Item 1.
BUSINESS
Laboratory Corporation of America® Holdings (LabCorp® or the Company) is a leading global life sciences company that is deeply integrated in guiding patient care. The Company provides comprehensive clinical laboratory and end-to-end drug development services through its LabCorp Diagnostics (LCD) and Covance Drug Development (CDD) segments. LabCorp is positioned at the convergence of research and care delivery to enable more precise and individualized healthcare, bringing together world-class diagnostics and drug development capabilities.
With nearly 65,000 employees worldwide, the Company’s mission is to improve health and improve lives by delivering world-class diagnostics, accelerating the availability of innovative medicines to patients, and using technology to change the way care is delivered. LabCorp, an S&P 500 company, was named to FORTUNE magazine's 2019 List of World's Most Admired Companies. The Company has also been recognized as a Best Place to Work for LGBTQ Equality with a perfect score from Human Rights Campaign's Corporate Equality Index (CEI), the nation's premier benchmarking survey and report on corporate policies and practices related to LGBTQ workplace equality.
The Company provides diagnostic, drug development and technology-enabled solutions for more than 160 million patient encounters per year, or more than 3 million per week. The Company also supports clinical trial activity in approximately 100 countries through its industry-leading central laboratory, preclinical, and clinical development businesses, generating more safety and efficacy data to support drug approvals than any other company. CDD collaborated on 85% of the novel drugs approved by the U.S. Food and Drug Administration (FDA) in 2019, including 100% of the novel oncology drugs and 86% of the rare and orphan disease drugs. In addition, CDD has been involved in the development of all of the current top 50 drugs on the market as measured by sales revenue.
The Company celebrated its 50th anniversary in 2019, marking its transformation from a laboratory in a former hospital in 1969 to a leading global life sciences company today. The Company, a Delaware corporation, is headquartered in Burlington, North Carolina, and was incorporated in 1971. Since its incorporation, the Company has continually expanded and diversified its business offerings, technological expertise, geographic reach, revenue base, and financial growth opportunities through a combination of organic investments and disciplined acquisitions.
The Company serves a broad range of customers, including managed care organizations (MCOs), biopharmaceutical, medical device and diagnostics companies, governmental agencies, physicians and other healthcare providers, hospitals and health systems, employers, patients and consumers, contract research organizations (CROs) and independent clinical laboratories. Leveraging the Company's extensive scientific and therapeutic experience, cutting-edge technology, and considerable real-world data and patient intelligence, the Company's customers can understand and respond to evolving patient needs with precision.
The breadth of the Company’s offerings has accelerated revenue and profit growth while generating strong returns for shareholders through share price appreciation. The Company's diversified service offerings also help to balance the impact of changes in the U.S. healthcare payment system, such as the reductions to the Medicare fee schedule under the Protecting Access to Medicare Act (PAMA), and associated reductions to other payer fee schedules, including Medicaid.
Power of Combined Capabilities
Today, the Company participates in drug development from discovery through commercialization; it is the go-to partner for the development, validation and commercialization of companion diagnostics, which are key drivers of precision medicine; it offers a growing menu of high-quality, high-value clinical laboratory tests; and, increasingly, it provides guidance to consumers and care providers about how to integrate drugs and diagnostics into patient care. The Company has proprietary data sets with approximately 35 billion lab test results, including approximately 50 percent of the United States (U.S.) population and a significant database of experienced investigators and trial sites.
The combination of LCD’s and CDD’s core capabilities and scientific expertise enables the Company to create compelling solutions for clients. As an example, the combination has contributed to the Company's position as a market leader in the development and commercialization of companion and complementary diagnostics. LCD and CDD have been involved in the development of drugs and their associated companion diagnostics for more than 20 years, and together have supported more FDA-approved companion diagnostics than any other company. In 2019, the Company's dedicated companion diagnostics team collaborated with 30 clients on more than 150 companion diagnostics projects.
Health systems customers continue to express interest in the Company's ability to both reduce their lab testing costs and bring them meaningful clinical research opportunities through the power of the Company's uniquely combined capabilities. The Company continues to increase CDD site partnerships with U.S.-based health systems and have offered these health systems many meaningful clinical research opportunities. The two-pronged value proposition continues to gain traction with health system partners.
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By combining LCD patient population data with CDD's site location tools and protocol design insights, the Company delivers a truly integrated patient-centric approach to recruitment. Through the LCD portal, patients can consent to release their medical information to CDD to be contacted for opportunities to participate in research including clinical studies, medical device studies and other studies to inform new therapies and better understand patients' needs. As a result of the powerful combination of LCD and CDD insights and data, the Company has the opportunity to win studies and recruit patients and investigators for trials more efficiently in important therapeutic areas like oncology.
Focus on the Future
The Company believes that it can play a larger role in the rapidly evolving healthcare environment by supporting customers’ transition to value-based care, streamlining the drug development process, and creating a leading and differentiated consumer experience.
Value-Based Care
As the healthcare system continues the transition to value-based care, the Company is supporting customers that are more focused on quality of care and outcomes through its differentiated, comprehensive solutions including leading laboratory services, clinical decision support (CDS), robust data integration offerings, drug development solutions, and payer and provider collaborations. The Company is a critical player in enabling targeted, tailored, high-value care in part by helping physicians choose the right test to determine the right medication at the right dosage, and helping to deliver the next generation of lifesaving drugs.
In 2019, LabCorp established new data collaborations with more than 30 value-based care organizations including the announcement of a strategic collaboration with New Jersey Primary Care Association (NJPCA) to advance value-based care at 23 community health centers throughout New Jersey. The project will help NJPCA members achieve value-based care objectives by providing integrated lab and clinical data in a more accessible, comprehensive and secure manner, with a focus on improving outcomes for patients with chronic conditions, such as diabetes and chronic kidney disease. The platform will be available through LabCorp’s Care Intelligence application, which is supported by HealthEC. It will allow for population health analyses, showing trends across communities, and for enhanced monitoring of individual patients to understand when intervention is needed and how a patient is responding to treatment.
Through the efforts of a dedicated team, LabCorp also continues to expand its service solutions to support clients in meeting value-based care goals and objectives, and to work with organizations focused directly on value-based care, such as Accountable Care Organizations, Clinically Integrated Networks, Integrated Delivery Networks, Independent Physicians Associations, national provider groups and Federally Qualified Health Centers. In 2019, LabCorp launched lab-based data reports called Insight Analytics. These reports support provider organizations in the efficient use of laboratory testing (laboratory stewardship), and the enhanced management of patients with chronic conditions such as diabetes, chronic kidney disease, and cardiovascular disease.
Streamlining Drug Development
In today’s healthcare landscape, there is a need to streamline the drug and device development process to bring new therapies to market faster. However, the number of compounds in the pipeline continues to grow and the development path is increasingly complex and costly. These trends have led to growing competition for investigators and patients in clinical studies. In this environment, demand from biopharmaceutical companies for data-driven study design and execution, scalable, innovative tools and processes, and access to relevant analytes, biomarkers and tests continues to rise.
CDD’s unique end-to-end global capabilities provide biopharmaceutical and medical device companies with differentiated solutions to streamline development with a focus on more efficient study design, and faster and more targeted identification of eligible patients and investigators with the power of combined capabilities with LCD. The Company’s investment in CDD’s unmatched combination of capabilities, analytics and scale has strengthened its leadership advantage in areas such as precision medicine, companion diagnostics and decentralized trials. The Company’s integration of new innovations in this space, using sophisticated analytics capabilities and artificial intelligence, are intended to enhance efficiency and quality. In addition, LCD’s strategic relationships with hospitals and health systems create opportunities for those organizations to become research partners to participate in studies and clinical trials with CDD.
The unique combination of the Company’s diagnostic and drug development operating models enables the Company to create differentiated and innovative solutions to streamline the drug and device development process. In 2019, the Company introduced an innovative new patient direct offering, streamlining patient recruitment by using LCD data to quickly and effectively contact appropriate candidates for trials through targeting a set of patients likely to qualify for the study based on diagnosis code, test results, and geographic location. After patients are enrolled, they are then routed to a LCD patient service center (PSC) for testing.
The Company also expects to see increasing adoption of decentralized, hybrid and virtual clinical trials by clinical trial sponsors. These offerings, individually or in combination, may speed patient recruitment and site selection, and improve trial design and data quality, thereby decreasing study duration, costs, and the patient burden of participating in clinical research.
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The Growing Importance of the Consumer in Healthcare
As patients have more responsibility for the costs of their care and technological advances drive an expectation of convenient channels for accessing healthcare, the Company continues to invest heavily in new tools, technology and services to facilitate a differentiated consumer experience.
In 2019, the Company announced an expansion to its Pixel by LabCorp™ platform, which was first introduced in 2018 with an initial offering of self-collection kits to empower consumers to order and obtain wellness tests in the comfort and privacy of their homes. The expanded Pixel offering allows consumers to purchase testing online, visit a convenient LCD PSC for specimen collection by a phlebotomist, and receive confidential results through a secure online portal. The tests are performed in LCD’s laboratories, using the same equipment and processes as the testing that clinicians order for their patients during in-office visits. The Company also continues to invest in and evaluate technologies that may enable additional methods for self-collection of specimens, and is exploring the potential use of wearable devices for diagnostics and in clinical trials.
The Company also continued its partnership with Walgreens to open comfortable and convenient PSCs inside Walgreens stores. At the close of 2019, more than 130 LabCorp at Walgreens sites were open or in progress to open in multiple states.
The Company performs the DNA testing for 23andMe. The Company also continues to support telemedicine, and other new care delivery models, that empower and engage healthcare consumers.
Hospital and Health System Partnerships
As the healthcare industry continues to consolidate, the new combined organizations can provide economies of scale and the capital to make substantially greater investments in technology, and in some cases they can exercise greater control over how and where patients access care. That industry consolidation generates additional opportunities for the Company’s unique combination of diagnostics and drug development. The Company can offer a wide range of highly efficient and integrated lab testing across multiple types of care settings and can simplify information technology structures and interfaces to standardize lab testing and data. That data can also lead to differentiated integrated solutions, as the Company can identify patients who may be eligible for clinical trials and physicians who may be able to serve as clinical trial investigators.
For more than three decades, the Company has developed and maintained a broad range of collaborations with hospitals and health systems and the Company continues to develop those relationships. In 2019, the Company announced a collaboration with the Mount Sinai Health System, New York City's largest integrated healthcare delivery system, to establish the Mount Sinai Digital and Artificial Intelligence (AI)-Enabled Pathology Center of Excellence. The Company, which has implemented the Philips IntelliSite Pathology Solution in four of its laboratories and plans to deploy it to additional laboratories, will use its experience and expertise to lead the integration of digital pathology into clinical practice across Mount Sinai's hospitals. Other new or extended strategic relationships with health systems and other large provider organizations across the country include South Bend Medical Foundation, MetroPath and New Jersey Primary Care Association. The Company believes that these relationships are foundational in delivering high-quality, outcomes-driven, and cost-effective care to patients.
Company Reporting
The Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports are made available free of charge through the Investor Relations section of the Company’s website at www.labcorp.com as soon as reasonably practicable after such material is electronically filed with, or furnished to, the U.S. Securities and Exchange Commission (SEC). Additionally, the SEC maintains a website at http://www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers, including the Company, that file electronically with the SEC.
The matters discussed in this “Business” section should be read in conjunction with the Consolidated Financial Statements found in Item 8 of Part II of this report, which include additional financial information about the Company. This report includes forward-looking statements that involve risks or uncertainties. The Company’s results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including the risk factors described in Item 1A
Item 1A. Risk Factors
Investors should carefully consider all of the information set forth in this report, including the following risk factors, before deciding to invest in any of the Company’s securities. The risks below are not the only ones that the Company faces. Additional risks not presently known to the Company, or that it presently deems immaterial, may also negatively impact the Company. The Company’s business, consolidated financial condition, revenues, results of operations, profitability, reputation or cash flows could be materially impacted by any of these factors.
This report also includes forward-looking statements that involve risks or uncertainties. The Company’s results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including the risks described below and elsewhere. See “Forward-Looking Statements” in Item 7.
Changes in payer regulations or policies (or in the interpretation of current regulations or policies), insurance regulations or approvals, or changes in other laws, regulations or policies in the United States (U.S.), may adversely affect U.S. governmental and third-party coverage or reimbursement for clinical laboratory testing and may have a material adverse effect upon the Company.
U.S. and state government payers, such as Medicare and Medicaid, as well as insurers, including managed care organizations (MCOs), have increased their efforts to control the cost, utilization and delivery of healthcare services. From time to time, Congress has considered and implemented changes in Medicare fee schedules in conjunction with budgetary legislation. The first phase of reductions pursuant to the Protecting Access to Medicare Act (PAMA) came into effect on January 1, 2018, and will continue annually subject to certain phase-in limits through 2025, and without limitations for subsequent periods. Further reductions due to changes in policy regarding coverage of tests or other requirements for payment, such as prior authorization, diagnosis code and other claims edits, or a physician or qualified practitioner’s signature on test requisitions, may be implemented from time to time. Reimbursement for pathology services performed by LabCorp Diagnostics (LCD) is also subject to statutory and regulatory reduction. Reductions in the reimbursement rates and changes in payment policies of other third-party payers may occur as well. Such changes in the past have resulted in reduced payments as well as added costs and have decreased test utilization for the commercial laboratory industry by adding more complex new regulatory and administrative requirements. Further changes in third-party payer regulations, policies, or laboratory benefit or utilization management programs may have a material adverse effect on LCD's business. Actions by federal and state agencies regulating insurance, including healthcare exchanges, or changes in other laws, regulations, or policies may also have a material adverse effect upon LCD's business.
The Company could face significant monetary damages and penalties and/or exclusion from government programs if it violates anti-fraud and abuse laws.
The Company is subject to extensive government regulation at the federal, state, and local levels in the U.S. and other countries where it operates. The Company’s failure to meet governmental requirements under these regulations, including those relating to billing practices and financial relationships with physicians, hospitals, and health systems could lead to civil and criminal penalties, exclusion from participation in Medicare and Medicaid and possible prohibitions or restrictions on the use of its laboratories. While the Company believes that it is in material compliance with all statutory and regulatory requirements, there is a risk that government authorities might take a contrary position. This risk includes, but is not limited to, the potential that government enforcement
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authorities may take a contrary position with respect to the Eliminating Kickbacks in Recovery Act (EKRA), given its recent passage and lack of associated regulations to clarify or add exceptions. Such occurrences, regardless of their outcome, could damage the Company’s reputation and adversely affect important business relationships.
The Company’s business could be harmed from the loss or suspension of a license or imposition of a fine or penalties under, or future changes in, or interpretations of, the law or regulations of the Clinical Laboratory Improvement Act of 1967, and the Clinical Laboratory Improvement Amendments of 1988 (CLIA), or those of Medicare, Medicaid or other national, state or local agencies in the U.S. and other countries where the Company operates laboratories.
The commercial laboratory testing industry is subject to extensive U.S. regulation, and many of these statutes and regulations have not been interpreted by the courts. CLIA extends federal oversight to virtually all clinical laboratories operating in the U.S. by requiring that they be certified by the federal government or by a federally approved accreditation agency. The sanction for failure to comply with CLIA requirements may be suspension, revocation or limitation of a laboratory’s CLIA certificate, which is necessary to conduct business, as well as significant fines and/or criminal penalties. In addition, the Company is subject to regulation under state law. State laws may require that laboratories and/or laboratory personnel meet certain qualifications, specify certain quality controls or require maintenance of certain records. The Company also operates laboratories outside of the U.S. and is subject to laws governing its laboratory operations in the other countries where it operates.
Applicable statutes and regulations could be interpreted or applied by a prosecutorial, regulatory or judicial authority in a manner that would adversely affect the Company's business. Potential sanctions for violation of these statutes and regulations include significant fines and the suspension or loss of various licenses, certificates and authorizations, which could have a material adverse effect on the Company’s business. In addition, compliance with future legislation could impose additional requirements on the Company, which may be costly.
U.S. Food and Drug Administration (FDA) regulation of diagnostic products and increased FDA regulation of laboratory-developed tests (LDTs) could result in increased costs and the imposition of fines or penalties, and could have a material adverse effect upon the Company’s business.
The FDA has regulatory responsibility for instruments, test kits, reagents and other devices used by clinical laboratories. The FDA enforces laws and regulations that govern the development, testing, manufacturing, performance, labeling, advertising, marketing, distribution and surveillance of diagnostic products, and it regularly inspects and reviews the manufacturing processes and product performance of diagnostic products. LCD’s point-of-care testing devices are subject to regulation by the FDA.
Since the 1990s, the FDA has asserted that it has authority to regulate LDTs as medical devices, but has exercised enforcement discretion to refrain from systematic regulation of LDTs. In 2014, the FDA issued draft guidance describing how it intended to discontinue its enforcement discretion policy and begin regulating LDTs as medical devices; however, that draft guidance has not been finalized, and FDA has instead continued its enforcement discretion policy and has indicated that it intends to work with Congress to enact comprehensive legislative preform of diagnostics oversight. As such, LDTs developed by high complexity clinical laboratories are currently generally offered as services to health care providers under the CLIA regulatory framework administered by the Centers for Medicare and Medicaid Services (CMS) of the U.S. Department of Health and Human Services (HHS), without the requirement for FDA clearance or approval. There are other regulatory and legislative proposals that would increase general FDA oversight of clinical laboratories and LDTs. The outcome and ultimate impact of such proposals on the business is difficult to predict at this time. On February 20, 2020, the FDA issued a statement with a table of pharmacogenetic associations setting forth certain gene-drug interactions that the agency has determined are supported by the scientific literature to help ensure that claims being made for pharmacogenetic tests are grounded in sound science, thereby reducing the risk of enforcement actions with respect to LDTs offering claims consistent with the table. The FDA noted that while it is committed to work with Congress on new comprehensive diagnostic oversight reform legislation, it could still take enforcement actions under the current medical device framework regarding diagnostic claims the agency determines not to be sufficiently supported. Even without issuance of a finalized LDT oversight framework, in light of the April 4, 2019, FDA warning letter issued to Inova Genomics Laboratory related to certain LDTs that Inova offered, as well as the February 2020 pharmacogenetics statement, there may be an increased risk of FDA enforcement actions for laboratory tests offered by companies without FDA clearance or approval.
Current FDA regulation of the Company’s diagnostic products and potential future increased regulation of the Company’s LDTs could result in increased costs and administrative and legal actions for noncompliance, including warning letters, fines, penalties, product suspensions, product recalls, injunctions and other civil and criminal sanctions, which could have a material adverse effect upon the Company.
Failure to comply with U.S., state, local or international environmental, health and safety laws and regulations, including the U.S. Occupational Safety and Health Administration Act and the U.S. Needlestick Safety and Prevention Act, could result in fines and penalties and loss of licensure, and have a material adverse effect upon the Company’s business.
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As previously discussed in Item 1 of Part I of this report, the Company is subject to licensing and regulation under laws and regulations relating to the protection of the environment and human health and safety, including laws and regulations relating to the handling, transportation and disposal of medical specimens, infectious and hazardous waste and radioactive materials, as well as regulations relating to the safety and health of laboratory employees. Failure to comply with these laws and regulations could subject the Company to denial of the right to conduct business, fines, criminal penalties and/or other enforcement actions that would have a material adverse effect on its business. In addition, compliance with future legislation could impose additional requirements on the Company that may be costly.
