Business context and reporting period
Laboratory Corporation of America Holdings (LabCorp) filed this unaudited Form 10-Q for the three months ended March 31, 2018. It operates LabCorp Diagnostics (LCD) and Covance Drug Development (CDD), which generated 62% and 38% of quarterly revenue, respectively. Comparisons with first-quarter 2017 reflect retrospective adoption of ASC 606.
Financial performance and position
Amounts are in millions of dollars except per-share data. Year-over-year comparisons are against the restated 2017 quarter.
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Revenue | $2,848.3 | $2,413.7 | +18.0% |
| Gross profit / margin | $779.0 / 27.3% | $712.5 / 29.5% | Margin down 2.2 percentage points |
| Operating income / margin | $305.4 / 10.7% | $318.1 / 13.2% | Income down 4.0% |
| Net earnings attributable to LabCorp | $173.2 | $183.0 | Down 5.4% |
| Diluted EPS | $1.67 | $1.75 | Down 4.6% |
| Cash from operations | $154.7 | $225.9 | Down $71.2 |
| Capital expenditures | $72.5 | $72.2 | Approximately unchanged |
Revenue growth comprised 13.4% from acquisitions, 3.2% organic growth and approximately 1.5% favorable currency translation. LCD revenue rose 8.0%; CDD revenue rose 39.3%, primarily reflecting acquisitions. Management reported LCD requisition volume growth of 3.0%, partly offset by 0.9% negative price and mix, including lower reimbursement following PAMA implementation.
At March 31, cash was $361.8, current assets $2,896.6 and current liabilities $2,104.0. Total debt was approximately $6,777.0, comprising $417.7 current and $6,359.3 long-term debt; cash-adjusted debt was approximately $6,415.2. The company had $15.0 outstanding on its $1,000.0 revolving facility and $72.2 of letters of credit that reduce facility availability. Its total-debt-to-pro-forma-trailing-12-month-EBITDA ratio was 3.3 to 1.0; it reported compliance with debt covenants. Operating cash flow less capital expenditures was approximately $82.2, calculated from reported figures.
Material changes and unusual items
- Operating income declined despite strong revenue growth. Consolidated gross margin fell to 27.3% from 29.5%; management cited acquisition-related costs and a $31.0 one-time employee bonus, as well as reimbursement pressure. The bonus was recorded primarily in cost of revenues ($24.8) and SG&A ($6.2).
- SG&A was $397.0, up 15.8%; amortization was $62.3, up 30.9%; restructuring and other special charges were $14.3 versus $3.9. The company also reported $17.9 of integration and other costs, primarily related to Chiltern, and $3.1 of integration consulting costs.
- Interest expense increased 21.2% to $63.5, primarily due to debt issued and the new term loan associated with the Chiltern acquisition. Operating cash flow fell, which management attributed primarily to the bonus payment and working-capital needs supporting business growth.
- ASC 606 was adopted using the full retrospective method. It changed revenue presentation and timing, including gross presentation of certain CDD investigator fees and classification of LCD bad-debt expense as a reduction of revenue. The filing says the accounting change increases revenue and lowers earnings, with no cash-flow impact.
- The TCJA reduced the federal corporate tax rate, but its other provisions partly offset the benefit. The company recorded $14.9 of additional provisional tax expense in Q1 and said its TCJA accounting remained subject to refinement.
Outlook, risks and contingencies
Management expected 2018 revenue growth of 10%–12%, driven by the Chiltern and PAML acquisitions, organic growth and favorable currency translation; it forecast a consolidated effective tax rate of approximately 25% and capital expenditures of approximately 3.5% of revenue. It also intended to continue pursuing acquisitions and investing in information technology and operational efficiency. These are forward-looking expectations, not guarantees.
Key disclosed risks include changes to healthcare reimbursement and coverage, including PAMA; regulatory, billing, privacy and cybersecurity matters; competition and customer or contract losses; acquisition integration and leverage; and litigation. The filing describes multiple pending lawsuits and investigations, including False Claims Act and employment matters. The company stated that it could not estimate reasonably probable losses for certain proceedings; outcomes could affect results in a particular period. It said it did not then expect those matters to have a material adverse effect on financial condition.
Subsequent events: on April 30, 2018, LabCorp agreed to sell Covance Food Solutions for $670.0 in cash. On April 2, holders of zero-coupon subordinated notes became eligible to convert under the specified terms through June 29; LabCorp said it could fund the cash portion with cash on hand or revolving-facility borrowings. On April 24, the board increased the share-repurchase authorization to $1,000.0, with no expiration.
Important facts for investors to verify
- How much of reported revenue growth and future growth is attributable to acquisitions, organic volume, price and mix, and currency—and how ASC 606 affects comparability.
- Whether margins and operating income recover as the one-time bonus and acquisition-integration costs subside, particularly amid PAMA reimbursement pressure.
- Working-capital trends, cash conversion, planned capital expenditures and the effects of the $670.0 divestiture on proceeds and ongoing operations.
- Debt, leverage, interest costs, available revolver capacity, and any cash or borrowing needs if zero-coupon note conversions occur.
- Final TCJA tax accounting and the effective tax rate achieved against management’s approximately 25% expectation.
- Developments in disclosed litigation and regulatory matters, for which the filing does not provide clear loss estimates.