was 18.3% (unchanged); CDD was 5.6% versus 7.4%. Nine-month LCD margin was 18.3% versus 18.5%; CDD was 6.3% versus 8.9%.
  • Cash flow: Nine-month operating cash flow was $895.4, up from $727.0. Investing used $2,050.4, mainly reflecting acquisitions and equity investments; capital expenditures were $216.8. Financing provided $1,111.3, including debt proceeds, partly offset by $298.1 of share repurchases. Cash declined $24.3 to $409.3.
  • Debt and liquidity: September 30 debt was $7,218.4, including $7,200.3 long-term debt, compared with $5,849.5 at year-end 2016. Current assets were $2,900.6 and current liabilities $1,537.2. The company reported a 3.5x total-debt-to-pro-forma-trailing-12-month EBITDA ratio and compliance with debt covenants. Its $1,000 revolving facility had no borrowings outstanding; $66.0 of letters of credit reduced availability.

Material changes versus the prior comparable period

  • Q3 LCD revenue grew 9.9%; requisitions rose 7.3%, including 2.3% organic growth. Hurricanes reduced volume by about 1.0%, while revenue per requisition increased 2.4%.
  • Q3 CDD revenue rose 8.6%, but operating earnings fell 17.1%. For the nine months, CDD revenue rose 1.1% while operating earnings fell 29.1%, with lower margins tied to acquisition and transaction costs, higher personnel costs, restructuring and a software-project termination.
  • Chiltern was acquired September 1 for approximately $1,224.5 in cash. It contributed $47.8 revenue and $5.3 operating income in the period. The company also completed the PAML acquisition in May and acquired other laboratories. Purchase price allocations remained preliminary.
  • Total assets increased to $16,691.8 from $14,247.0, primarily reflecting acquisitions, including higher goodwill and intangible assets. The company issued $1,200.0 of senior notes and added a $750.0 term loan during the period.

Outlook, commentary, risks and unusual items

  • Management estimated preliminary 2018 Medicare Clinical Laboratory Fee Schedule rates could reduce revenue from tests paid under that schedule by 6%–8%. Such tests represented less than 10% of total company revenue in 2016. The company said it was evaluating the proposed rates and seeking clarification or revision.
  • The expanded CDD LaunchPad initiative was expected to generate approximately $20.0 of pretax savings in 2017 and $45.0 annually thereafter, with about $30.0 of pretax charges expected in 2017. Management said LabCorp had achieved its three-year goals of $150.0 in net LaunchPad savings and $100.0 in Covance cost synergies.
  • Management expected 2017 capital expenditures of approximately 3% of net revenue and intended to continue pursuing acquisitions and investments, including in information technology. No company-wide earnings or revenue guidance was provided in the supplied filing text.
  • Q3 and year-to-date special items included restructuring, acquisition-related legal and integration costs, and $20.9 of asset impairment losses, including costs from terminating a CDD software project and forgiving certain hurricane-affected customer debt. Hurricane impacts also increased assessed collection risk and bad debt expense.
  • Risks include reimbursement and regulatory changes, notably PAMA; billing and compliance exposure; litigation; acquisition integration and leverage; customer retention and pricing; cybersecurity and systems execution; and foreign-currency and interest-rate movements. The company said two CDD reporting units remained under monitoring for potential goodwill impairment.
  • Numerous legal matters and government inquiries were disclosed. The company stated it could not estimate reasonably probable losses for certain proceedings; it did not believe currently available information indicated a material adverse effect on financial condition, though outcomes could materially affect a particular period’s results.
  • Disclosure controls were deemed effective as of September 30, 2017. PAML and Chiltern were being integrated into internal controls but were excluded from management’s 2017 annual internal-control assessment.

Important facts for investors to verify

  1. How final PAMA rates compare with the preliminary rates and the realized impact on LCD revenue and margins.
  2. Whether CDD operating performance improves as Chiltern is integrated and LaunchPad actions progress; assess realized savings against stated targets and charges.
  3. Acquisition integration, final purchase-price allocations, goodwill and intangible-asset impairment assumptions, and the performance of the two monitored CDD reporting units.
  4. Debt levels, the 3.5x leverage measure, covenant headroom, refinancing needs and cash available after acquisition spending and potential convertible-note settlements.
  5. Developments in disclosed litigation, billing inquiries, reimbursement matters and hurricane-related collections or bad debt.