Failure to comply with privacy and security laws and regulations could result in fines, penalties and damage to the Company’s reputation with customers and have a material adverse effect upon the Company’s business.
If the Company does not comply with existing or new laws and regulations related to protecting the privacy and security of personal or health information, it could be subject to monetary fines, civil penalties or criminal sanctions.
In the U.S., the Health Insurance Portability and Accountability Act of 1996 (HIPAA) privacy and security regulations, including the expanded requirements under U.S. Health Information Technology for Economic and Clinical Health Act (HITECH), establish comprehensive standards with respect to the use and disclosure of protected health information (PHI), by covered entities, in addition to setting standards to protect the confidentiality, integrity and security of PHI.
HIPAA restricts the Company’s ability to use or disclose PHI, without patient authorization, for purposes other than payment, treatment or healthcare operations (as defined by HIPAA), except for disclosures for various public policy purposes and other permitted purposes outlined in the privacy regulations. HIPAA and HITECH provide for significant fines and other penalties for wrongful use or disclosure of PHI in violation of the privacy and security regulations, including potential civil and criminal fines and penalties. The regulations establish a complex regulatory framework on a variety of subjects, including:
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The circumstances under which the use and disclosure of PHI are permitted or required without a specific authorization by the patient, including, but not limited to, treatment purposes, activities to obtain payments for the Company’s services, and its healthcare operations activities;
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A patient’s rights to access, amend and receive an accounting of certain disclosures of PHI;
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The content of notices of privacy practices for PHI;
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Administrative, technical and physical safeguards required of entities that use or receive PHI; and
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The protection of computing systems maintaining electronic PHI.
The Company has implemented policies and procedures designed to comply with the HIPAA privacy and security requirements as applicable. The privacy and security regulations establish a “floor” and do not supersede state laws that are more stringent. Therefore, the Company is required to comply with both additional federal privacy and security regulations and varying state privacy and security laws. In addition, federal and state laws that protect the privacy and security of patient information may be subject to enforcement and interpretations by various governmental authorities and courts, resulting in complex compliance issues. For example, the Company could incur damages under state laws pursuant to an action brought by a private party for the wrongful use or disclosure of health information or other personal information.
On June 28, 2018, the California legislature passed the California Consumer Privacy Act (CCPA), which was effective January 1, 2020. The CCPA created new transparency requirements and granted California residents several new rights with regard their personal information. Failure to comply with the CCPA may result in, among other things, significant civil penalties and injunctive relief, or potential statutory or actual damages. The Company implemented processes to manage compliance with the CCPA. In addition, California residents have the right to bring a private right of action in connection with certain types of incidents. These claims may result in significant liability and potential damages.
The Company may also be required to comply with the data privacy and security laws of other countries in which it operates or with which it transfers and receives data. For example, the European Union’s (EU) General Data Protection Regulation (GDPR), which took effect May 25, 2018, created a range of new compliance obligations for subject companies and imposes penalties for noncompliance of up to the greater of €20 million or 4% of worldwide revenue. The Company has established processes and frameworks to manage compliance with the GDPR, but there remains uncertainty as to how EU supervisory authorities will interpret and enforce the regulation. The costs of compliance with the GDPR could be significant. Potential fines and penalties in the event of a violation of the GDPR could have a material adverse effect on the Company’s business and operations. In addition, similar data protection regulations addressing access, use, disclosure and transfer of personal data have been enacted or updated in countries where the Company does business, including in Asia, Latin America, Canada and Europe. The Company expects to make changes to its business practices and to incur additional costs associated with compliance with these evolving and complex regulations.
Failure to maintain the security of customer-related information or compliance with security requirements could damage the Company’s reputation with customers, cause it to incur substantial additional costs and become subject to litigation and enforcement actions.
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The Company receives and stores certain personal and financial information about its customers. In addition, the Company depends upon the secure transmission of confidential information over public networks, including information permitting cashless payments. The Company also works with third-party service providers and vendors that provide technology systems and services that are used in connection with the receipt, storage, and transmission of customer personal and financial information. A compromise in the Company’s security systems, or those of the Company's third party service providers and vendors, that results in customer personal information being obtained by unauthorized persons or the Company’s or third party's failure to comply with security requirements for financial transactions could adversely affect the Company’s reputation with its customers and others, as well as the Company’s results of operations, financial condition and liquidity. It could also result in litigation against the Company and the imposition of fines and penalties. For example, in connection with the AMCA Incident the Company has incurred, and expects to continue to incur, costs, and the Company is involved in pending and threatened litigation, as well as various government and regulatory inquiries and processes. For additional information about the AMCA Incident, see Note 16 Commitments and Contingencies to the Consolidated Financial Statements.
The Company depends on third parties to provide services critical to the Company's business, and depends on them to comply with applicable laws and regulations. Additionally, any breaches of the information technology systems of third parties could have a material adverse effect on the Company's operations.
The Company depends on third parties to provide services critical to the Company's business, including supplies, ground and air transport of clinical and diagnostic testing supplies and specimens, research products, and people, among other services. Third parties that provide services to the Company are subject to similar risks related to security of customer-related information and compliance with U.S., state, local, or international environmental, health and safety, and privacy and security laws and regulations as the Company. Any failure by third parties to comply with applicable laws, or any failure of third parties to provide services more generally, could have a material impact on the Company, whether because of the loss of the ability to receive services from the third parties, legal liability of the Company for the actions or inactions of third parties, or otherwise.
In addition, third parties to whom the Company outsources certain services or functions may process personal data, or other confidential information of the Company. A breach or attack affecting these third parties could also harm the Company's business, results of operations and reputation.
Discontinuation or recalls of existing testing products; failure to develop or acquire licenses for new or improved testing technologies; or the Company’s customers using new technologies to perform their own tests could adversely affect the Company’s business.
From time to time, manufacturers discontinue or recall reagents, test kits or instruments used by the Company to perform laboratory testing. Such discontinuations or recalls could adversely affect the Company’s costs, testing volume and revenue.
The commercial laboratory industry is subject to changing technology and new product introductions. The Company’s success in maintaining a leadership position in genomic and other advanced testing technologies will depend, in part, on its ability to develop, acquire or license new and improved technologies on favorable terms and to obtain appropriate coverage and reimbursement for these technologies. The Company may not be able to negotiate acceptable licensing arrangements, and it cannot be certain that such arrangements will yield commercially successful diagnostic tests. If the Company is unable to license these testing methods at competitive rates, its research and development (R&D) costs may increase as a result. In addition, if the Company is unable to license new or improved technologies to expand its esoteric testing operations, its testing methods may become outdated when compared with the Company’s competition, and testing volume and revenue may be materially and adversely affected.
In addition, advances in technology may lead to the development of more cost-effective technologies such as point-of-care testing equipment that can be operated by physicians or other healthcare providers (including physician assistants, nurse practitioners and certified nurse midwives, generally referred to herein as physicians) in their offices or by patients themselves without requiring the services of freestanding clinical laboratories. Development of such technology and its use by the Company’s customers could reduce the demand for its laboratory testing services and the utilization of certain tests offered by the Company and negatively impact its revenues.
Currently, most commercial laboratory testing is categorized as high or moderate complexity, and thereby is subject to extensive and costly regulation under CLIA. The cost of compliance with CLIA makes it impractical for most physicians to operate clinical laboratories in their offices, and other laws limit the ability of physicians to have ownership in a laboratory and to refer tests to such a laboratory. Manufacturers of laboratory equipment and test kits could seek to increase their sales by marketing point-of-care laboratory equipment to physicians and by selling test kits approved for home or physician office use to both physicians and patients. Diagnostic tests approved for home use are automatically deemed to be “waived” tests under CLIA and may be performed in physician office laboratories as well as by patients in their homes with minimal regulatory oversight. Other tests meeting certain FDA criteria also may be classified as “waived” for CLIA purposes. The FDA has regulatory responsibility over instruments, test kits, reagents and other devices used by clinical laboratories, and it has taken responsibility from the U.S. Centers for Disease Control and Prevention for classifying the complexity of tests for CLIA purposes. Increased approval of “waived” test kits could
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lead to increased testing by physicians in their offices or by patients at home, which could affect the Company’s market for laboratory testing services and negatively impact its revenues.
Healthcare reform and changes to related products (e.g., health insurance exchanges), changes in government payment and reimbursement systems, or changes in payer mix, including an increase in capitated reimbursement mechanisms and evolving delivery models, could have a material adverse effect on the Company's revenues, profitability and cash flow.
LCD's testing services are billed to MCOs, Medicare, Medicaid, physicians and physician groups, hospitals, patients and employer groups. Most testing services are billed to a party other than the physician or other authorized person who ordered the test. Increases in the percentage of services billed to government and MCOs could have an adverse effect on the Company’s revenues.
The Company serves many MCOs. These organizations have different contracting philosophies, which are influenced by the design of their products. Some MCOs contract with a limited number of clinical laboratories and engage in direct negotiation of rates. Other MCOs adopt broader networks with generally uniform fee structures for participating clinical laboratories. In some cases, those fee structures are specific to independent clinical laboratories, while the fees paid to hospital-based and physician-office laboratories may be different, and are typically higher. MCOs may also offer Managed Medicare or Managed Medicaid plans. In addition, some MCOs use capitation rates to fix the cost of laboratory testing services for their enrollees. Under a capitated reimbursement arrangement, the clinical laboratory receives a per-member, per-month payment for an agreed upon menu of laboratory tests provided to MCO members during the month, regardless of the number of tests performed.
Capitation shifts the risk of increased test utilization (and the underlying mix of testing services) to the commercial laboratory provider. The Company makes significant efforts to obtain adequate compensation for its services in its capitated arrangements. For the year ended December 31, 2019, such capitated contracts accounted for approximately $298.0 million, or 4.3%, of LCD's revenues.
The Company's ability to attract and retain MCOs is critical given the impact of healthcare reform, related products and expanded coverage (e.g. health insurance exchanges and Medicaid expansion) and evolving value-based care and risk-based reimbursement delivery models (e.g., accountable care organizations (ACOs) and Independent Physician Associations (IPAs)).
A portion of the managed care fee-for-service revenues is collectible from patients in the form of deductibles, coinsurance and copayments. As patient cost-sharing has been increasing, the Company's collections may be adversely impacted.
In addition, Medicare and Medicaid and private insurers have increased their efforts to control the cost, utilization and delivery of healthcare services, including commercial laboratory services. Measures to regulate healthcare delivery in general, and clinical laboratories in particular, have resulted in reduced prices, added costs and decreased test utilization for the commercial laboratory industry by increasing complexity and adding new regulatory and administrative requirements. Pursuant to legislation passed in late 2003, the percentage of Medicare beneficiaries enrolled in Managed Medicare plans has increased. The percentage of Medicaid beneficiaries enrolled in Managed Medicaid plans has also increased, and is expected to continue to increase; however, changes to, or repeal of, the Patient Protection and Affordable Care Act (ACA) may continue to affect coverage, reimbursement, and utilization of laboratory services, as well as administrative requirements, in ways that are currently unpredictable. Further healthcare reform could adversely affect laboratory reimbursement from Medicare, Medicaid or commercial carriers.
The Company also experienced delays in the pricing and implementation of new molecular pathology codes among various payers, including Medicaid, Medicare and commercial carriers. While some delays were expected, several non-commercial payers required an extended period of time to price key molecular codes, and a number of those payers, mostly government entities, indicated that they would no longer pay for tests that they had previously covered. These issues (particularly payer policy changes) and changes in coverage had a negative impact on revenue, revenue per requisition, and margins and cash flows beginning in 2014, and are expected to have a continuing negative impact. Similarly, the Clinical Laboratory Fee Schedule (CLFS) coding and billing changes related to toxicology and other procedures were implemented in 2016 and 2017. The Company experienced delays in the pricing and implementation of the new toxicology codes; however, the Company largely overcame issues related to price and margins through direct negotiation with the associated payers. Limited coding and billing changes related to other procedure types were implemented in 2018 and 2019. While limited changes are expected to be implemented in 2020, the Company expects some delays in pricing and implementation of these new codes.
In addition, some MCOs are implementing, directly or through third parties, various types of laboratory benefit management programs that may include lab networks, utilization management tools (such as prior authorization and/or prior notification), and claims edits, which may impact coverage or reimbursement for commercial laboratory tests. Some of these programs address commercial laboratory testing broadly, while others are focused on certain types of testing such as molecular, genetic and toxicology testing.
The Company expects the efforts to impose reduced reimbursement, more stringent payment policies, and utilization and cost controls by government and other payers to continue. If LCD cannot offset additional reductions in the payments it receives for
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its services by reducing costs, increasing test volume, and/or introducing new services and procedures, it could have a material adverse effect on the Company’s revenues, profitability and cash flows. In 2014, Congress passed PAMA, requiring Medicare to change the way payment rates are calculated for tests paid under the CLFS, and to base the payment on the weighted median of rates paid by private payers. On June 23, 2016, CMS issued a final rule to implement PAMA that required applicable laboratories, including LCD, to begin reporting their test-specific private payer payment amounts to CMS during the first quarter of 2017. CMS exercised enforcement discretion to permit reporting for an additional 60 days, through May 30, 2017. CMS used that private market data to calculate weighted median prices for each test (based on applicable current procedural technology (CPT) codes) to represent the new CLFS rates beginning in 2018, subject to certain phase-in limits, which were revised by Congress in 2019. For 2018-2020, a test price cannot be reduced by more than 10.0% per year; for 2021-2023, a test price cannot be reduced by more than 15.0% per year. The process of data reporting and repricing will be repeated every three years for Clinical Diagnostic Laboratory Tests (CDLTs) beginning in 2021. Under the current law, the second data reporting period for CDLTs will occur during the first quarter of 2021 (based on data collected in 2019), and new CLFS rates for CDLTs will be established based on that data beginning in 2022, subject to the previously described phase-in limits for 2022-2023. The third data reporting period for CDLTs will occur during the first quarter of 2024, and new CLFS rates for CDLTs will be established based on that data beginning in 2025. CLFS rates for 2024 and subsequent periods will not be subject to phase-in limits. CLFS rates for Advanced Diagnostic Laboratory Tests (ADLTs) will be updated annually. CMS published its initial proposed CLFS rates under PAMA for 2018-2020 on September 22, 2017. Following a public comment period, CMS made adjustments and published final CLFS rates for 2018-2020 on November 17, 2017, with additional adjustments published on December 1, 2017. For 2019, the Company realized a net reduction in reimbursement of approximately $107.0 million from all payers affected by the CLFS (approximately $70.0 million in 2018). Unless implementation of PAMA is further delayed or changed, an additional reduction of approximately $90.0 million is expected for 2020, from all payers affected by the CLFS.
Healthcare reform legislation also contains numerous regulations that will require the Company, as an employer, to implement significant process and record-keeping changes to be in compliance. These changes increase the cost of providing healthcare coverage to employees and their families. Given the limited release of regulations to guide compliance, as well as potential changes to the ACA, the exact impact to employers, including the Company, is uncertain.
Changes in government regulation or in practices relating to the biopharmaceutical industry could decrease the need for certain services that Covance Drug Development (CDD) provides.
CDD assists biopharmaceutical companies in navigating the regulatory drug approval process. Changes in regulations such as a relaxation in regulatory requirements or the introduction of simplified drug approval procedures, or an increase in regulatory requirements that CDD has difficulty satisfying or that make its services less competitive, could eliminate or substantially reduce the demand for its services. Also, if government efforts to contain drug costs impact biopharmaceutical company profits from new drugs, or if health insurers were to change their practices with respect to reimbursement for biopharmaceutical products, some of CDD’s customers may spend less, or reduce their growth in spending on R&D.
On December 13, 2016, the 21st Century Cures Act was signed into law. This Act provides funding designed to increase government spending on certain drug development initiatives; contains several provisions designed to help make the drug development process more streamlined and efficient; and allows the FDA to increase staffing to support drug development, review and regulation. These provisions should be helpful to biopharmaceutical companies and contract research organizations (CROs), including CDD, to the extent that they capitalize on the use of data, adaptive trial designs, real-world evidence, biomarkers and other development tools that are accepted by the FDA.
In addition, implementation of healthcare reform legislation that adds costs could limit the profits that can be made from the development of new drugs. This could adversely affect R&D expenditures by biopharmaceutical companies, which could in turn decrease the business opportunities available to CDD both in the U.S. and other countries. New laws or regulations may create a risk of liability, increase CDD costs or limit service offerings through CDD.
Failure to comply with the regulations of drug regulatory agencies, such as the FDA, the Medicines and Healthcare products Regulatory Agency in the United Kingdom (U.K.), the European Medicines Agency, the National Medical Products Administration in China (NMPA), and the Pharmaceuticals and Medical Devices Agency in Japan, could result in sanctions and/or remedies against CDD and have a material adverse effect upon the Company.
The operation of CDD's preclinical laboratory facilities and clinical trial operations must conform to good laboratory practice (GLP) and good clinical practice (GCP), as applicable, as well as all other applicable standards and regulations, as further described in Item 1 of Part I of this report. The business operations of CDD’s clinical and preclinical laboratories also require the import, export and use of medical devices, in vitro diagnostic devices, reagents, and human and animal biological products. Such activities are subject to numerous applicable local and international regulations with which CDD must comply. If CDD does not comply, CDD could potentially be subject to civil, criminal or administrative sanctions and/or remedies, including suspension of its ability to conduct preclinical and clinical studies, and to import or export to or from certain countries, which could have a material adverse
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effect upon the Company.
Additionally, certain CDD services and activities must conform to current good manufacturing practice GMP, as further described in Item 1 of Part I of this report. Failure to maintain compliance with GLP, GCP, or GMP regulations and other applicable requirements of various regulatory agencies could result in warning or untitled letters, fines, unanticipated compliance expenditures, suspension of manufacturing, and civil, criminal or administrative sanctions and/or remedies against CDD, including suspension of its laboratory operations, which could have a material adverse effect upon the Company.
Increased competition, including price competition, could have a material adverse effect on the Company’s revenues and profitability.
As further described in Item 1 of Part I of this report, both LCD and CDD operate in highly competitive industries. The commercial laboratory business is intensely competitive both in terms of price and service. Pricing of laboratory testing services is often one of the most significant factors used by physicians, third-party payers and consumers in selecting a laboratory. As a result of significant consolidation in the commercial laboratory industry, larger commercial laboratory providers are able to increase cost efficiencies afforded by large-scale automated testing. This consolidation results in greater price competition. LCD may be unable to increase cost efficiencies sufficiently, if at all, and as a result, its net earnings and cash flows could be negatively impacted by such price competition. The Company may also face increased competition from companies that do not comply with existing laws or regulations or otherwise disregard compliance standards in the industry. Additionally, the Company may also face changes in fee schedules, competitive bidding for laboratory services, or other actions or pressures reducing payment schedules as a result of increased or additional competition.
