LabCorp Holdings Inc. — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015. Unaudited results. Dollar amounts are in millions unless stated otherwise.
Business context
LabCorp completed its $6,150.7 acquisition of Covance on February 19, 2015, materially expanding the business and changing its reporting segments to LabCorp Diagnostics (LCD) and Covance Drug Development (CDD). Comparisons with 2014 are therefore substantially affected by the acquisition.
Key financial results
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net revenue | $2,269.9 | $1,551.8 | $6,260.9 | $4,498.9 |
| Operating income | $306.9 | $241.4 | $759.5 | $691.4 |
| Net earnings attributable to LabCorp | $152.8 | $137.2 | $322.6 | $391.6 |
| Diluted EPS | $1.49 | $1.59 | $3.24 | $4.53 |
| Operating cash flow | Not stated separately | Not stated separately | $597.8 | $525.3 |
- Q3 net revenue rose 46.3%; management attributed 41.7 percentage points of year-over-year growth to Covance. LCD revenue increased 6.2%, including 2.2% organic requisition growth. Nine-month net revenue rose 39.2%.
- Approximate gross margin, calculated against net revenue, was 33.6% in Q3 versus 36.8% a year earlier, and 34.5% for the nine-month period versus 36.8%. Operating margin on the same basis was approximately 13.5% versus 15.6% in Q3, and 12.1% versus 15.4% year to date.
- Q3 attributable earnings increased 11.4%, but diluted EPS fell 6.3%, reflecting the larger share count after acquisition consideration was partly paid in stock. Nine-month attributable earnings declined 17.6% and diluted EPS declined 28.5%.
- Nine-month capital expenditures were $170.7; operating cash flow less capital expenditures was approximately $427.1. Management expects 2015 capital expenditures of $270–$295.
- Cash was $713.0 at September 30, 2015, versus $580.0 at December 31, 2014. Total debt, including current maturities, was $6,681.2, versus $3,029.8 at year-end 2014. The company reported a 3.8x total-debt-to-LTM-EBITDA ratio and compliance with debt covenants.
- Current assets were $2,707.1 and current liabilities $1,844.4. The $1,000 revolving credit facility had no borrowings outstanding; $45.4 of letters of credit reduced availability.
Material changes and management commentary
- Acquisition financing and related costs drove nine-month interest expense to $218.1 from $77.4. The period included $37.4 of make-whole expense on prepaid Covance notes and $15.2 of deferred financing and bridge-loan costs.
- Q3 SG&A was 16.9% of net revenue, down from 19.7%; management cited acquisition scale, Project LaunchPad and integration synergies. LCD bad-debt expense also improved as a percentage of segment revenue.
- Nine-month restructuring and special charges were $59.9, including severance, facility closures and IT asset impairment. The company also recorded $166.0 of acquisition deal costs and $17.0 of consulting expenses related to Project LaunchPad and integration.
- Management suspended share repurchases following the acquisition and does not expect to resume them until leverage approaches its 2.5x debt-to-EBITDA target. There is no specific earnings guidance in the supplied filing text.
Outlook, risks and contingencies
- A CDD committed-minimum-volume contract representing approximately $70 of annual revenue was scheduled to expire October 31, 2015. The company was evaluating a wind-down; related additional employee and facility costs were under negotiation and not yet determinable.
- Covance purchase accounting remained preliminary, particularly for certain tax items and intangible assets; management expected to complete the valuation by year-end 2015. Acquired Covance operations were still being integrated, and management said they would be excluded from its 2015 annual internal-control assessment.
- The company identified reimbursement and regulatory changes, payer and customer consolidation, acquisition integration and synergy execution, contract cancellations or cost overruns, foreign exchange, cybersecurity, and litigation as risks. It noted proposed Medicare laboratory-rate changes under PAMA and was evaluating their potential impact.
- Legal matters include government inquiries and False Claims Act allegations, as well as professional-liability and employment cases. Management stated it could not estimate reasonably probable losses for certain proceedings; outcomes could affect results in a particular period. It said California Medi-Cal reimbursement changes and recoupments were not expected to materially affect consolidated revenue or results.
- Management reported disclosure controls were effective as of September 30, 2015. It stated market-risk exposure was not material to financial position or results, while noting interest-rate and foreign-currency exposures.
Most important facts for investors to verify
- How much reported growth and earnings reflect Covance versus organic performance, and whether integration synergies materialize.
- The final Covance purchase-price allocation, including goodwill, intangible values, amortization and tax effects.
- Debt reduction pace, covenant headroom and the effect of interest costs on cash generation and EPS.
- Revenue and costs following the expiration of the CDD contract, and any resulting restructuring charges.
- Actual effects of Medicare and Medicaid reimbursement changes, including PAMA implementation and California recoupments.
- Developments in material litigation, investigations, and the Alberta joint venture’s contract renewal after March 2017.