Labcorp Holdings Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019. Labcorp operates LabCorp Diagnostics (LCD) and Covance Drug Development (CDD); they represented approximately 62% and 38% of quarterly revenue, respectively. Amounts are in millions of dollars except per-share data.
Financial performance
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Revenue | $2,791.2 | $2,848.3 | -2.0% |
| Gross profit / margin | $789.7 / 28.3% | $779.0 / 27.3% | Margin +1.0 percentage point |
| Operating income / margin | $318.2 / 11.4% | $305.4 / 10.7% | Income +4.2% |
| Net earnings attributable to Labcorp | $185.6 | $173.2 | +7.2% |
| Diluted EPS | $1.86 | $1.67 | +11.4% |
| Cash from operations | $165.8 | $179.7 | -$13.9 |
| Capital expenditures | $94.2 | $72.5 | +$21.7 |
Gross margin improved as cost of revenues fell 3.3%, including because the prior-year period included a one-time employee bonus. Operating performance diverged by segment: LCD operating income declined 11.6% to $268.3, with margin down 1.5 percentage points to 15.6%; CDD operating income rose 128.0% to $88.0, with margin up 4.6 points to 8.2%. Interest expense declined to $56.7 from $63.5. The effective tax rate was 27.0%, versus 28.6%.
Cash, debt and liquidity
- Cash was $348.8 at quarter-end, down $78.0 from year-end 2018. Operating cash flow of $165.8 was more than offset by $140.5 used in investing and $103.2 used in financing.
- Operating cash flow less capital expenditures was approximately $71.6, compared with $107.2 in Q1 2018.
- Total debt was approximately $6.0 billion, comprising $501.7 of current borrowings and current maturities and $5,495.6 of long-term debt. The $500.0 of 2.625% notes due 2020 was classified as current.
- The company had no revolving-credit borrowings and reported $1.0 billion of revolving capacity, reduced by $72.2 of letters of credit. It was in covenant compliance; total debt to trailing-12-month pro forma EBITDA was 3.0 to 1.0.
- Adoption of lease accounting added $770.0 of operating lease liabilities; quarter-end operating and finance lease liabilities totaled $765.8 and $56.4, respectively. The adoption materially affected the balance sheet but not the income statement.
Changes, outlook and management commentary
- Revenue fell 2.0%, primarily from business dispositions (-1.8 percentage points), PAMA reimbursement changes (-1.0 point) and foreign exchange (-approximately 0.9 point), partly offset by organic growth of 1.2% and acquisitions of 0.5%.
- LCD revenue declined 2.7%; excluding the approximately 1.5% PAMA impact, LCD organic revenue growth was 1.9%. CDD revenue declined 0.4%, as foreign exchange offset organic growth and acquisitions.
- Management expected an additional approximately $115 million of 2019 revenue reduction from PAMA, absent further delay or change. PAMA had reduced 2018 revenue by approximately $70 million.
- Management expected 2019 capital expenditures of approximately 4% of revenue. It stated that LCD LaunchPad phase II was expected to generate approximately $200 million in net savings over three years, with approximately $40 million of one-time implementation costs and roughly one-third of savings each year. CDD LaunchPad was on track for $150 million in savings by end-2020; Chiltern integration synergies were expected to reach $30 million by end-2019.
- On April 17, 2019, Labcorp announced the Envigo transaction: $595 million cash consideration, a $110 million note receivable, and net implied cash consideration of $485 million. Closing was expected in Q2 2019. The company projected $156 million of incremental revenue on a pro forma 2018 basis and expected the transaction to be earnings- and cash-accretive in year one.
- Labcorp repurchased $100.1 million of shares in January and authorized a new $1.25 billion repurchase plan in February; no repurchases had occurred under the new plan by quarter-end.
Risks, contingencies and unusual items
- Restructuring and other special charges were $20.6, up from $14.3, mainly severance, facility closures, right-of-use asset impairment and integration costs.
- Other, net expense increased to $10.4 from $3.5, principally due to larger investment losses; foreign-currency transaction losses were $4.7 versus $2.0.
- The filing describes ongoing litigation, False Claims Act and billing-related matters, employment and consumer class actions, and government inquiries. Two DOJ subpoenas received in April 2019 concerned non-human primate shipments and third-party test orders/payments; Labcorp stated it was cooperating. Management could not estimate reasonably probable losses for certain proceedings, but did not believe currently available information indicated a material adverse effect on financial condition.
- A 2018 ransomware incident temporarily affected testing and other systems. The company reported no patient or client data theft, filed an insurance claim, and had recognized no estimated insurance proceeds; claims or regulatory actions remained possible.
- Key stated business risks include reimbursement and regulatory changes, pricing and competition, customer and contract losses, acquisition integration, cybersecurity and technology disruption, collection and payer-mix pressures, litigation, and foreign-exchange exposure. Management reported disclosure controls were effective at March 31, 2019.
Important facts for investors to verify
- Whether the projected $115 million 2019 PAMA impact, organic growth and segment margin trends materialize.
- Progress on LaunchPad savings, implementation costs and Chiltern synergies, particularly given LCD’s lower operating income and margin.
- Cash conversion and working-capital trends: operating cash flow declined, while receivables and unbilled services increased.
- Debt maturities and refinancing or repayment plans, leverage and liquidity after the Envigo transaction and any convertible-note settlements.
- Envigo transaction closing, final economics, integration results and realization of projected accretion.
- Developments in DOJ inquiries, litigation, the ransomware insurance claim and any associated financial exposure.