Competitors in the CRO industry range from hundreds of smaller CROs to a limited number of large CROs with global capabilities. CDD’s main competition consists of these small and large CROs, as well as in-house departments of biopharmaceutical companies and, to a lesser extent, select universities and teaching hospitals. CDD’s services have from time to time experienced periods of increased price competition that had an adverse effect on a segment's profitability and consolidated revenues and net income. There is competition among CROs for both customers and potential acquisition candidates. Additionally, few barriers to entering the CRO industry further increases possible new competition.
These competitive pressures may affect the attractiveness or profitability of LCD’s and CDD’s services, and could adversely affect the financial results of the Company.
Failure to obtain and retain new customers, the loss of existing customers or material contracts, or a reduction in services or tests ordered or specimens submitted by existing customers, or the inability to retain existing and/or create new relationships with health systems could impact the Company’s ability to successfully grow its business.
To maintain and grow its business, the Company needs to obtain and retain new customers and business partners. In addition, a reduction in tests ordered or specimens submitted by existing customers, a decrease in demand for the Company's services from existing customers, or the loss of existing contracts, without offsetting growth in its customer base, could impact the Company's ability to successfully grow its business and could have a material adverse effect on the Company’s revenues and profitability. The Company competes primarily on the basis of the quality of services, reporting and information systems, reputation in the medical community and the drug development industry, the pricing of services and ability to employ qualified personnel. The Company's failure to successfully compete on any of these factors could result in the loss of existing customers, an inability to gain new customers and a reduction in the Company's business.
Continued and increased consolidation of MCOs, biopharmaceutical companies, health systems, physicians and other customers could adversely affect the Company's business.
Many healthcare companies and providers, including MCOs, biopharmaceutical companies, health systems and physician practices are consolidating through mergers, acquisitions, joint ventures and other types of transactions and collaborations. In addition to these more traditional horizontal mergers that involve entities that previously competed against each other, the healthcare industry is experiencing an increase in vertical mergers, which involve entities that previously did not offer competing goods or services. As the healthcare industry consolidates, competition to provide goods and services may become more intense, and vertical mergers may give those combined companies greater control over more aspects of healthcare, including increased bargaining power. This competition and increased customer bargaining power may adversely affect the price and volume of the Company’s services.
In addition, as the broader healthcare industry trend of consolidation continues, including the acquisition of physician practices by health systems, relationships with hospital-based health systems and integrated delivery networks are becoming more important. LCD has a well-established base of relationships with those systems and networks, including collaborative agreements. LCD's inability to retain its existing relationships with those physicians as they become part of healthcare systems and networks and/or to create new relationships could impact its ability to successfully grow its business.
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Changes or disruption in services or supplies provided by third parties, including transportation, could adversely affect the Company’s business.
The Company depends on third parties to provide services critical to the Company’s business. Although the Company has a significant proprietary network of ground and air transport capabilities, certain of the Company's businesses are heavily reliant on third-party ground and air travel for transport of clinical trial and diagnostic testing supplies and specimens, research products, and people. A significant disruption to these travel systems, or the Company's access to them, could have a material adverse effect on the Company's business. The Company is also reliant on an extensive network of third-party suppliers and vendors of certain services and products, including for certain animal populations. Disruptions to the continued supply of these services, products, or animal populations may arise from export/import restrictions or embargoes, political or economic instability, pressure from animal rights activists, adverse weather, natural disasters, public health crises, transportation disruptions, or other causes, as well as from termination of relationships with suppliers or vendors for their failure to follow the Company’s performance standards and requirements. Disruption of supply could have a material adverse effect on the Company’s business.
Damage or disruption to the Company’s facilities could adversely affect the Company’s business.
Many of the Company’s facilities could be difficult to replace in a short period of time. Any event that causes a disruption of the operation of these facilities might impact the Company's ability to provide service to customers and, therefore, could have a material adverse effect on the Company's financial condition, results of operations and cash flows.
The Company bears financial risk for contracts that, for reasons beyond the Company's control, may be underpriced, subject to cost overruns, delayed, or terminated or reduced in scope.
The Company has many contracts that are structured as fixed-price for fixed-contracted services or fee-for-service with a cap. The Company bears the financial risk if these contracts are underpriced or if contract costs exceed estimates. Such underpricing or significant cost overruns could have an adverse effect on the Company's business, results of operations, financial condition and cash flows.
Many of CDD’s contracts, in particular, provide for services on a fixed-price or fee-for-service with a cap basis and they may be terminated or reduced in scope either immediately or upon notice. Cancellations may occur for a variety of reasons, including:
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Failure of products to satisfy safety requirements;
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Unexpected or undesired results of the products;
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Insufficient clinical trial subject enrollment;
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Insufficient investigator recruitment;
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A customer's decision to terminate the development of a product or to end a particular study; and
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CDD’s failure to perform its duties properly under the contract.
Although its contracts often entitle it to receive the costs of winding down the terminated projects, as well as all fees earned up to the time of termination, the loss, reduction in scope or delay of a large contract or the loss, delay or conclusion of multiple contracts could materially adversely affect CDD.
Contract research services in the drug development industry create liability risks.
In contracting to work on drug development trials and studies, CDD faces a range of potential liabilities, including:
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Errors or omissions that create harm to clinical trial subjects during a trial or to consumers of a drug after the trial is completed and regulatory approval of the drug has been granted;
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General risks associated with clinical pharmacology facilities, including negative consequences from the administration of drugs to clinical trial participants or the professional malpractice of clinical pharmacology physicians;
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Risks that animals in CDD’s facilities may be infected with diseases that may be harmful and even lethal to themselves and humans despite preventive measures contained in CDD's business policies, including those for the quarantine and handling of imported animals; and
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Errors and omissions during a trial that may undermine the usefulness of a trial or data from the trial or study or may delay the entry of a drug to the market.
CDD contracts with physicians, also referred to as investigators, to conduct the clinical trials to test new drugs on clinical trial subjects. These tests can create a risk of liability for personal injury or death to clinical trial subjects resulting from negative reactions to the drugs administered or from professional malpractice by third party investigators.
While CDD endeavors to include in its contracts provisions entitling it to be indemnified and entitling it to a limitation of liability, these provisions are not always successfully obtained and, even if obtained, do not uniformly protect CDD against liability arising from certain of its own actions. CDD could be materially and adversely affected if it were required to pay damages or bear the costs of defending any claim that is not covered by a contractual indemnification provision, or in the event that a party which must indemnify it does not fulfill its indemnification obligations, or in the event that CDD is not successful in limiting its liability
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or in the event that the damages and costs exceed CDD's insurance coverage. CDD may also be required to agree to contract provisions with clinical trial sites or its customers related to the conduct of clinical trials, and CDD could be materially and adversely affected if it were required to indemnify a site or customer against claims pursuant to such contract terms. There can be no assurance that CDD will be able to maintain sufficient insurance coverage on acceptable terms.
Adverse results in material litigation matters could have a material adverse effect upon the Company’s business.
The Company may become subject in the ordinary course of business to material legal actions related to, among other things, intellectual property disputes, contract disputes, data and privacy issues, professional liability and employee-related matters. The Company may also receive inquiries and requests for information from governmental agencies and bodies, including Medicare or Medicaid payers, requesting comment and/or information on allegations of billing irregularities, billing and pricing arrangements, or privacy practices that are brought to their attention through audits or third parties. Legal actions could result in substantial monetary damages as well as damage to the Company’s reputation with customers, which could have a material adverse effect upon its business.
The Company's quarterly operating results may vary.
The Company's operating results, may vary significantly from quarter to quarter and are influenced by factors over which the Company has little control, such as:
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Changes in the general global economy;
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Exchange rate fluctuations;
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The commencement, completion, delay or cancellation of large projects or contracts or groups of projects;
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The progress of ongoing projects;
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Weather;
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The timing of and charges associated with completed acquisitions or other events; and
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Changes in the mix of the Company's services.
The Company believes that operating results for any particular quarter are not necessarily a meaningful indication of future results. While fluctuations in the Company's quarterly operating results could negatively or positively affect the market price of the Company's common stock, these fluctuations may not be related to the Company's future overall operating performance.
The failure to successfully obtain, maintain and enforce intellectual property rights and defend against challenges to the Company’s intellectual property rights could adversely affect the Company.
Many of the Company’s services, products and processes rely on intellectual property, including patents, copyrights, trademarks and trade secrets. In some cases, that intellectual property is owned by another party and licensed to the Company, sometimes exclusively. The value of the Company’s intellectual property relies in part on the Company’s ability to maintain its proprietary rights to such intellectual property. If the Company is unable to obtain or maintain the proprietary rights to its intellectual property, if it is unable to prevent attempted infringement against its intellectual property, or if it is unable to defend against claims that it is infringing on another party’s intellectual property, the Company could be adversely affected. These adverse effects could include the Company having to abandon, alter and/or delay the deployment of products, services or processes that rely on such intellectual property; having to procure and pay for licenses from the holders of intellectual property rights that the Company seeks to use; and having to pay damages, fines, court costs and attorney's fees in connection with intellectual property litigation.
CDD’s revenues depend on the biopharmaceutical industry.
CDD’s revenues depend greatly on the expenditures made by the biopharmaceutical industry in R&D. In some instances, biopharmaceutical companies are reliant on their ability to raise capital in order to fund their R&D projects. Biopharmaceutical companies are also reliant on reimbursement for their products from government programs and commercial payers. Accordingly, economic factors and industry trends affecting CDD’s customers in these industries may also affect CDD. If these companies were to reduce the number of R&D projects they conduct or outsource, whether through the inability to raise capital, reductions in reimbursement from governmental programs or commercial payers, industry trends, economic conditions or otherwise, CDD could be materially adversely affected.
Actions of animal rights activists may have an adverse effect on the Company.
CDD's preclinical services utilize animals in preclinical testing of the safety and efficacy of drugs. Such activities are required for the development of new medicines and medical devices under regulatory regimes in the U.S., Europe, Japan and other countries. Acts of vandalism and other acts by animal rights activists who object to the use of animals in drug development could have an adverse effect on the Company.
Animal populations may suffer diseases that can damage CDD's inventory, harm its reputation, result in decreased sales of research products or result in other liability.
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It is important that research products be free of diseases, including infectious diseases. The presence of diseases can distort or compromise the quality of research results, cause loss of animals in CDD’s inventory, result in harm to humans or outside animal populations if the disease is not contained to animals in inventory, or result in other losses. Such results could harm CDD’s reputation or have an adverse effect on CDD's financial condition, results of operations, and cash flows.
Failure to conduct animal research in compliance with animal welfare laws and regulations could result in sanctions and/or remedies against CDD and have a material adverse effect upon the Company.
The conduct of animal research at CDD’s facilities must be in compliance with applicable laws and regulations in the jurisdictions in which those activities are conducted. These laws and regulations include the U.S Animal Welfare Act (AWA), which governs the care and use of warm-blooded animals for research in the U.S. other than laboratory rats, mice and chickens, and is enforced through periodic inspections by the U.S. Department of Agriculture (USDA). The AWA establishes facility standards regarding several aspects of animal welfare, including housing, ventilation, lighting, feeding and watering, handling, veterinary care and recordkeeping. Similar laws and regulations apply in other jurisdictions in which CDD conducts animal research, including the European Union (E.U.) and China. CDD complies with licensing and registration requirement standards set by these laws and regulations in the jurisdictions in which it conducts animal research. If an enforcement agency determines that CDD’s equipment, facilities, laboratories or processes do not comply with applicable standards, it may issue an inspection report documenting the deficiencies and setting deadlines for any required corrective actions. For noncompliance, the agency may take action against CDD that may include fines, suspension and/or revocation of animal research licenses, or confiscation of research animals.
An inability to attract and retain experienced and qualified personnel, including key management personnel, could adversely affect the Company’s business.
The loss of key management personnel or the inability to attract and retain experienced and qualified employees at the Company’s clinical laboratories, drug development, and diagnostic facilities could adversely affect the business. The success of the Company is dependent in part on the efforts of key members of its management team. Success in maintaining the Company’s leadership position in genomic and other advanced testing and diagnostic technologies will depend in part on the Company’s ability to attract and retain skilled research professionals. In addition, the success of the Company’s early discovery, clinical and commercial laboratories also depends on employing and retaining qualified and experienced professionals, including specialists, who perform laboratory research activities and testing services. The same is true for patient-facing staff with specialized training required to perform activities related to specimen collection or clinical research activities. In the future, if competition for the services of these professionals increases, the Company may not be able to continue to attract and retain individuals in its markets. Changes in key management, or the ability to attract and retain qualified personnel, could lead to strategic and operational challenges and uncertainties, distractions of management from other key initiatives, and inefficiencies and increased costs, any of which could adversely affect the Company’s business, financial condition, results of operations, and cash flows.
Unproductive labor environment, union strikes, work stoppages, Works Council negotiations, or failure to comply with labor or employment laws could adversely affect the Company's operations and have a material adverse effect upon the Company's business.
The Company is a party to a limited number of collective bargaining agreements with various labor unions and is subject to unionization activity, employment and labor laws and unionization activity in the U.S. Similar employment and labor obligations exist across other countries in which it conducts business, including appropriate engagement with Works Councils in Europe. Disputes with regard to the terms of labor agreements or obligations for consultation, potential inability to negotiate acceptable contracts with these unions, unionization activity, or a failure to comply with labor or employment laws could result in, among other things, labor unrest, strikes, work stoppages, slowdowns by the affected workers, fines and penalties. If any of these events were to occur, or other employees were to become unionized, the Company could experience a significant disruption of its operations or higher ongoing labor costs, either of which could have a material adverse effect upon the Company's business. Additionally, future labor agreements, or renegotiation of labor agreements or provisions of labor agreements, or changes in labor or employment laws, could compromise its service reliability and significantly increase its costs, which could have a material adverse effect upon the Company's business. Also, the Company may incur substantial additional costs and become subject to litigation and enforcement actions if the Company fails to comply with legal requirements affecting its workforce and labor practices, including laws and regulations related to wage and hour practices, Office of Federal Contract Compliance Programs (OFCCP) compliance, and unlawful workplace harassment and discrimination.
A significant increase in LCD's or CDD's days sales outstanding could have an adverse effect on the Company’s business, including its cash flow, by increasing its bad debt or decreasing its cash flow.
Billing for laboratory services is a complex process. Laboratories bill many different payers, including doctors, patients, hundreds of insurance companies, Medicare, Medicaid and employer groups, all of which have different billing requirements. In addition to billing complexities, LCD has experienced an increase in patient responsibility as a result of managed care fee-for-service plans that continue to increase patient deductibles, coinsurance and copayments, or implement restrictive coverage or
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administrative policies that can further increase patient costs. LCD expects this trend to continue. A material increase in LCD’s days sales outstanding level could have an adverse effect on the Company's business, including potentially increasing its bad debt rate and decreasing its cash flows. Although CDD does not face the same level of complexity in its billing processes, it could also experience delays in billing or collection, and a material increase in CDD’s days sales outstanding could have an adverse effect on the Company’s business, including potentially decreasing its cash flows.
Failure in the Company’s information technology systems or delays or failures in the development and implementation of updates or enhancements to those systems could significantly increase testing turnaround time or delay billing processes and otherwise disrupt the Company’s operations or customer relationships.
The Company’s operations and customer relationships depend, in part, on the continued performance of its information technology systems. Despite network security measures and other precautions the Company has taken, its information technology systems are potentially vulnerable to physical or electronic break-ins, computer viruses and similar disruptions. In addition, the Company is in the process of integrating the information technology systems of its recently acquired subsidiaries, and the Company may experience system failures or interruptions as a result of this process. Sustained system failures or interruption of the Company’s systems in one or more of its operations could disrupt the Company’s ability to process laboratory requisitions, perform testing, provide test results or drug development data in a timely manner and/or bill the appropriate party. Failure of the Company’s information technology systems could adversely affect the Company’s business, profitability and financial condition.
Hardware and software failures, delays in the operation of computer and communications systems, the failure to implement new systems or system enhancements to existing systems, and cybersecurity breaches may harm the Company.
The Company's success depends on the efficient and uninterrupted operation of its computer and communications systems. A failure of the network or data-gathering procedures could impede the processing of data, delivery of databases and services, customer orders and day-to-day management of the business and could result in the corruption or loss of data. While certain operations have appropriate disaster recovery plans in place, there currently are not redundant facilities everywhere in the world to provide information technology capacity in the event of a system failure. Despite any precautions the Company may take, damage from fire, floods, hurricanes, power loss, telecommunications failures, computer viruses, break-ins, cybersecurity breaches and similar events at the Company's various computer facilities could result in interruptions in the flow of data to the servers and from the servers to customers. In addition, any failure by the computer environment to provide required data communications capacity could result in interruptions in service. In the event of a delay in the delivery of data, the Company could be required to transfer data collection operations to an alternative provider of server-hosting services. Such a transfer could result in delays in the ability to deliver products and services to customers. Additionally, significant delays in the planned delivery of system enhancements, or improvements and inadequate performance of the systems once they are completed could damage the Company's reputation and harm the business.
Security breaches and unauthorized access to the Company's or its customers’ data could harm the Company’s reputation and adversely affect its business.
The Company has experienced and expects to continue to experience attempts by computer programmers and hackers to attack and penetrate the Company’s layered security controls, like the 2018 ransomware attack. The Company has also experienced and expects to continue to experience similar attempts to attack and penetrate the systems of third-party suppliers and vendors to whom the Company has provided data, like the 2019 data breach of Retrieval-Masters Credit Bureau, Inc. d/b/a/ American Medical Collections Agency (AMCA). These attempts, if successful, could result in the misappropriation or compromise of personal information or proprietary or confidential information stored within the Company's systems or within the systems of third-parties, create system disruptions or cause shutdowns. External actors may be able to develop and deploy viruses, worms and other malicious software programs that attack the Company’s systems, the systems of third-parties, or otherwise exploit any security vulnerabilities. Outside parties may also attempt to fraudulently induce employees to take actions, including the release of confidential or sensitive information or to make fraudulent payments through illegal electronic spamming, phishing, spear phishing, or other tactics. The Company has robust information security procedures and other safeguards in place, including evaluating the cybersecurity status of third-party suppliers and vendors that will have access to the Company’s data or information technology systems, which are monitored and routinely tested internally and by external parties. However, because the techniques used to obtain unauthorized access, disable or degrade service, or sabotage systems change frequently and often are not recognized until launched against a target, the Company may be unable to anticipate all of these techniques or to implement adequate preventive measures. In addition, as cyber threats continue to evolve, the Company may be required to expend additional resources to continue to enhance the Company’s information security measures or to investigate and remediate any information security vulnerabilities. The Company’s remediation efforts may not be successful and could result in interruptions, delays or cessation of service. This could also impact the cost and availability of cyber insurance to the Company. Breaches of the Company’s or third-parties' security measures and the unauthorized dissemination of personal, proprietary or confidential information about the Company or its customers or other third-parties could expose customers’ private information. Such breaches could expose customers to the risk of financial or medical identity theft or expose the Company or other third-parties to a risk of loss or misuse of this information, result in litigation and
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potential liability for the Company, damage the Company’s brand and reputation or otherwise harm the Company’s business. Any of these disruptions or breaches of security could have a material adverse effect on the Company’s business, regulatory compliance, financial condition and results of operations.
Operations may be disrupted and adversely impacted by the effects of natural disasters, political crises, public health crises, and other events outside of the Company's control.
Natural disasters, such as adverse weather, fires, earthquakes, power shortages and outages, political crises, such as terrorism, war, political instability, or other conflict, criminal activities, public health crises, such as coronavirus (COVID-19) and disease epidemics and pandemics, and other disruptions or events outside of the Company’s control could negatively affect the Company’s operations. Any of these events may result in a temporary decline of volumes in both segments. In addition, such events may temporarily interrupt the Company’s ability to transport specimens, the Company's ability to efficiently commence studies, the Company’s information technology systems, the Company’s ability to utilize certain laboratories, and/or the Company’s ability to receive material from its suppliers. Such events can also affect customer operations and thereby impact testing volume. Long-term disruptions in the infrastructure and operations caused by such events (particularly involving locations in which the Company has operations), could harm the Company's operating results.
A significant deterioration in the economy could negatively impact testing volumes, drug development services, cash collections and the availability of credit.
The Company’s operations are dependent upon ongoing demand for diagnostic testing and drug development services by patients, physicians, hospitals, MCOs, biopharmaceutical companies and others. A significant downturn in the economy could negatively impact the demand for diagnostic testing and drug development services, as well as the ability of customers to pay for services rendered. In addition, uncertainty in the credit markets could reduce the availability of credit and impact the Company’s ability to meet its financing needs in the future.
Foreign currency exchange fluctuations could have an adverse effect on the Company’s business.
The Company has business and operations outside the U.S., and CDD derives a significant portion of its revenues from international operations. Since the Company's consolidated financial statements are denominated in U.S. dollars, fluctuations in exchange rates from period to period will have an impact on reported results. In addition, CDD may incur costs in one currency related to its services or products for which it is paid in a different currency. As a result, factors associated with international operations, including changes in foreign currency exchange rates, could significantly affect CDD's results of operations, financial condition and cash flows.
The Company's international operations could subject it to additional risks and expenses that could adversely impact the business or results of operations.
The Company's international operations expose it to risks from failure to comply with foreign laws and regulations that differ from those under which the Company operates in the U.S. In addition, the Company may be adversely affected by other risks of expanded operations in foreign countries, including, but not limited to, changes in reimbursement by foreign governments for services provided by the Company; compliance with export controls and trade regulations; changes in tax policies or other foreign laws; compliance with foreign labor and employee relations laws and regulations; restrictions on currency repatriation; judicial systems that less strictly enforce contractual rights; countries that do not have clear or well-established laws and regulations concerning issues relating to commercial laboratory testing or drug development services; countries that provide less protection for intellectual property rights; and procedures and actions affecting approval, production, pricing, reimbursement and marketing of products and services. Further, international operations could subject the Company to additional expenses that the Company may not fully anticipate, including those related to enhanced time and resources necessary to comply with foreign laws and regulations, difficulty in collecting accounts receivable and longer collection periods, and difficulties and costs of staffing and managing foreign operations. In some countries, the Company's success will depend in part on its ability to form relationships with local partners. The Company's inability to identify appropriate partners or reach mutually satisfactory arrangements could adversely affect the business and operations.
Expanded international operations may increase the Company’s exposure to liabilities under the anti-corruption laws.
Anti-corruption laws in the countries where the Company conducts business, including the U.S. Foreign Corrupt Practices Act (FCPA), U.K. Bribery Act, and similar laws in other jurisdictions, prohibit companies and their intermediaries from engaging in bribery including improperly offering, promising, paying or authorizing the giving of anything of value to individuals or entities for the purpose of corruptly obtaining or retaining business. The Company operates in some parts of the world where corruption may be common and where anti-corruption laws may conflict to some degree with local customs and practices. The Company maintains an anti-corruption program including policies, procedures and training and safeguards in the engagement and management of third parties acting on the Company’s behalf. Despite these safeguards, the Company cannot guarantee protection from corrupt acts committed by employees or third parties associated with the Company. Violations or allegations of violations of anti-corruption
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laws could have a significant adverse effect on the business or results of operations.
Changes in tax laws and regulations or the interpretation of such may have a significant impact on the financial position, results of operations and cash flows of the Company.
U.S. and foreign governments continue to review, reform and modify tax laws, including with respect to the Organisation for Economic Co-operation and Development’s base erosion and profit shifting initiative. Changes in tax laws and regulations could result in material changes to the domestic and foreign taxes that the Company is required to provide for and pay.
In addition, the Company is subject to regular audits with respect to its various tax returns and processes in the jurisdictions in which it operates. Errors or omissions in tax returns, process failures or differences in interpretation of tax laws by tax authorities and the Company may lead to litigation, payments of additional taxes, penalties and interest.
A failure to identify and successfully close and integrate strategic acquisition targets could have a material adverse effect on the Company's business objectives and its revenues and profitability.
Part of the Company's strategy involves deploying capital in investments that enhance the Company's business, which includes pursuing strategic acquisitions to strengthen the Company's scientific capabilities and enhance therapeutic expertise, enhance esoteric testing and global drug development capabilities, and increase presence in key geographic areas. Since 2015, the Company has invested net cash of approximately $7.2 billion and equity of $1.8 billion in strategic business acquisitions. However, the Company cannot assure that it will be able to identify acquisition targets that are attractive to the Company or that are of a large enough size to have a meaningful impact on the Company's operating results. Furthermore, the successful closing and integration of a strategic acquisition entails numerous risks, including, among others:
•
Failure to obtain regulatory clearance, including due to antitrust concerns;
•
Loss of key customers or employees;
•
Difficulty in consolidating redundant facilities and infrastructure and in standardizing information and other systems;
•
Unidentified regulatory problems;
•
Failure to maintain the quality of services that such companies have historically provided;
•
Unanticipated costs and other liabilities;
•
Potential liabilities related to litigation including the acquired companies;
•
Potential periodic impairment of goodwill and intangible assets acquired;
•
Coordination of geographically separated facilities and workforces; and
•
The potential disruption of the ongoing business and diversion of management's resources.
The Company cannot assure that current or future acquisitions, if any, or any related integration efforts will be successful, or that the Company's business will not be adversely affected by any future acquisitions, including with respect to revenues and profitability. Even if the Company is able to successfully integrate the operations of businesses that it may acquire in the future, the Company may not be able to realize the benefits that it expects from such acquisitions.
The Company’s level of indebtedness could adversely affect the Company’s liquidity, results of operations and business.
At December 31, 2019, indebtedness on the Company's outstanding Senior Notes totaled approximately $5,860.0 million in aggregate principal. The Company is also a party to credit agreements relating to a $1.0 billion revolving credit facility and a 2019 term loan with a balance of $375.0 million as of December 31, 2019. Under the term loan facility and the revolving credit facility, the Company is subject to negative covenants limiting subsidiary indebtedness and certain other covenants typical for investment-grade-rated borrowers, and the Company is required to maintain a leverage ratio within certain limits.
The Company’s level of indebtedness could adversely affect its business. In particular, it could increase the Company’s vulnerability to sustained, adverse macroeconomic weakness, limit its ability to obtain further financing, and limit its ability to pursue certain operational and strategic opportunities, including large acquisitions.
The Company may also enter into additional transactions or credit facilities, including other long-term debt, which may increase its indebtedness and result in additional restrictions upon the business. In addition, major debt rating agencies regularly evaluate the Company's debt based on a number of factors. There can be no assurance that the Company will be able to maintain its existing debt ratings, and failure to do so could adversely affect the Company's cost of funds, liquidity and access to capital markets.
Global economic conditions and government and regulatory changes, including, but not limited to, the U.K.'s exit from the European Union (E.U.) could adversely impact the Company’s business and results of operations.
The Company could be adversely impacted due to the consequences of changes in the economy, governments or regulations across the globe. On January 31, 2020 the U.K. withdrew from its membership of the E.U. (often referred to as Brexit). During an implementation period which is due to end on December 31, 2020, E.U. laws and regulations will continue to apply to the U.K. The terms of future relations between the U.K. and E.U. following this implementation period have not yet been determined. Until
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this process is completed, it is difficult to anticipate how the clinical trial landscape in the U.K. might change in the next several years.
This type of development or other government or regulatory change could depress economic activity, which could adversely impact the Company’s business, financial condition and results of operations. This could include long-term volatility in the currency markets and long-term detrimental effects on the value of affected currencies.
The Company’s uses of financial instruments to limit its exposure to interest rate and currency fluctuations could expose it to risks and financial losses that may adversely affect the Company’s financial condition, liquidity and results of operations.
To reduce the Company’s exposure to interest rate fluctuations and currency exchange fluctuations, it has entered into, and in the future may enter into for these or other purposes, financial swaps, or hedging arrangements, with various financial counterparties. In addition to any risks related to the counterparties, there can be no assurances that the Company’s hedging activity will be effective in insulating it from the risks associated with the underlying transactions, that the Company would not have been better off without entering into these hedges, or that the Company will not have to pay additional amounts upon settlement.
Item 1B.
Item 1B. UNRESOLVED STAFF COMMENTS
None.
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Item 2.
Item 2. PROPERTIES
The Company's corporate headquarters are located in Burlington, North Carolina, and include facilities that are both owned and leased.
LabCorp Diagnostics (LCD) operates through a network of patient service centers, branches, rapid response laboratories, primary laboratories, and specialty laboratories. The table below summarizes certain information as to LCD's principal operating and administrative facilities as of December 31, 2019.
Location
Nature of Occupancy
Primary Facilities:
Birmingham, Alabama
Leased
Phoenix, Arizona
Owned
Los Angeles, California
Leased
Monrovia, California
Leased
San Diego, California
Leased
San Francisco, California
Leased
Shelton, Connecticut
Leased
Tampa, Florida
Leased
Westborough, Massachusetts
Leased
St. Paul, Minnesota
Owned
Kansas City, Missouri
Owned
Raritan, New Jersey
Owned
Burlington, North Carolina (5)
Owned/Leased
Research Triangle Park, North Carolina (3)
Leased
Dublin, Ohio
Owned
Brentwood, Tennessee
Leased
Dallas, Texas
Leased
Houston, Texas
Leased
Herndon, Virginia
Leased
Seattle, Washington
Leased
Spokane, Washington (3)
Leased
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Covance Drug Development (CDD) operates on a global scale. The table below summarizes certain information as to CDD's principal operating and administrative facilities as of December 31, 2019.
Location
Nature of Occupancy
Primary Facilities:
Mechelen, Belgium
Leased
Beijing, China
Leased
Shanghai, China (3)
Owned/Leased
Muenster, Germany
Owned
Pune, India
Leased
Bangalore, India
Leased
Singapore
Leased
Geneva, Switzerland
Owned
Eye, United Kingdom
Owned
Harrogate, United Kingdom
Owned
Huntington, United Kingdom
Owned
Leeds, United Kingdom
Owned
Maidenhead, United Kingdom
Leased
Shardlow, United Kingdom
Owned
York, United Kingdom
Leased
San Francisco, California
Leased
Daytona Beach, Florida
Leased
Greenfield, Indiana
Owned
Indianapolis, Indiana
Leased
Gaithersburg, Maryland
Leased
Ann Arbor, Michigan
Leased
Minneapolis, Minnesota
Leased
Princeton, New Jersey
Leased
Somerset, New Jersey
Owned
Dallas, Texas
Leased
Chantilly, Virginia
Leased
Madison, Wisconsin
Owned
All of the Company’s primary laboratory and drug development facilities have been built or improved for the purpose of providing commercial laboratory testing or drug development services. The Company believes that these existing facilities and plans for expansion are suitable and adequate and will provide sufficient production capacity for the Company's currently foreseeable level of operations. The Company believes that if it were unable to renew a lease or if a lease were to be terminated on any of the facilities it presently leases, it could find alternate space at competitive market rates and readily relocate its operations to such new locations without material disruption to its operations.
Item 3.
Item 3.
LEGAL PROCEEDINGS
See Note 16 Commitments and Contingencies to the Consolidated Financial Statements.
Item 4.
Item 4.
MINE SAFETY DISCLOSURES
Not applicable.
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PART II
Item 5.
Item 5.
MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
The Company's common stock, par value $0.10 per share, or Common Stock, trades on the New York Stock Exchange or NYSE under the symbol “LH.”
Holders
On February 26, 2020, there were approximately 1,038 holders of record of the Common Stock.
Transfer Agent
The transfer agent for the Company's Common Stock is American Stock Transfer & Trust Company, Shareholder Services, 6201 Fifteenth Avenue, Brooklyn, NY 11219, telephone: 800-937-5449, website: www.amstock.com.
Dividends
The Company has not historically paid dividends on its Common Stock and does not presently anticipate paying any dividends on its Common Stock in the foreseeable future.
Common Stock Performance
The graph below shows the cumulative total return assuming an investment of $100 on December 31, 2014, in each of the Company’s common stock, the Standard & Poor’s, or S&P Composite-500 Stock Index and the S&P 500 healthcare Index, or Peer Group, and assuming that all dividends were reinvested.
Comparison of Five Year Cumulative Total Return
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Issuer Purchases of Equity Securities (all amounts in millions, except per share amounts)
The following table sets forth information with respect to purchases of shares of the Company’s Common Stock made during the quarter ended December 31, 2019, by or on behalf of the Company:
At the end of 2018, the Company had outstanding authorization from the board of directors to purchase up to $443.5 of Company common stock. On February 6, 2019, the board of directors replaced the Company’s existing share repurchase plan with a new plan authorizing repurchase of up to $1.25 billion of the Company’s shares. The repurchase authorization has no expiration date. During 2019, the Company purchased 2.9 shares of its common stock at an average price of $154.94 for a total cost of $450.0, of which $100.0 was repurchased prior to the new plan in February 2019. At the end of 2019, the Company had outstanding authorization from the board of directors to purchase an additional $900.0 of Company common stock.
Item 6.
Item 6.
SELECTED FINANCIAL DATA (in millions, except per share amounts)
The selected financial data presented below under the captions “Statement of Operations Data” and “Balance Sheet Data” as of and for the five-year period ended December 31, 2019, are derived from consolidated financial statements of the Company, which have been audited by an independent registered public accounting firm.
(a)
During 2019, the Company recorded net restructuring charges of $54.6. The charges were comprised of $32.9 in severance and other personnel costs and $24.9 in facility-related costs primarily associated with facility closures and general integration initiatives. These charges were offset by the reversal of previously established reserves of $1.7 in unused severance and $1.5 in unused facility-related costs.
(b)
During 2018, the Company recorded net restructuring charges of $48.1. The charges were comprised of $40.3 in severance and other personnel costs and $11.8 in facility-related costs primarily associated with facility closures and general integration initiatives. These charges were offset by the reversal of previously established reserves of $2.0 in unused severance and $2.0 in unused facility-related costs.
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(c)
During 2017, the Company recorded net restructuring charges of $70.9. The charges were comprised of $36.1 in severance and other personnel costs and $39.9 in facility-related costs primarily associated with facility closures and general integration initiatives. These charges were offset by the reversal of previously established reserves of $0.5 in unused severance and $4.6 in unused facility-related costs. The Company also recognized asset impairment losses of $23.5 related to the termination of software development projects within the Covance Drug Development (CDD) segment and the forgiveness of certain indebtedness for LabCorp Diagnostics (LCD) customers in areas heavily impacted by hurricanes during the third quarter.
(d)
During 2016, the Company recorded net restructuring charges of $58.4. The charges were comprised of $30.9 in severance and other personnel costs and $33.8 in facility-related costs primarily associated with facility closures and general integration initiatives. These charges were offset by the reversal of previously established reserves of $2.8 in unused severance and $3.5 in unused facility-related costs.
(e)
During 2015, the Company recorded net restructuring charges of $113.9. The charges were comprised of $59.2 in severance and other personnel costs and $55.8 in facility-related costs primarily associated with facility closures and general integration initiatives. These charges were offset by the reversal of previously established reserves of $1.1 in unused facility-related costs.
(f)
See Note 5 Leases and Note 12 Debt to the Consolidated Financial Statements.
(g)
During 2016, the Company revised the final purchase price allocation for Covance. As a result, an out of period adjustment of $25.6 was recorded to reduce goodwill and increase a deferred tax asset as of December 31, 2015. The Company concluded that the impact of this adjustment was not material to the current or prior periods.
(h)
Net earnings attributable to Laboratory Corporation of America Holdings in 2017 includes a provisional net benefit of $519.0 due to the Tax Cuts and Jobs Act (TCJA). For additional information on the TCJA, see Note 14 Income Taxes to the Consolidated Financial Statements.
Item 7.
Item 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in millions)
General
During the year ended December 31, 2019, the Company's revenue grew by 2.0%, driven by growth from acquisitions of 2.3% and organic growth of 1.6% (which includes the negative impact from PAMA of 0.9%), partially offset by the disposition of businesses of 1.4% and negative foreign currency translation of 0.5%.
The Company defines organic growth as the increase in revenue excluding revenue from acquisitions for the first twelve months after the close of each acquisition.
On June 3, 2019, the Company's CDD segment completed the acquisition of Envigo's nonclinical contract research services business, expanding CDD's global nonclinical drug development capabilities with additional locations and resources. Additionally, the Company divested the Covance Research Products (CRP) business, which was a part of the CDD segment, to Envigo. As part of this sale, CDD entered into a multi-year, renewable supply agreement with Envigo. The Company paid cash consideration of $601.0, received a floating rate secured note of $110.0, and recorded a loss on the sale of CRP of $12.2. The Company funded the transaction through a new term loan facility. During the year ended December 31, 2019, the Company also acquired various other businesses and related assets for approximately $286.4 in cash (net of cash acquired).
The Company remains on track to deliver $150.0 of net savings from CDD's three-year LaunchPad initiative by the end of 2020. The Company expects phase II of LCD’s LaunchPad initiative to deliver approximately $200.0 in net savings by the end of 2021, while incurring approximately $40.0 in one-time implementation costs. Approximately one-third of the total savings are expected to be realized each year.
The Company is also exposed to risks related to information security arising from the information technology systems and operations of third parites, including thosse of the Company's vendors and partners. For example, on May 14, 2019, Retrieval-Masters Credit Bureau, Inc. d/b/a/ American Medical Collections Agency (AMCA), an external collection agency, notified the Company about a security incident AMCA experienced that may have involved certain personal information about some of the Company's patients (the AMCA Incident). The Company referred patient balances to AMCA only when direct collection efforts were unsuccessful. The Company's systems were not impacted by the AMCA Incident. Upon learning of the AMCA Incident, the Company promptly stopped sending new collection requests to AMCA and stopped AMCA from continuing to work on any pending collection requests on behalf of the Company. AMCA informed the Company that it appeared that an unauthorized user had access to AMCA's system between August 1, 2018 and March 30, 2019, and that AMCA could not rule out the possibility that personal
information on AMCA's system was at risk during that time period. Information on AMCA's affected system from the Company may have included name, address, and balance information for the patient and person responsible for payment, along with the patient's phone number, date of birth, referring physician, and date of service. The Company was later informed by AMCA that health insurance information may have been included for some individuals, and because some insurance carriers utilize the Social Security Number as a subscriber identification number, the Social Security Number for some individuals may also have been affected. No ordered tests, laboratory test results, or diagnostic infonnation from the Company were in the AMCA affected system. The Company notified individuals for whom it had a valid mailing address. For the individuals whose Social Security Number was affected, the notice included an offer to enroll in credit monitoring and identity protection services that will be provided free of charge for 24 months. The Company has incurred, and expects to continue to incur, costs related to the AMCA Incident. In addition, the Company is involved in pending and threatened litigation related to the AMCA Incident, as well as various government and regulatory inquiries and processes. For additional information about the AMCA Incident, see Note 16 Commitments and Contingencies to the Consolidated Financial Statements.
PAMA, which went into effect on January 1, 2018, resulted in a net reduction of revenue of approximately $107.0 and $70.0 in 2019 and 2018, respectively from all payers affected by the Clinical Lab Fee Schedule. Unless further implementation of PAMA is delayed or changed, an additional reduction of approximately $90.0 is expected for 2020.
Effective January 1, 2019, the Company adopted Accounting Standards Codification (ASC) 842 Leases using the modified retrospective method. The Company elected the package of practical expedients, which includes not reassessing whether existing contracts contain leases under the new definition of a lease, reassessing the classification of existing leases, and reassessing whether previously capitalized initial direct costs qualify for capitalization under the new standard. The Company also elected not to separate lease and non-lease components. The adoption of this standard resulted in the recording of $778.1 of additional operating lease liabilities as of December 31, 2019.
Results of Operations
The following tables present the financial measures that management considers to be the most significant indicators of the Company's performance. For discussion of 2018 results and comparison with 2017 results refer to “Management's Discussion and Analysis of Financial Conditions and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018.
Years ended December 31, 2019 and 2018
Revenues
The 2.0% increase in revenues for the year ended December 31, 2019, as compared with the corresponding period in 2018 was primarily due to growth from acquisitions of 2.3%, organic growth of 1.6% (which includes the negative impact from PAMA of 0.9%), partially offset by the disposition of businesses of 1.4% and negative foreign currency translation of 0.5%.
LCD revenues for the year ended December 31, 2019, were $7,000.1, a decrease of 0.4% over revenues of $7,030.8 in the corresponding period in 2018. The decline in revenues was due to the negative impact from the disposition of businesses of 1.9% and negative currency translation of 0.1%, partially offset by acquisitions of 1.2% and organic revenue growth of 0.4% which includes the negative impact of lower reimbursement from PAMA of 1.5%.
CDD revenues for the year ended December 31, 2019, were $4,578.1, an increase of 6.1% over revenues of $4,313.1 in the corresponding period in 2018. The increase in revenues was due to acquisitions, which contributed growth of 4.1%, an increase in organic growth of 3.8%, partially offset by negative foreign currency translation of approximately 1.2% and a business disposition of 0.6%. Excluding pass-throughs, organic revenue grew mid-to-high single digits.
Cost of Revenues
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Cost of revenues (primarily laboratory, labor and distribution costs) increased 1.8% in 2019 as compared with 2018 primarily due to acquisitions and organic volume growth. Cost of revenues as a percentage of revenues remained consistent in 2019 as compared to 2018 at approximately 72.0%.
Labor and testing supplies for the year ended December 31, 2019, comprise over 71.3% of the Company’s cost of revenues. Cost of revenues has increased over the two-year period ended December 31, 2019, primarily due to the impact of acquisitions, overall growth in the Company's volume, and increases in merit-based labor costs.
Selling, General and Administrative Expenses
Selling, general and administrative expenses as a percentage of revenues increased to 14.1% in 2019 compared to 13.9% in 2018. The increase in selling, general and administrative expenses as a percentage of revenues is primarily due to acquisitions and cybersecurity investments.
During 2019, the Company incurred $69.2 of acquisition and divestiture related costs, $15.2 in management transition costs, $11.5 in costs related to the Retrieval-Masters Credit Bureau, Inc. d/b/a/ American Medical Collection Agency (AMCA) data breach, and $10.1 of non-capitalized costs associated with the implementation of a major system as part of its LaunchPad business process improvement initiative, partially offset by $9.1 in reimbursements related to the 2018 ransomware attack and a $14.1 gain related to the settlement of a contingent purchase price related to a 2016 acquisition. These items increased selling, general and administrative expenses by $82.8. Excluding these charges, selling, general and administrative expenses as a percentage of revenues were 13.3% for the year ended December 31, 2019.
During 2018, the Company incurred integration and other costs of $54.7 primarily relating to the Chiltern acquisition and the sale of the Covance Food Solutions business. On July 16, 2018, the Company reported that it had detected suspicious activity on its information technology network and was taking steps to respond to and contain the activity. The activity was subsequently determined to be a new variant of ransomware affecting certain LCD information technology systems. As a direct result of the ransomware attack experienced during July, the Company incurred $12.6 in consulting fees and employee overtime during the recovery period following the attack. The Company also recorded $9.6 in consulting expenses relating to the Chiltern integration and management integration costs along with a special one-time bonus of $31.1 ($6.3 of which was recorded in selling, general and administrative expenses) to its non-bonus eligible employees in recognition of the benefits the Company received from the passage of the TCJA. In addition, the Company incurred $9.8 of non-capitalized costs associated with the implementation of a major system as part of its LaunchPad business process improvement initiative. Excluding these charges, selling, general and administrative expenses as a percentage of revenues were 13.0% for the year ended December 31, 2018.
Amortization Expense
The increase in amortization of intangibles and other assets from 2018 through 2019 primarily reflects the impact of acquisitions offset by the impact of business dispositions and working capital and earnout adjustments.
Restructuring and Other Charges
During 2019, the Company recorded net restructuring charges of $54.6; $26.7 within LCD and $27.9 within CDD. The charges were comprised of $32.9 in severance and other personnel costs and $24.9 in facility-related costs primarily associated with general integration activities. The charges were offset by the reversal of previously established reserves of $1.7 in unused severance and $1.5 in unused facility-related costs.
During 2018, the Company recorded net restructuring charges of $48.1; $20.5 within LCD and $27.6 within CDD. The charges were comprised of $40.3 in severance and other personnel costs and $11.8 in facility-related costs primarily associated with general
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integration activities. The charges were offset by the reversal of previously established reserves of $2.0 in unused severance and $2.0 in unused facility-related costs.
Interest Expense
The decrease in interest expense for 2019 as compared with the corresponding period in 2018 is primarily due to lower average debt balances, partially offset by $5.0 of accelerated deferred financing fees and make-whole premiums associated with the debt refinancing in the fourth quarter of 2019.
Equity Method Income, Net
Equity method income, net represents the Company's ownership share in joint venture partnerships along with equity investments in other companies in the healthcare industry. All of these partnerships and investments reside within the LCD segment. The decrease in income for 2019 as compared with the corresponding period in 2018 was primarily due to the decreased profitability of the Company's joint ventures combined with the consolidation of a joint venture during the second quarter of 2018 related to the acquisition of Pathology Associates Medical Laboratories (PAML).
Other, Net
For the year ended December 31, 2019, Other, net included a loss of $13.3, primarily related to the sale of its CRP business, offset by $20.9 in net gains on venture fund investments. For the year ended December 31, 2018, Other, net included a gain of $258.3 recognized on the sale of the Covance Food Solutions (CFS) business offset by losses on the dispositions of the Company's forensic testing services businesses in the U.K. and the U.S. of $48.9 and $24.5, respectively, the impairment of a venture fund investment of $5.2 and a $7.5 pension settlement charge. In addition, foreign currency transaction losses were $11.1 and $3.6, respectively, for the 2019 and 2018 periods presented.
Income Tax Expense
In 2019, the Company's effective tax rate was 25.3%. The 2019 rate was favorable compared to the 2018 rate as a result of the favorable revaluation of deferred taxes resulting from tax law changes and clarifications. The Company's share-based compensation benefit was unfavorable compared to 2018.
In 2018, the Company's effective tax rate was 30.3%. The 2018 rate was unfavorable as a result of the re-measurement of deferred taxes primarily due to the Company's state rate mix and state income tax law changes. In 2018, the Company recorded additional tax for TCJA under SAB 118. Additionally, the 2018 rate was higher due to increased income taxes paid on divestitures where next tax basis was lower than net book basis.
Both 2019 and 2018 were negatively impacted by the global intangible low taxed income tax.
The Company considers substantially all of its foreign earnings to be permanently reinvested overseas.
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Operating Results by Segment
LCD operating income was $1,086.0 for the year ended December 31, 2019, a decrease of 6.9% over operating income of $1,166.7 in the corresponding period of 2018 and a decrease of 110 basis points in operating margin year-over-year. The decrease in operating income and margin was primarily due to lower reimbursement as a result of PAMA, higher personnel costs, disposition of businesses, and cybersecurity expenses, partially offset by the Company’s LaunchPad initiatives, and acquisitions. The Company remains on track to deliver approximately $200.0 of net savings from its three-year, phase II of LabCorp Diagnostics’ LaunchPad initiative by the end of 2021.
CDD operating income was $411.5 for the year ended December 31, 2019, an increase of 35.5% over operating income of $303.6 in the corresponding period of 2018 and an increase of 200 basis points in operating margin year-over-year. The increase in operating income and margin were primarily due to organic demand, LaunchPad savings, acquisitions and currency translation, partially offset by personnel costs, and cybersecurity investments. The Company is on track to deliver $150.0 of net savings from its three-year CDD LaunchPad initiative by the end of 2020.
General corporate expenses are comprised primarily of administrative services such as executive management, human resources, legal, finance, corporate affairs, and information technology. Corporate expenses were $167.3 for the year ended December 31, 2019, an increase of 15.7% over corporate expenses of $144.6 in the corresponding period of 2018. The increase in corporate expenses in 2019 is primarily due to higher personnel costs, including executive transition costs and increases in merit based labor costs, as well as the benefit of a favorable legal settlement in 2018.
Liquidity, Capital Resources and Financial Position
The Company's strong cash-generating capability and financial condition typically have provided ready access to capital markets. The Company's principal source of liquidity is operating cash flow, supplemented by proceeds from debt offerings. The Company's senior unsecured revolving credit facility is further discussed in Note 12 Debt to the Company's Consolidated Financial Statements.
Management’s discussion and analysis of cash flows for the year ended December 31, 2018 compared to the year ended December 31, 2017 may be found in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations Liquidity, Capital Resources and Financial Position” section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2018.
In summary the Company's cash flows were as follows:
Cash and Cash Equivalents
Cash and cash equivalents at December 31, 2019 and 2018 totaled $337.5 and $426.8, respectively. Cash and cash equivalents consist of highly liquid instruments, such as time deposits and other money market investments, which have original maturities of three months or less.
Cash Flows from Operating Activities
During the year ended December 31, 2019, the Company's operations provided $1,444.7 of cash as compared to $1,305.4 in 2018. The $139.3 increase in cash provided from operations in 2019 as compared with the corresponding 2018 period was primarily due to higher cash earnings, partially offset by increased working capital to support growth. In addition, the Company had a net tax payment of approximately $105.0 related to the divestiture of its food and forensic testing service businesses in 2018, the
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proceeds from which are recorded in net cash provided by investing activities. The Company’s 2019 earnings were impacted by $54.6 of restructuring and other charges compared to an impact of $48.1 during the same period in 2018.
Cash Flows from Investing Activities
Net cash used by investing activities for the year ended December 31, 2019, was $1,283.1 as compared to net cash provided by investing activities of $206.7 for the year ended December 31, 2018. The $1,489.8 increase in cash used by investing activities for the year ended December 31, 2019, was primarily due to a year over year increase of $758.2 in cash paid for acquisitions. In addition, the Company had proceeds of $708.3 from the sale of assets and disposition of businesses during 2018 in comparison to $7.7 during 2019. Capital expenditures were $400.2 and $379.8 for the years ended December 31, 2019 and 2018, respectively. Capital expenditures in 2019 were 3.5% of revenues primarily in connection with projects to support growth in the Company's core businesses, projects related to LaunchPad and further Covance integration initiatives. The Company intends to continue to pursue acquisitions to fund growth, to make important investments in its business, including in information technology, and to improve efficiency and enable the execution of the Company's mission. Such expenditures are expected to be funded by cash flow from operations or, as needed, through borrowings under debt facilities, including the Company's revolving credit facility or any successor facility. The Company expects capital expenditures in 2020 to be approximately 3.5% to 4.0% of revenues, primarily in connection with projects to support growth in the Company's core businesses, facility updates, ongoing projects related to LaunchPad within the LCD business, LaunchPad's expansion within the CDD business, and further acquisition integration initiatives.
Cash Flows from Financing Activities
Net cash used in financing activities for the year ended December 31, 2019, was $252.7 compared to cash used in financing activities of $1,389.9 for the year ended December 31, 2018. This movement in cash within financing activities for 2019, as compared to 2018, was primarily a result of $198.5 net financing proceeds offset by $450.0 in share repurchases in 2019 compared to $695.0 in net financing payments and $700.0 in share repurchases in 2018.
On June 3, 2019, the Company entered into a new $850.0 term loan facility in addition to its $750.0 2017 term loan facility. The 2019 term loan facility will mature on June 3, 2021. Proceeds of the 2019 term loan facility were used for general corporate purposes, including to repay approximately $250.0 of the 2017 term loan facility and in connection with the acquisition of Envigo's nonclinical research services business.
On November 25, 2019, the Company issued $1,050.0 in debt securities, consisting of $400.0 aggregate principal amount of 2.300% Senior Notes due 2024 and $650.0 aggregate principal amount of 2.950% Senior Notes due 2029. The net proceeds from the new Senior Notes were used to redeem all of the outstanding $500.0 principal amount of its 2.625% Senior Notes due February 1, 2020, redeem $187.9 of the outstanding 4.625% Senior Notes due November 15, 2020 in a tender offer, and to repay $348.3 outstanding under the Company's term loan credit facilities.
In total, during 2019, the Company redeemed or repaid $687.9 million of its Senior Notes and $1,002.0 million of its term loans. In addition, the Company borrowed and repaid a total of $495.0 million of debt through its revolving credit facility within 2019. The Company will continue to evaluate all opportunities for strategic deployment of capital in light of market conditions.
The Company's revolving credit facility consists of a five year revolving facility in the principal amount of up to $1,000.0 with the option of increasing the facility by up to an additional $350.0, subject to the agreement of one or more new or existing lenders to provide such additional amounts and certain other customary conditions.
Under the Company's term loan credit facilities and the revolving credit facility, the Company is subject to negative covenants limiting subsidiary indebtedness and certain other covenants typical for investment grade-rated borrowers and the Company is required to maintain certain leverage ratios. The Company was in compliance with all covenants under the term loan credit facilities and the revolving credit facility at December 31, 2019. As of December 31, 2019, the ratio of total debt to consolidated pro forma trailing 12 month earnings before interest, tax, depreciation, and amortization (EBITDA) was 3.1 to 1.0.
At the end of 2018, the Company had outstanding authorization from the board of directors to purchase up to $443.5 of Company common stock. On February 6, 2019, the board of directors replaced the Company’s existing share repurchase plan with a new plan authorizing repurchase of up to $1.25 billion of the Company’s shares. The repurchase authorization has no expiration date. During 2019, the Company purchased 2.9 shares of its common stock at an average price of $154.94 for a total cost of $450.0, of which $100.0 was repurchased prior to the new plan in February 2019. At the end of 2019, the Company had outstanding authorization from the board of directors to purchase an additional $900.0 of Company common stock.
During 2019 and 2018, the Company settled notices to convert $8.6 and $0.3 aggregate principal amount at maturity of its zero-coupon subordinated notes due 2021 (the zero-coupon notes) with a conversion value of $16.6 and $0.7, respectively. The total cash used for these settlements was $8.2 and $0.3 and the Company also issued 0.1 and 0.0 additional shares of common stock, respectively. As a result of these conversions in 2019 and 2018, the Company also reversed approximately $2.0 and $0.2, respectively,
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of deferred tax liability to reflect the tax benefit realized upon issuance of the shares. On December 19, 2019, the Company redeemed any remaining outstanding zero-coupon notes that did not convert.
Credit Ratings
The Company’s investment grade debt ratings from Moody’s and BBB from Standard & Poor's (S&P) contribute to its ability to access capital markets.
(a)
Contingent future licensing payments will be made if certain events take place, such as the launch of a specific test, the transfer of certain technology, and the achievement of specified revenue milestones.
(b)
The table does not include obligations under the Company’s pension and postretirement benefit plans, which are included in Note 17 Pension and Postretirement Plans to Consolidated Financial Statements. Benefits under the Company's postretirement medical plan are made when claims are submitted for payment, the timing of which is not practicable to estimate.
(c)
The table does not include the Company’s reserve for unrecognized tax benefits. The Company had a $37.2 and $26.7 reserve for unrecognized tax benefits, including interest and penalties, at December 31, 2019, and 2018, respectively, which is included in Note 14 Income Taxes to Consolidated Financial Statements. For the year ended December 31, 2019, approximately $6.1 of the tax reserve is classified in accrued expenses and other in the Company's Consolidated Balance Sheet while the remaining $31.1 is classified in deferred income taxes and other tax liabilities. For the year ended December 31, 2018, approximately $6.0 of the tax reserve is classified in accrued expenses and other in the Company's Consolidated Balance Sheet while the remaining $20.7 is classified in deferred income taxes and other tax liabilities.
(d)
Interest payments due by period for the Company's debt subject to variable interest rates are calculated based on rates in place as of December 31, 2019.
(e)
Excludes amount of debt issuance costs included in the long-term debt balance.
Off-Balance Sheet Arrangements
The Company does not have transactions or relationships with “special purpose” entities, and the Company does not have any off-balance sheet financing other than normal operating leases and letters of credit.
Other Commercial Commitments
As of December 31, 2019, the Company provided letters of credit aggregating approximately $76.3, primarily in connection with certain insurance programs. Letters of credit provided by the Company are secured by the Company’s revolving credit facility and are renewed annually.
The contractual value of the noncontrolling interest put in the Company's Ontario subsidiary totaled $15.8 and $15.0 at December 31, 2019, and 2018, respectively, and has been classified as mezzanine equity in the Company's consolidated balance sheet.
Based on current and projected levels of cash flows from operations, coupled with availability under its revolving credit facility, the Company believes it has sufficient liquidity to meet both its anticipated short-term and long-term cash needs; however, the Company continually reassesses its liquidity position in light of market conditions and other relevant factors.
Critical Accounting Policies
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and
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liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported periods. While the Company believes these estimates are reasonable and consistent, they are by their very nature estimates of amounts that will depend on future events. Accordingly, actual results could differ from these estimates. The Company’s Audit Committee periodically reviews the Company’s significant accounting policies. The Company’s critical accounting policies arise in conjunction with the following:
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Revenue recognition;
•
Business combinations;
•
Pension expense;
•
Accruals for self-insurance reserves;
•
Income taxes; and
•
Goodwill and indefinite-lived assets.
Revenue Recognition
LCD
Within the LCD segment, a revenue transaction is initiated when LCD receives a requisition order to perform a diagnostic test. The information provided on the requisition form is used to determine the party that will be billed for the testing performed and the expected reimbursement. LCD recognizes revenue and satisfies its performance obligation for services rendered when the testing process is complete and the associated results are reported. Revenues are distributed among four payer portfolios - clients, patients, Medicare and Medicaid and third-party.
The following are descriptions of the LCD payer portfolios:
Clients
Client payers represent the portion of LCD’s revenue related to physicians, hospitals, health systems, accountable care organizations (ACOs), employers and other entities where payment is received exclusively from the entity ordering the testing service. Generally, client revenues are recorded on a fee-for-service basis at LCD’s client list price, less any negotiated discount. A portion of client billing is for laboratory management services, collection kits and other non-testing services or products. In these cases, revenue is recognized when services are rendered or delivered.
Patients
This portfolio includes revenue from uninsured patients and member cost-share for insured patients (e.g., coinsurance, deductibles and non-covered services). Uninsured patients are billed based upon LCD’s patient fee schedules, net of any discounts negotiated with physicians on behalf of their patients. LCD bills insured patients as directed by their health plan and after consideration of the fees and terms associated with an established health plan contract.
Medicare and Medicaid
This portfolio relates to fee-for-service revenue from traditional Medicare and Medicaid programs. Net revenue from these programs is based on the fee schedule established by the related government authority. In addition to contractual discounts, other adjustments including anticipated payer denials are considered when determining net revenue. Any remaining adjustments to revenue are recorded at the time of final collection and settlement. These adjustments are not material to LCD’s results of operations in any period presented.
Third-Party
Third-party includes revenue related to MCOs. The majority of LCD's third-party revenue is reimbursed on a fee-for-service basis. These payers are billed at LCD's established list price and revenue is recorded net of contractual discounts. The majority of LCD’s MCO revenues are recorded based upon contractually negotiated fee schedules with revenues for non-contracted MCOs recorded based on historical reimbursement experience.
Third-party reimbursement is also received through capitation agreements with MCOs and independent physician associations (IPAs). Under capitated agreements, revenue is recognized based on a negotiated per-member, per-month payment for an agreed upon menu of tests, or based upon the proportionate share earned by LCD from a capitation pool. When the agreed upon reimbursement is based solely on an established rate per member, revenue is not impacted by the volume of testing performed. Under a capitation pool arrangement, the aggregate value of an established rate per member is distributed based on the volume and complexity of the procedures performed by laboratories participating in the agreement. LCD recognizes revenue monthly, based upon the established capitation rate or anticipated distribution from a capitated pool.
LCD has a formal process to estimate implicit price concessions for uncollectable accounts. The majority of LCD's collection risk is related to accounts receivable from both insured and uninsured patients who are unwilling or unable to pay. Anticipated
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write-offs are recorded as adjustments to revenue an at an amount considered necessary to record the segment's revenue at its net realizable value. In addition to contractual discounts, other adjustments including anticipated payer denials and other external factors that could affect the collectablity of its receivables are considered when determining revenue and the net receivable amount. Any remaining adjustments to revenue are recorded at the time of final collection and settlement. These adjustments are not material to LCD's results of operations in any period presented.
CDD
The nature of CDD’s obligations include agreements to provide preclinical services, to manage a full clinical trial, provide services for a specific phase of a trial, or provide research products to the customer. Generally, the amount of the transaction price estimated at the beginning of the contract is equal to the amount expected to be billed to the customer. Other payments may also factor into the calculation of transaction price, such as volume-based rebates that are retroactively applied to prior transactions in the period.
Historically a majority of CDD's revenues have been earned under contracts that range in duration from a few months to a few years, but can extend in duration up to five years or longer. Occasionally, CDD also has entered into minimum volume arrangements with certain customers. Under these types of arrangements, if the annual minimum dollar value of a service commitment is not reached, the customer is required to pay CDD for the shortfall. Annual minimum commitment shortfalls are not recognized until the end of the period when the amount has been determined and agreed to by the customer.
CDD recognizes revenue either as services are performed or as products are delivered, depending on the nature of the work contracted. If performance is completed at a specific point in time, the Company evaluates the nature of the agreement to determine when the good or service is transferred into the customer’s control.
Service contracts generally take the form of fee-for-service or fixed-price arrangements subject to pricing adjustments based on changes in scope. In cases where performance spans multiple accounting periods, revenue is recognized as services are performed, measured on a proportional-performance basis, using either input or output methods that are specific to the service provided. In an output method, revenue is determined by dividing the actual units of output achieved by the total units of output required under the contract and multiplying that percentage by the total contract value. The total contract value, or total contractual payments, represents the aggregate contracted price for each of the agreed upon services to be provided.
When using an input method, revenue is recognized by dividing the actual units of input incurred by the total units of input budgeted in the contract, and multiplying that percentage by the total contract value. In each situation, the Company believes that the methods used most accurately depict the progress of the Company towards completing its obligations. Billing schedules and payment terms are generally negotiated on a contract-by-contract basis. In some cases, CDD bills the customer for the total contract value in progress-based installments as certain non-contingent billing milestones are reached over the contract duration. These milestones include, but are not limited to, contract signing, initial dosing, investigator site initiation, patient enrollment and/or database lock. The term “billing milestone” relates only to a billing trigger in a contract whereby amounts become billable and payable in accordance with a negotiated predetermined billing schedule throughout the term of a project. These billing milestones are generally not performance-based (i.e., there is no potential additional consideration tied to specific deliverables or performance). In other cases, billing and payment terms are tied to the passage of time (e.g., monthly billings). In either case, the total contract value and aggregate amounts billed to the customer would be the same at the end of the project.
Proportional performance contracts typically contain a single service (e.g., management of a clinical study) and therefore no allocation of the contract price is required. Fee-for-service contracts are typically priced based on transaction volume. Since the volume of activities in a fee-for-service contract is unspecified, the contract price is entirely variable and is allocated to the time period in which it is earned. For contracts that include multiple distinct goods and services, CDD allocates the contract price to the goods and services based on a customer price list, if available. If a price list is not available, CDD will estimate the transaction price using either market prices or an “expected cost plus margin” approach.
While CDD attempts to negotiate terms that provide for billing and payment of services prior or within close proximity to the provision of services, this is not always possible. While a project is ongoing, cash payments are not necessarily representative of aggregate revenue earned at any particular point in time, as revenues are recognized when services are provided, while amounts billed and paid are in accordance with the negotiated billing and payment terms.
In some cases, payments received are in excess of revenue recognized. For example, a contract invoicing schedule may provide for an upfront payment of 10% of the full contract value upon contract signing, but at the time of signing performance of services has not yet begun. Payments received in advance of services being provided are deferred as contract liabilities on the balance sheet. As the contracted services are subsequently performed and the associated revenue is recognized, the contract liability balance is reduced by the amount of revenue recognized during the period.
In other cases, services may be provided and revenue recognized before the customer is invoiced. In these cases, revenue recognized will exceed amounts billed, and the difference, representing a contract asset, is recorded for the amount that is currently
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not billable to the customer pursuant to contractual terms. Once the customer is invoiced, the contract asset is reduced for the amount billed, and a corresponding account receivable is recorded. All contract assets are billable to customers within one year from the respective balance sheet date.
Most contracts are terminable with or without cause by the customer, either immediately or upon notice. These contracts often require payment to CDD of expenses to wind down the study or project, fees earned to date and, in some cases, a termination fee or a payment to CDD of some portion of the fees or profits that could have been earned by CDD under the contract if it had not been terminated early. Termination fees are included in revenues when services are performed and realization is assured.
The following are descriptions of the full range of drug development services provided by CDD:
Preclinical services include fee-for-service activities such as bioanalytical testing services, and proportional performance activities such as toxicology studies. Until June 3, 2019, preclinical services also included the sale of research models. See Note 3 Business Acquisitions and Dispositions to the Consolidated Financial Statements for more information. Revenue for sale of research models was recognized at a point in time, typically upon shipment, when control transferred to the customer. Revenue for bioanalytical testing services is recognized at a point in time upon communication of results to the customer. Revenue for proportional performance activities, including toxicology studies, is recognized using an input-based measure of progress in which revenue is recognized as expenses are incurred for the research models, labor hours, and other costs attributable to the study.
Through its central laboratory, CDD produces and supplies specimen collection kits that are utilized in clinical studies, and provides transportation, project management, data management, and laboratory testing services on an as-needed basis throughout the duration of its customers’ clinical studies. Revenue for central laboratory services is recognized using an output-based measure of progress based on volume of activities in each period. CDD also provides long-term specimen storage services, for which revenue is recognized using an input-based measure of progress based on costs incurred.
CDD provides clinical development and commercialization services, including clinical pharmacology services, full management of Phase II through IV clinical studies, and market access solutions. Revenue for clinical pharmacology services, which includes first-in-human trials, is recognized using an output-based measure of progress based on bed nights. The majority of clinical development and commercialization service long-term contracts are service contracts for clinical research that represent a single performance obligation (e.g., management of a clinical study). Revenue for these service contracts is recognized over time based on the progress of the performance obligation which was measured by the proportion of the actual costs incurred to the total costs expected to complete the contract (including labor and pass-through costs such as investigator grants and reimbursable out-of-pocket expenses). This cost-based method of revenue recognition required management to estimate the costs to complete these services on an ongoing basis. Clinical services utilizing the input-based measure of progress account for approximately 50% of CDD revenue. Revenue for market access solutions is recognized using various methods. Revenue for fee-for-service arrangements, such as reimbursement consulting hotlines and patient assistance programs, is recognized using an output method based on transaction volume which corresponds to the amount charged to the customer. For consulting services billed based on time and materials, revenue is recognized using the right to invoice practical expedient.
CDD endeavors to assess and monitor the creditworthiness of its customers to which it grants credit terms in the ordinary course of business. CDD maintains a provision for doubtful accounts relating to amounts due that may not be collected. This bad debt provision is monitored on a monthly basis and adjusted as circumstances warrant. Since the recorded bad debt provision is based upon management's judgment, actual bad debt write-offs may be greater or less than the amount recorded. Historically, bad debt write-offs have not been material.
Business Combinations
The Company accounted for business combination transactions under the acquisition method of accounting and reported the results of operations of the acquired entities from its respective date of acquisition. Assets acquired were recorded at their estimated fair values as of the acquisition date. Estimated fair values were based on various valuation methodologies including: an income approach using primarily discounted cash flow techniques for the customer relationships intangible assets. The aforementioned income methods utilize management’s estimates of future operating results and cash flows discounted using a weighted-average cost of capital that reflects market participant assumptions. The excess of the fair value of the consideration conveyed over the fair value of the assets acquired was recorded as goodwill. The goodwill reflects management's expectations of the ability to gain access to and penetrate the acquired entities' historical patient base and the benefits of being able to leverage operational efficiencies with favorable growth opportunities based on positive demographic trends in the market. None of the goodwill recorded as a result from these transactions is deductible for federal income tax purposes.
As described in Note 3 Business Acquisitions and Dispositions to the consolidated financial statements, the Company acquired the nonclinical contract research services business of Envigo for consideration of $601.0 in 2019, which resulted in $141.4 of identifiable intangible assets and $379.3 of goodwill being recorded. Management applied significant judgment in estimating the fair value of identifiable intangible assets, which involved the use of significant estimates and assumptions with respect to the
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customer attrition rates and the discount rate. During the year ended December 31, 2019, the Company also acquired various businesses and related assets for approximately $286.4 in cash (net of cash acquired). The purchase consideration for all acquisitions year to date has been allocated to the estimated fair market value of the net assets acquired, including approximately $184.3 in identifiable intangible assets and a residual amount of non-tax-deductible goodwill of approximately $115.1.
Pension Expense
The Company has a defined-benefit retirement plan (Company Plan) and a non-qualified supplemental retirement plan (PEP). In October 2009, the Company received approval from its board of directors to freeze any additional service-based credits for any years of service after December 31, 2009, on the Company Plan and the PEP. Both plans have been closed to new participants. Employees participating in the Company Plan and the PEP no longer earn service-based credits, but continue to earn interest credits.
The Company Plan covers substantially all employees employed by the Company prior to December 31, 2009. The benefits to be paid under the Company Plan are based on years of credited service through December 31, 2009, interest credits and average compensation. The Company's policy is to fund the Company Plan with at least the minimum amount required by applicable regulations. The PEP covers a portion of the Company's senior management group. Prior to 2010, the PEP provided for the payment of the difference, if any, between the amount of any maximum limitation on annual benefit payments under the Employee Retirement Income Security Act of 1974 and the annual benefit that would be payable under the Company Plan but for such limitation. Effective January 1, 2010, employees participating in the PEP no longer earn service-based credits. The PEP is an unfunded plan.
As a result of the Covance acquisition, the Company sponsors two defined-benefit pension plans for the benefit of its employees at two U.K. subsidiaries (U.K. Plans) and one defined-benefit pension plan for the benefit of its employees at a German subsidiary (German Plan), all of which are legacy plans of previously acquired companies and are closed to new entrants. Benefit amounts for all three plans are based upon years of service and compensation. The German Plan is unfunded while the U.K. Plans are funded. The Company’s funding policy for the U.K. Plans has been to contribute annually amounts at least equal to the local statutory funding requirements.
As a result of the Envigo acquisition, the Company assumed a defined benefit pension plan for the benefit of Envigo's U.K. employees (the Envigo plan), which is a legacy plan of a company previously acquired by Envigo. The Envigo plan is a funded plan that is closed to future accrual. The Company’s funding policy has been to contribute amounts at least equal to the local statutory funding requirements.
The Company's net pension cost is developed from actuarial valuations. Inherent in these valuations are key assumptions, including discount rates and expected return on plan assets, which are updated on an annual basis at the beginning of each year. The Company is required to consider current market conditions, including changes in interest rates, in making these assumptions. Changes in pension costs may occur in the future due to changes in these assumptions. The key assumptions used in accounting for the defined-benefit retirement plans were a 3.3% discount rate and a 6.5% expected long-term rate of return on plan assets for the Company Plan, a 3.4% discount rate for the PEP, a 1.9% discount rate and a 2.0% expected salary increase for the German plan and a 2.9% discount rate, a 3.6% expected salary increase for the U.K. Plans and a 2.3% discount rate and 3.9% expected return on assets for the Envigo plan as of December 31, 2019.
Discount Rate
The Company evaluates several approaches toward setting the discount rate assumption that is used to value the benefit obligations of its retirement plans. At year-end, priority was given to use of the Towers Watson Bond:Link model, which simulates the purchase of investment-grade corporate bonds at current market yields with principal amounts and maturity dates closely matching the Company's projected cash disbursements from its plans. This completed model represents the yields to maturity at which the Company could theoretically settle its plan obligations at year end. The weighted-average yield on the modeled bond portfolio is then used to form the discount rate assumption used for each retirement plan. A one percentage point decrease or increase in the discount rate would have resulted in a respective increase or decrease in 2019 retirement plan expense of $2.0 for the Company Plan and PEP. A one percentage point decrease or increase in the discount rate would have resulted in a respective increase or decrease in 2019 retirement plan expense of $0.4 for the U.K. Plans.
Return on Plan Assets
In establishing its expected return on plan assets assumption, the Company reviews its asset allocation and develops return assumptions based on different asset classes adjusting for plan operating expenses. Actual asset over/under performance compared to expected returns will respectively decrease/increase unrecognized loss. The change in the unrecognized loss will change amortization cost in upcoming periods. A one percentage point increase or decrease in the expected return on plan assets would have resulted in a corresponding change in 2019 pension expense of $2.4 for the Company Plan. A one percentage point increase or decrease in the expected return on plan assets would have resulted in a corresponding change in 2019 pension expense of $3.5 for the U.K. Plans.
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Net pension cost for 2019 was $13.8 as compared with $20.9 in 2018 and $14.6 in 2017. The decrease in pension expense was due to decreases in the amount of net amortization and deferral as a result of higher discount rates. In addition, a $7.5 settlement charge was incurred in 2018. Pension expense for the Company Plan and the PEP is expected to decrease to $11.8 in 2020 primarily due to the impact of strong asset returns in 2019 for the Company Plan offset by lower discount rates impacting the PEP. Pension expense for the Germany Plan and the U.K. Plans is expected to decrease to a credit of $3.5 in 2020, primarily due to the impact of freezing the legacy U.K. Plans as of December 31, 2019, leading to a lower service cost in 2020.
Further information on the Company’s defined-benefit retirement plans is provided in Note 17 Pension and Postretirement Plans to the Consolidated Financial Statements.
Accruals for Self-Insurance Reserves
Accruals for self-insurance reserves (including workers’ compensation, auto and employee medical) are determined based on a number of assumptions and factors, including historical payment trends and claims history, actuarial assumptions and current and estimated future economic conditions. These estimated liabilities are not discounted.
The Company is self-insured (up to certain limits) for professional liability claims arising in the normal course of business, generally related to the testing and reporting of laboratory test results. The Company maintains excess insurance which limits the Company’s maximum exposure on individual claims. The Company estimates a liability that represents the ultimate exposure for aggregate losses below those limits. The liability is based on assumptions and factors for known and incurred but not reported claims, including the frequency and payment trends of historical claims.
If actual trends differ from these estimates, the financial results could be impacted. Historical trends have not differed significantly from these estimates.
Income Taxes
The Company accounts for income taxes utilizing the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and for tax loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company does not recognize a tax benefit, unless the Company concludes that it is more likely than not that the benefit will be sustained on audit by the taxing authority based solely on the technical merits of the associated tax position. If the recognition threshold is met, the Company recognizes a tax benefit measured at the largest amount of the tax benefit that the Company believes is greater than 50% likely to be realized. The Company records interest and penalties in income tax expense.
Goodwill and Indefinite-Lived Assets
The Company assesses goodwill and indefinite-lived intangibles for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. In accordance with updates to the Financial Accounting Standards Board's (FASB) authoritative guidance regarding goodwill and indefinite-lived intangible asset impairment testing, an entity is allowed to first assess qualitative factors as a basis for determining whether it is necessary to perform quantitative impairment testing. If an entity determines that it is not more likely than not that the estimated fair value of an asset is less than its carrying value, then no further testing is required. Otherwise, impairment testing must be performed in accordance with the original accounting standards. The updated FASB guidance also allows an entity to bypass the qualitative assessment for any reporting unit in its goodwill assessment and proceed directly to performing the quantitative assessment. Similarly, a company can proceed directly to a quantitative assessment in the case of impairment testing for indefinite-lived intangible assets as well.
The quantitative goodwill impairment test includes the estimation of the fair value of each reporting unit as compared to the carrying value of the reporting unit. Reporting units are businesses with discrete financial information that is available and reviewed by management. The Company estimates the fair value of a reporting unit using both income-based and market-based valuation methods. The income-based approach is based on the reporting unit's forecasted future cash flows that are discounted to the present value using the reporting unit's weighted average cost of capital. For the market-based approach, the Company utilizes a number of factors such as publicly available information regarding the market capitalization of the Company as well as operating results, business plans, market multiples, and present value techniques. Based upon the range of estimated values developed from the income and market-based methods, the Company determines the estimated fair value for the reporting unit. If the estimated fair value of the reporting unit exceeds the carrying value, the goodwill is not impaired and no further review is required. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit.
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The income-based fair value methodology requires management's assumptions and judgments regarding economic conditions in the markets in which the Company operates and conditions in the capital markets, many of which are outside of management's control. At the reporting unit level, fair value estimation requires management's assumptions and judgments regarding the effects of overall economic conditions on the specific reporting unit, along with assessment of the reporting unit's strategies and forecasts of future cash flows. Forecasts of individual reporting unit cash flows involve management's estimates and assumptions regarding:
•
Annual cash flows, on a debt-free basis, arising from future revenues and profitability, changes in working capital, capital spending and income taxes for at least a five-year forecast period.
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A terminal growth rate for years beyond the forecast period. The terminal growth rate is selected based on consideration of growth rates used in the forecast period, historical performance of the reporting unit and economic conditions.
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A discount rate that reflects the risks inherent in realizing the forecasted cash flows. A discount rate considers the risk-free rate of return on long-term treasury securities, the risk premium associated with investing in equity securities of comparable companies, the beta obtained from the comparable companies and the cost of debt for investment grade issuers. In addition, the discount rate may consider any company-specific risk in achieving the prospective financial information.
Under the market-based fair value methodology, judgment is required in evaluating market multiples and recent transactions. Management believes that the assumptions used for its impairment tests are representative of those that would be used by market participants performing similar valuations of the reporting units.
Management performed its annual goodwill and intangible asset impairment testing as of the beginning of the fourth quarter of 2019. The Company elected to perform the qualitative assessment for goodwill and intangible assets for the domestic LCD reporting units, a quantitative assessment for the CDD reporting units and a quantitative assessment for the Canadian reporting unit and its indefinite-lived assets consisting of acquired Canadian licenses.
In the qualitative assessment, the Company considered relevant events and circumstances for each reporting unit, including (i) current year results, ii) financial performance versus management’s annual and five-year strategic plans, iii) changes in the reporting unit carrying value since prior year, (iv) industry and market conditions in which the reporting unit operates, (v) macroeconomic conditions, including discount rate changes, and (vi) changes in products or services offered by the reporting unit. If applicable, performance in recent years was compared to forecasts included in prior valuations. Based on the results of the qualitative assessment, the Company concluded that it was not more likely than not that the carrying values of the goodwill and intangible assets were greater than their fair values, and that further quantitative testing was not necessary.
In 2019, the Company utilized a combination of the market and income approaches to determine the fair value of the CDD reporting units and the income approach to determine the fair value of the Canadian reporting unit and its indefinite-lived assets consisting of acquired Canadian licenses. Based upon the results of the quantitative assessments, the Company concluded that the fair values of the goodwill and intangible assets, including the indefinite-lived Canadian licenses, was greater than the carrying value.
It is possible that the Company's conclusions regarding impairment or recoverability of goodwill or intangible assets in any reporting unit could change in future periods. There can be no assurance that the estimates and assumptions used in the Company's goodwill and intangible asset impairment testing performed as of the beginning of the fourth quarter of 2019 will prove to be accurate predictions of the future, if, for example, (i) the businesses do not perform as projected, (ii) overall economic conditions in 2019 or future years vary from current assumptions (including changes in discount rates), (iii) business conditions or strategies for a specific reporting unit change from current assumptions, including loss of major customers, (iv) investors require higher rates of return on equity investments in the marketplace or (v) enterprise values of comparable publicly traded companies, or actual sales transactions of comparable companies, were to decline, resulting in lower multiples of revenues and EBITDA. The Company will continue to monitor the financial performance of and assumptions for one of the CDD reporting units for which an income approach was performed in 2019 and where the fair value exceeded carrying value by approximately 10%. Goodwill for this reporting unit as of December 31, 2019, was $2.2 billion. Management's impairment analysis for this reporting unit utilized significant judgments and assumptions related to the market comparable method analysis, such as selected market multiples, and related to cash flow projections, such as revenue and terminal growth rate, projected operating income, and the discount rate. A significant increase in the discount rate, decrease in the revenue and terminal growth rate, decreased operation margin or substantial reductions in end markets and volume assumptions could have a negative impact on the estimated fair value of this reporting unit. A future impairment charge for goodwill or intangible assets could have a material effect on the Company's consolidated financial position and results of operations. Management notes that a 1% change in the discount rate would reduce the headroom to approximately 1%.
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FORWARD-LOOKING STATEMENTS
Laboratory Corporation of America® Holdings together with its subsidiaries (the Company) has made in this report, and from time to time may otherwise make in its public filings, press releases and discussions by Company management, forward-looking statements concerning the Company’s operations, performance and financial condition, as well as its strategic objectives. Some of these forward-looking statements relate to future events and expectations and can be identified by the use of forward-looking words such as “believes”, “expects”, “may”, “will”, “should”, “seeks”, “approximately”, “intends”, “plans”, “estimates”, or “anticipates” or the negative of those words or other comparable terminology. Such forward-looking statements are subject to various risks and uncertainties and the Company claims the protection afforded by the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those currently anticipated due to a number of factors in addition to those discussed elsewhere herein, including in the “Risk Factors” section of this Annual Report on Form 10-K, and in the Company’s other public filings, press releases, and discussions with Company management, including:
1.
changes in government and third-party payer regulations, reimbursement, or coverage policies or other future reforms in the healthcare system (or in the interpretation of current regulations), new insurance or payment systems, including state, regional or private insurance cooperatives (e.g., health insurance exchanges) affecting governmental and third-party coverage or reimbursement for commercial laboratory testing, including the impact of the U.S. Protecting Access to Medicare Act of 2014 (PAMA);
2.
significant monetary damages, fines, penalties, assessments, refunds, repayments, damage to the Company's reputation, unanticipated compliance expenditures and/or exclusion or debarment from or ineligibility to participate in government programs, among other adverse consequences, arising from enforcement of anti-fraud and abuse laws and other laws applicable to the Company in jurisdictions in which the Company conducts business;
3.
significant fines, penalties, costs, unanticipated compliance expenditures and/or damage to the Company’s reputation arising from the failure to comply with applicable privacy and security laws and regulations, including the U.S. Health Insurance Portability and Accountability Act of 1996, the U.S. Health Information Technology for Economic and Clinical Health Act, the European Union's General Data Protection Regulation and similar laws and regulations in jurisdictions in which the Company conducts business;
4.
loss or suspension of a license or imposition of a fine or penalties under, or future changes in, or interpretations of applicable licensing laws or regulations regarding the operation of clinical laboratories and the delivery of clinical laboratory test results, including, but not limited to, the U.S. Clinical Laboratory Improvement Act of 1967 and the U.S. Clinical Laboratory Improvement Amendments of 1988 and similar laws and regulations in jurisdictions in which the Company conducts business;
5.
penalties or loss of license arising from the failure to comply with applicable occupational and workplace safety laws and regulations, including the U.S. Occupational Safety and Health Administration requirements and the U.S. Needlestick Safety and Prevention Act and similar laws and regulations in jurisdictions in which the Company conducts business;
6.
fines, unanticipated compliance expenditures, suspension of manufacturing, enforcement actions, damage to the Company's reputation, injunctions, or criminal prosecution arising from failure to maintain compliance with current good manufacturing practice regulations and similar requirements of various regulatory agencies in jurisdictions in which the Company conducts business;
7.
sanctions or other remedies, including fines, unanticipated compliance expenditures, enforcement actions, injunctions or criminal prosecution arising from failure to comply with the Animal Welfare Act or applicable national, state and local laws and regulations in jurisdictions in which the Company conducts business;
8.
changes in testing guidelines or recommendations by government agencies, medical specialty societies and other authoritative bodies affecting the utilization of laboratory tests;
9.
changes in applicable government regulations or policies affecting the approval, availability of, and the selling and marketing of diagnostic tests, drug development, or the conduct of drug development and medical device and diagnostic studies and trials, including regulations and policies of the U.S. Food and Drug Administration, the U.S. Department of Agriculture, the Medicine and Healthcare products Regulatory Agency in the United Kingdom (U.K.), the National Medical Products Administration in China, the Pharmaceutical and Medical Devices Agency in Japan, the European Medicines Agency and similar regulations and policies of agencies in other jurisdictions in which the Company conducts business;
10.
changes in government regulations or reimbursement pertaining to the biopharmaceutical and medical device and diagnostic industries, changes in reimbursement of biopharmaceutical products or reduced spending on research and development by biopharmaceutical customers;
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11.
liabilities that result from the failure to comply with corporate governance requirements;
12.
increased competition, including price competition, potential reduction in rates in response to price transparency and consumerism, competitive bidding and/or changes or reductions to fee schedules and competition from companies that do not comply with existing laws or regulations or otherwise disregard compliance standards in the industry;
13.
changes in payer mix or payment structure, including insurance carrier participation in health insurance exchanges, an increase in capitated reimbursement mechanisms, the impact of a shift to consumer-driven health plans or plans carrying an increased level of member cost-sharing, and adverse changes in payer reimbursement or payer coverage policies (implemented directly or through a third-party utilization management organization) related to specific diagnostic tests, categories of testing or testing methodologies;
14.
failure to retain or attract managed care organization (MCO) business as a result of changes in business models, including new risk-based or network approaches, out-sourced laboratory network management or utilization management companies, or other changes in strategy or business models by MCOs;
15.
failure to obtain and retain new customers, an unfavorable change in the mix of testing services ordered, or a reduction in tests ordered, specimens submitted or services requested by existing customers;
16.
difficulty in maintaining relationships with customers or retaining key employees as a result of uncertainty surrounding the integration of acquisitions and the resulting negative effects on the business of the Company;
17.
consolidation and convergence of MCOs, biopharmaceutical companies, health systems, large physician organizations and other customers, potentially causing material shifts in insourcing, utilization, pricing and reimbursement, including full and partial risk-based models;
18.
failure to effectively develop and deploy new systems, system modifications or enhancements required in response to evolving market and business needs;
19.
customers choosing to insource services that are or could be purchased from the Company;
20.
failure to identify, successfully close and effectively integrate and/or manage acquisitions of new businesses;
21.
inability to achieve the expected benefits and synergies of newly-acquired businesses, including due to items not discovered in the due diligence process, and the impact on the Company's cash position, levels of indebtedness and stock price;
22.
termination, loss, delay, reduction in scope or increased costs of contracts, including large contracts and multiple contracts;
23.
liability arising from errors or omissions in the performance of testing services, contract research services or other contractual arrangements;
24.
changes or disruption in the provision or transportation of services or supplies provided by third parties; or their termination for failure to follow the Company's performance standards and requirements;
25.
damage or disruption to the Company's facilities;
26.
damage to the Company's reputation, loss of business, or other harm from acts of animal rights activists or potential harm and/or liability arising from animal research activities;
27.
adverse results in litigation matters;
28.
inability to attract and retain experienced and qualified personnel;
29.
failure to develop or acquire licenses for new or improved technologies, such as point-of-care testing, mobile health technologies, and digital pathology, or potential use of new technologies by customers and/or consumers to perform their own tests;
30.
substantial costs arising from the inability to commercialize newly licensed tests or technologies or to obtain appropriate coverage or reimbursement for such tests;
31.
failure to obtain, maintain and enforce intellectual property rights for protection of the Company's products and services and defend against challenges to those rights;
32.
scope, validity and enforceability of patents and other proprietary rights held by third parties that may impact the Company's ability to develop, perform, or market the Company's products or services or operate its business;
33.
business interruption or other impact on the business due to natural disasters, including adverse weather, fires and earthquakes, political crises, including terrorism and war, public health crises and disease epidemics and pandemics, and other events outside of the Company's control;
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34.
discontinuation or recalls of existing testing products;
35.
a failure in the Company's information technology systems, including with respect to testing turnaround time and billing processes, or the failure of the Company or its third-party suppliers and vendors to maintain the security of business information or systems or to protect against cybersecurity attacks such as denial of service attacks, malware, ransomware and computer viruses, or delays or failures in the development and implementation of the Company’s automation platforms, any of which could result in a negative effect on the Company’s performance of services, a loss of business or increased costs, damages to the Company’s reputation, significant litigation exposure, an inability to meet required financial reporting deadlines, or the failure to meet future regulatory or customer information technology, data security and connectivity requirements;
36.
business interruption, increased costs, and other adverse effects on the Company's operations due to the unionization of employees, union strikes, work stoppages, general labor unrest or failure to comply with labor or employment laws;
37.
failure to maintain the Company's days sales outstanding levels, cash collections (in light of increasing levels of patient responsibility), profitability and/or reimbursement arising from unfavorable changes in third-party payer policies, payment delays introduced by third party utilization management organizations and increasing levels of patient payment responsibility;
38.
impact on the Company's revenues, cash collections and the availability of credit for general liquidity or other financing needs arising from a significant deterioration in the economy or financial markets or in the Company's credit ratings by Standard & Poor's and/or Moody's;
39.
failure to maintain the expected capital structure for the Company, including failure to maintain the Company's investment grade rating;
40.
changes in reimbursement by foreign governments and foreign currency fluctuations;
41.
inability to obtain certain billing information from physicians, resulting in increased costs and complexity, a temporary disruption in receipts and ongoing reductions in reimbursements and revenues;
42.
expenses and risks associated with international operations, including, but not limited to, compliance with the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act, other applicable anti-corruption laws and regulations, trade sanction laws and regulations, and economic, political, legal and other operational risks associated with foreign jurisdictions;
43.
failure to achieve expected efficiencies and savings in connection with the Company's business process improvement initiatives;
44.
changes in tax laws and regulations or changes in their interpretation, including the U.S. Tax Cuts and Jobs Act (TCJA); and
45.
global economic conditions and government and regulatory changes, including, but not limited to the U.K.'s exit from the European Union.
Except as may be required by applicable law, the Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Given these uncertainties, one should not put undue reliance on any forward-looking statements.
Item 7A.
Item 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK (in millions)
Market risk is the potential loss arising from adverse changes in market rates and prices, such as foreign currency exchange rates, interest rates and other relevant market rate or price changes. In the ordinary course of business, the Company is exposed to various market risks, including changes in foreign currency exchange and interest rates, and the Company regularly evaluates the exposure to such changes. The Company addresses its exposure to market risks, principally the market risks associated with changes in foreign currency exchange rates and interest rates, through a controlled program of risk management that includes, from time to time, the use of derivative financial instruments such as foreign currency forward contracts, cross currency swaps and interest rate swap agreements. Although, as set forth below, the Company’s zero-coupon subordinated notes contained features were considered to be embedded derivative instruments, the Company does not hold or issue derivative financial instruments for trading purposes.
Foreign Currency Exchange Rates
Approximately 12.7% and 13.6% of the Company's revenues for the year ended December 31, 2019 and 2018, respectively, were denominated in currencies other than the U.S. dollar (USD). The Company's financial statements are reported in USD and, accordingly, fluctuations in exchange rates will affect the translation of revenues and expenses denominated in foreign currencies into USD for purposes of reporting the Company's consolidated financial results. In both 2019 and 2018, the most significant
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currency exchange rate exposures were to the Canadian dollar, Swiss franc, euro and British pound. Excluding the impacts from any outstanding or future hedging transactions, a hypothetical change of 10% in average exchange rates used to translate all foreign currencies to USD would have impacted income before income taxes for 2019 by approximately $4.3. Gross accumulated currency translation adjustments recorded as a separate component of shareholders’ equity were $104.4 and $(176.6) at December 31, 2019, and 2018, respectively. The Company does not have significant operations in countries in which the economy is considered to be highly inflationary.
The Company earns revenue from service contracts over a period of several months and, in some cases, over a period of several years. Accordingly, exchange rate fluctuations during this period may affect the Company's profitability with respect to such contracts. The Company is also subject to foreign currency transaction risk for fluctuations in exchange rates during the period of time between the consummation and cash settlement of transactions. The Company limits its foreign currency transaction risk through exchange rate fluctuation provisions stated in some of its contracts with customers, or it may hedge transaction risk with foreign currency forward contracts. At December 31, 2019, the Company had 34 open foreign exchange forward contracts with various amounts maturing monthly through January 2020 with a notional value totaling approximately $369.2. At December 31, 2018, the Company had 34 open foreign exchange forward contracts with various amounts maturing monthly through January 2019 with a notional value totaling approximately $487.9.
The Company is party to USD to Swiss Franc cross-currency swap agreements with an aggregate notional amount of $600.0, maturing in 2022 and 2025, as a hedge against the impact of foreign exchange movements on its net investment in a Swiss Franc functional currency subsidiary.
Interest Rates
Some of the Company's debt is subject to interest at variable rates. As a result, fluctuations in interest rates affect the Company's financial results. The Company attempts to manage interest rate risk and overall borrowing costs through an appropriate mix of fixed and variable rate debt including the utilization of derivative financial instruments, primarily interest rate swaps.
Borrowings under the Company's term loan credit facilities and revolving credit facility are subject to variable interest rates, unless fixed through interest rate swaps or other agreements. As of December 31, 2019, and 2018, the Company had approximately $375.0 and $0.0, respectively, of unhedged variable rate debt under the 2019 term loan credit facility and $0.0 and $527.1, respectively, under the 2017 term loan credit facility.
Each quarter-point increase or decrease in the variable rate would result in the Company's interest expense changing by approximately $0.9 per year for the Company's unhedged variable rate debt.
During the third quarter of 2013, the Company entered into two fixed-to-variable interest rate swap agreements for its 4.625% Senior Notes due 2020 with an aggregate notional amount of $600.0 and variable interest rates based on one-month London Interbank Offered Rate (LIBOR) plus 2.298% to hedge against changes in the fair value of a portion of the Company's long-term debt. The Company exited one of these swap arrangements in December 2019 in connection with the redemption of $187.9 of the 4.625% Senior Notes due 2020 and recorded a gain of $1.6.
On December 19, 2019, the Company redeemed any remaining outstanding zero-coupon subordinated notes due 2021 (the zero-coupon notes) that did not convert.
Item 8.
Item 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information required by this item is incorporated by reference to the Report of Independent Registered Public Accounting Firm and the consolidated financial statements, related notes and supplementary data. See the Index on Page.
Item 9.
Item 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not Applicable.
Item 9A.
Item 9A.
CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
As of the end of the period covered by this report, the Company carried out under the supervision and with the participation of the Company’s management, including the Company’s principal executive officer and principal financial officer, an evaluation of the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended). Based upon this evaluation, the Company’s principal executive officer and principal
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financial officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this annual report.
Changes in Internal Control over Financial Reporting
On June 3, 2019, the Company completed the acquisition of Envigo's nonclinical contract research services business. The Company’s management has extended its oversight and monitoring processes that support internal control over financial reporting to include the acquired Envigo operations. The Company’s management is continuing to integrate the acquired operations of Envigo's nonclinical contract research services business into the Company’s overall internal control over financial reporting process. However, management has excluded these operations from its annual assessment of internal controls over financial reporting for the year ending December 31, 2019. There have been no changes in the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) during the quarter ended December 31, 2019, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Report of Management on Internal Control over Financial Reporting
The Company's management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934).
The internal control over financial reporting at the Company was designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the U.S. Internal control over financial reporting includes those policies and procedures that:
•
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;
•
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the U.S.;
•
provide reasonable assurance that receipts and expenditures of the Company are being made only in accordance with authorization of management and directors of the Company; and
•
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.
The Company's management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019. Management based this assessment on criteria for effective internal control over financial reporting described in “Internal Control - Integrated Framework 2013” issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, the Company's management determined that, as of December 31, 2019, the Company maintained effective internal control over financial reporting. Management reviewed the results of its assessment with the Audit Committee of the Company’s board of directors.
On June 3, 2019, the Company completed the acquisition of Envigo's nonclinical contract research services business. As a result, management has excluded Envigo from its assessment of internal control over financial reporting. Envigo is a wholly-owned subsidiary whose total assets and total revenues, excluded from management's assessment, represent 1.3% and 1.1%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2019.
PricewaterhouseCoopers LLP, an independent registered public accounting firm, who audited and reported on the consolidated financial statements of the Company included in this annual report, also audited the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019, as stated in its report, which is included herein immediately preceding the Company’s audited financial statements.
Item 9B.
Item 9B.
OTHER INFORMATION
None.
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PART III
Item 10.
Item 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by the item regarding directors is incorporated by reference to the Company’s Definitive Proxy Statement to be filed with the Securities and Exchange Commission in connection with the Annual Meeting of Stockholders to be held in 2020 (the 2020 Proxy Statement) under the caption Election of Directors. Information regarding executive officers is incorporated by reference to the Company’s 2020 Proxy Statement under the caption Executive Officers. Information concerning the Company’s Audit Committee, including the designation of audit committee financial experts and information regarding compliance with Section 16(a) of the Exchange Act responsive to this item is incorporated by reference to the Company’s 2020 Proxy Statement under the captions Corporate Governance and Section 16(a) Beneficial Ownership Reporting Compliance respectively. Information concerning the Company's code of ethics is incorporated by reference to the Company's 2020 Proxy Statement under the caption Corporate Governance Policies and Procedures.
Item 11.
Item 11.
EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to information in the 2020 Proxy Statement under the captions “Executive Compensation” and “Director Compensation.”
Item 12.
Item 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
See Note 15 Stock Compensation Plans to the Consolidated Financial Statements for a discussion of the Company’s Stock Compensation Plans. Except for the above referenced footnote, the information called for by this item is incorporated by reference to information in the 2020 Proxy Statement under the captions “Security Ownership of Certain Beneficial Holders and Management,” “Compensation Discussion and Analysis” and “Executive Compensation.”
Item 13.
Item 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this item is incorporated by reference to information in the 2020 Proxy Statement under the captions “Board Independence” and “Related Party Transactions.”
Item 14.
Item 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is incorporated by reference to information in the 2020 Proxy Statement under the caption “Fees to Independent Registered Public Accounting Firm.”
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PART IV
Item 15.
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) List of documents filed as part of this report:
(1)
Consolidated Financial Statements and Report of Independent Registered Public Accounting Firm included herein:
See Index on page
(2)
Financial Statement Schedules:
All schedules are omitted as they are inapplicable or the required information is furnished in the Consolidated Financial Statements or notes thereto.
(3)
Index to and List of Exhibits
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Item 16. FORM 10-K SUMMARY
None.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
LABORATORY CORPORATION OF AMERICA HOLDINGS
Registrant
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Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant on February 28, 2020 in the capacities indicated.
Signature
Title
/s/ ADAM H. SCHECHTER
President and Chief Executive Officer
Adam H. Schechter
(Principal Executive Officer)
/s/ GLENN A. EISENBERG
Executive Vice President, Chief Financial Officer
Glenn A. Eisenberg
(Principal Financial Officer)
/s/ PETER J. WILKINSON
Senior Vice President and Chief Accounting Officer
Peter J. Wilkinson
(Principal Accounting Officer)
*
Director
Kerrii B. Anderson
*
Director
Jean-Luc Bélingard
*
Director
Jeffrey A. Davis
*
Director
D. Gary Gilliland, M.D., Ph.D.
*
Executive Chairman of the Board, Director
David P. King
*
Director
Garheng Kong, M.D., Ph.D.
*
Director
Peter M. Neupert
*
Director
Richelle Parham
*
Director
R. Sanders Williams, M.D.
* Sandra van der Vaart, by her signing her name hereto, does hereby sign this report on behalf of the directors of the Registrant after whose typed names asterisks appear, pursuant to powers of attorney duly executed by such directors and filed with the Securities and Exchange Commission.
By:
/s/ Sandra van der Vaart
Sandra van der Vaart
Attorney-in-fact
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LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND SCHEDULE
Page
Report of Independent Registered Public Accounting Firm
Consolidated Financial Statements:
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Comprehensive Earnings
Consolidated Statements of Changes in Shareholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
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Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of Laboratory Corporation of America Holdings
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Laboratory Corporation of America Holdings and its subsidiaries (the “Company”) as of December 31, 2019 and 2018, and the related consolidated statements of operations, comprehensive earnings, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2019, including the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.
Change in Accounting Principle
As discussed in Note 1 to the consolidated financial statements, the Company changed the manner in which it accounts for leases in 2019.
Basis for Opinions
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the Report of Management on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
As described in the Report of Management on Internal Control over Financial Reporting, management has excluded Envigo's nonclincial contract research services business (Envigo) from its assessment of internal control over financial reporting as of December 31, 2019, because it was acquired by the Company in a purchase business combination during 2019. We have also excluded Envigo from our audit of internal control over financial reporting. Envigo is a wholly-owned subsidiary whose total assets and total revenues excluded from management’s assessment and our audit of internal control over financial reporting represent 1.3% and 1.1%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2019.
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Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that (i) relate to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Valuation of LabCorp Diagnostics Segment (LCD) Net Accounts Receivable
As described in Notes 2 and 7 to the consolidated financial statements, the LCD business’s revenues are distributed among four payer portfolios - clients, patients, Medicare and Medicaid, and third-party. LCD accounts receivable due from these payer portfolios was $798.1 million as of December 31, 2019. The Company has a formal process to estimate implicit price concessions for uncollectable accounts. The Company considers negotiated discounts and anticipated adjustments, including historical collection experience for each of the payer portfolios, when revenues and accounts receivable are recorded. Anticipated write-offs are recorded as an adjustment to revenue and at an amount considered necessary to record the revenue at its net realizable value. In addition to contractual discounts, other adjustments including anticipated payer denials and other external factors that could affect the collectability of its receivables are considered when determining revenue and the net receivable amounts.
The principal considerations for our determination that performing procedures relating to the valuation of LCD net accounts receivable is a critical audit matter are there was significant judgment and estimation by management to determine net accounts receivable related to the LCD segment. This in turn led to a high degree of auditor judgment, subjectivity and effort to evaluate the audit evidence obtained related to the valuation of net LCD accounts receivable. Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the valuation of LCD net accounts receivable, including controls over management’s valuation analysis, data, and assumptions used to estimate amounts due from payers. These procedures also included, among others, testing management's process for developing the estimate of net accounts receivable, and the relevance of historical billing and collection data as an input to the analysis; testing the accuracy of a sample of revenue transactions and a sample of cash collections from the historical billing data and the historical collection which is used in management’s analysis; and performing a retrospective comparison of actual cash collected to the prior year estimate of net accounts receivable.
Revenue Recognition - Estimating Costs to Complete for Clinical Research Services
As described in Note 21 to the consolidated financial statements, Covance Drug Development (CDD) revenue was $4,578.1 million for the year ended December 31, 2019. Clinical services utilizing the cost-based measure of progress account for 50% of CDD revenue. The majority of clinical development and commercialization service long-term contracts within the Covance Drug Development segment (CDD) are service contracts for clinical research that represent a single performance obligation (e.g., management of a clinical study). Revenue for these service contracts is recognized over time based on the progress of the performance obligation which was measured by the proportion of the actual costs incurred to the total costs expected to complete the contract (including labor and pass-through costs such as investigator grants and reimbursable out-of-pocket expenses). This cost-based method of revenue recognition required management to estimate the costs to complete these service contracts on an ongoing basis.
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The principal considerations for our determination that performing procedures relating to estimating costs to complete for clinical research services is a critical audit matter are there was significant judgment and estimation by management when developing the costs to complete, including the labor and third party costs to complete the service contracts. This led to a high degree of auditor judgment, subjectivity and effort in evaluating evidence related to the cost estimates made by management.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the revenue recognition process, including controls over the determination of estimated costs to complete. These procedures also included, among others, testing, for a sample of contracts, actual costs incurred and evaluating the reasonableness of management’s estimation of costs to complete projects, including labor and third party costs to complete service contracts, based upon current scope, as well as evaluating whether the assumptions used were reasonable by performing a retrospective comparison of current year project costs to historical cost estimates made by management.
Acquisition of Nonclinical Contract Research Services Business of Envigo
As described in Note 3 to the consolidated financial statements, the Company acquired the nonclinical contract research services business of Envigo for consideration of $601.0 million in 2019, which resulted in $141.4 million of identifiable intangible assets. As disclosed, management applied significant judgment in estimating the fair value of identifiable intangible assets, which involved the use of significant estimates and assumptions with respect to the customer attrition rates and the discount rate.
The principal considerations for our determination that performing procedures relating to the acquisition of the nonclinical contract research services business of Envigo is a critical audit matter are there was significant judgment and estimation by management to determine the identifiable intangible assets. This in turn led to a high degree of auditor judgment, subjectivity and effort to evaluate the significant assumptions relating to the estimate, such as the customer attrition rates and the discount rate and to evaluate the audit evidence obtained related to the valuation of identifiable intangible assets acquired. In addition, the audit effort involved the use of professionals with specialized skill and knowledge to assist in performing these procedures and evaluating the evidence obtained from these procedures.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the acquisition accounting, including controls over management’s valuation of the identifiable intangible assets and controls over development of the assumptions related to the valuation of the identifiable intangible assets, including customer attrition rates and the discount rate. These procedures also included, among others, reading the purchase agreement, testing management’s process for estimating the fair value of identifiable intangible assets, and testing management’s significant assumptions used to estimate the fair value of the identifiable intangible assets. Testing management’s process included evaluating the appropriateness of the valuation methods and the reasonableness of significant assumptions including customer attrition rates, and the discount rate for identifiable intangible assets. Evaluating the reasonableness of customer attrition rates involved considering past performance of the acquired business as well as economics and industry forecasts. The discount rate was evaluated by considering the costs of capital of comparable businesses and other industry factors. Professionals with specialized skill and knowledge were used to assist in testing the discount rate.
Goodwill Impairment Assessment - Reporting Unit within the Covance Drug Development Segment
As described in Notes 1 and 9 to the consolidated financial statements, the Company’s consolidated goodwill balance was $7.9 billion as of December 31, 2019, and the goodwill associated with one of its reporting units within the Company’s Covance Drug Development (CDD) segment was $2.2 billion. The Company assesses goodwill for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Potential impairment is identified by comparing the fair value of a reporting unit to its carrying value, including goodwill. Fair value of a reporting unit is estimated using both income-based and market-based valuation methods. In particular, management’s impairment analysis for this reporting unit utilized significant judgments and assumptions related to the market comparable method analysis, such as selected market multiples and related to cash flow projections, such as revenue and terminal growth rates, projected operating margin, and the discount rate.
The principal considerations for our determination that performing procedures relating to the goodwill impairment assessment of the reporting unit within the CDD segment is a critical audit matter are there was significant judgment by management when developing the fair value estimate of the reporting unit. This in turn led to a high degree of auditor judgment, subjectivity, and audit effort in performing procedures to evaluate management’s market comparable method analysis and cash flow projections, including significant assumptions for the selected market multiples, revenue and terminal growth rates, projected operating margin,
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and the discount rate. Also, the audit effort involved the use of professionals with specialized skill and knowledge to assist in performing these procedures and evaluating the audit evidence obtained from these procedures.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to management’s goodwill impairment assessment, including controls over the significant assumptions used in the valuation of the reporting unit. These procedures also included, among others, testing management's process for estimating the fair value of the reporting unit which involved evaluating the appropriateness of the valuation methods and the reasonableness of significant assumptions used in the market comparable method analysis and cash flow projections, including the revenue and terminal growth rates, projected operating margin, discount rate and selected market multiples. Evaluating the reasonableness of the revenue and terminal growth rates and projected operating margin involved considering the past performance of the reporting unit and considering whether these assumptions were consistent with evidence obtained in other areas of the audit. Professionals with specialized skill and knowledge were used to assist in the evaluation of the appropriateness of the Company’s valuation methods and the reasonableness of the significant assumptions, including (i) the terminal growth rates impacting the reporting unit’s future cash flows, (ii) the selected market multiple applied to the reporting unit’s financial information and (iii) the discount rate.
/s/ PricewaterhouseCoopers LLP
Raleigh, North Carolina
February 28, 2020
We have served as the Company’s auditor since 1997.
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PART I - FINANCIAL INFORMATION
Item 1. Financial Information
LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In Millions)
The accompanying notes are an integral part of these consolidated financial statements.
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LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Millions, Except Per Share Data)
The accompanying notes are an integral part of these consolidated financial statements.
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LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS
(In Millions, Except Per Share Data)
The accompanying notes are an integral part of these consolidated financial statements.
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LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(In Millions)
The accompanying notes are an integral part of these consolidated financial statements.
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LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Millions)
The accompanying notes are an integral part of these consolidated financial statements.
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LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Financial Statement Presentation
Laboratory Corporation of America Holdings® together with its subsidiaries (the Company), is a leading global life sciences company that is deeply integrated in guiding patient care, providing comprehensive clinical laboratory and end-to-end drug development services. The Company’s mission is to improve health and improve lives by delivering world-class diagnostic solutions, bringing innovative medicines to patients faster and using technology to provide better care. The Company serves a broad range of customers, including managed care organizations (MCOs), biopharmaceutical companies, governmental agencies, physicians and other healthcare providers (e.g. physician assistants and nurse practitioners, generally referred to herein as physicians), hospitals and health systems, employers, patients and consumers, contract research organizations (CROs) and independent clinical laboratories. During 2018, the Company sold its Covance Food Solutions (CFS) business, which provided food testing and integrity services, as well as its domestic and international forensic analysis businesses. During 2019, the Company's CDD segment completed the acquisition of Envigo's nonclinical contract research services business, expanding CDD's global nonclinical drug development capabilities with additional locations and resources. Additionally, the Company divested the Covance Research Products (CRP) business, which was part of the CDD segment, to Envigo. As part of this sale, CDD entered into a multi-year, renewable supply agreement with Envigo.
The Company reports its business in two segments, LabCorp Diagnostics (LCD) and Covance Drug Development (CDD). For further financial information about these segments, including information for each of the last three fiscal years regarding revenue, operating income, and other important information, see Note 21 Business Segment Information to the Consolidated Financial Statements. In 2019, LCD and CDD contributed 60% and 40%, respectively, of revenues to the Company, and in 2018 contributed 62% and 38%, respectively.
The consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries for which it exercises control. Long-term investments in affiliated companies in which the Company exercises significant influence, but which it does not control, are accounted for using the equity method. Investments in which the Company does not exercise significant influence (generally, when the Company has an investment of less than 20% and no representation on the investee's board of directors) are accounted for at fair value or at cost minus impairment adjusted for observable price changes in orderly transactions for an identical or similar investment of the same issuer for those investments that do not have readily determinable fair values. All significant inter-company transactions and accounts have been eliminated. The Company does not have any variable interest entities or special purpose entities whose financial results are not included in the consolidated financial statements.
The financial statements of the Company's operating foreign subsidiaries are measured using the local currency as the functional currency. Assets and liabilities are translated at exchange rates as of the balance sheet date. Revenues and expenses are translated at average monthly exchange rates prevailing during the year. Resulting translation adjustments are included in “Accumulated other comprehensive income.”
Recently Adopted Guidance
Leases
In February 2016, the Financial Accounting Standards Board (FASB) issued a new accounting standard that sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e., lessees and lessors). The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease. A lessee is also required to record a right-of-use (ROU) asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. The Company has elected to utilize the short-term lease exemption and not record leases with initial terms of 12 months or less on the balance sheet. The new standard requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales-type leases and direct financing leases.
The Company adopted the standard on January 1, 2019, using the modified retrospective method. Comparative periods were not adjusted and are presented in accordance with lease guidance in effect for that period. The Company elected the package of practical expedients, which includes not reassessing whether existing contracts contain leases under the new definition of a lease, reassessing the classification of existing leases, and reassessing whether previously capitalized initial direct costs qualify for capitalization under the new standard. Leases with an initial term of 12 months or less are not recorded on the Consolidated Balance Sheets. Operating lease expense is recognized on a straight-line basis over the lease term.
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LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
Operating lease assets and liabilities are recognized at the commencement date, based on the present value of the future lease payments over the lease term. A certain number of these leases contain rent escalation clauses either fixed or adjusted periodically for inflation or market rates that are factored into the Company's determination of lease payments. The Company also has variable lease payments that do not depend on a rate or index, for items such as volume purchase commitments, which are recorded as variable cost when incurred. As most of the Company's leases do not provide an implicit rate, the Company estimates an incremental borrowing rate based on the credit quality of the Company and by comparing interest rates available in the market for similar borrowings, and adjusting this amount based on the impact of collateral over the term of each lease. The Company uses this rate to discount payments to present value. Some operating leases contain renewal options, some of which also include options to early terminate the leases. The exercise of these options is at the Company's discretion. The Company determined that all renewal options within leases for main laboratories, rapid response (STAT) laboratories, branches or combination sites were reasonably possible to be exercised and therefore are included in the accounting lease term.
The standard had a material impact in the consolidated balance sheets, but no material impact in the consolidated income statements. The most significant impact was the recognition of right-of-use (ROU) assets and lease liabilities for operating leases. See Note 5 Leases to the Consolidated Financial Statements.
Other
In July 2017, the FASB issued a new accounting standard intended to reduce the complexity associated with the issuer's accounting for certain financial instruments with characteristics of liabilities and equity. Specifically, a down round feature would no longer cause a free-standing equity-linked financial instrument (or embedded conversion option) to be accounted for as a derivative liability at fair value with changes in fair value recognized in current earnings. The Company adopted this standard effective January 1, 2019. The adoption of this standard did not have a material impact on the consolidated financial statements.
In February 2018, the FASB issued a new accounting standard update that gives entities the option to reclassify to retained earnings tax effects related to items in accumulated other comprehensive income that the FASB refers to as having been stranded in accumulated other comprehensive income as a result of tax reform. The Company's adoption of this standard effective January 1, 2019, did not have a material impact on the Company's consolidated financial statements.
Reimbursable Out-of-Pocket Expenses
CDD pays on behalf of its customers certain out-of-pocket costs for which the Company is reimbursed at cost, without mark-up or profit. Out-of-pocket costs paid by CDD are reflected in operating expenses, while the reimbursements received are reflected in revenues in the consolidated statements of operations.
Cost of Revenues
Cost of revenue includes direct labor and related benefit charges, other direct costs, shipping and handling fees, and an allocation of facility charges and information technology costs. Selling, general and administrative expenses consist primarily of administrative payroll and related benefit charges, advertising and promotional expenses, administrative travel and an allocation of facility charges and information technology costs. Cost of advertising is expensed as incurred.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported periods. Significant estimates include implicit price concessions, revenue estimates, the allowances for doubtful accounts, deferred tax assets, fair values of acquired assets and assumed liabilities in business combinations, amortization lives for acquired intangible assets, and accruals for self-insurance reserves, litigation reserves and pensions. The allowance for doubtful accounts is determined based on historical collections trends, the aging of accounts, current economic conditions and regulatory changes. Actual results could differ from those estimates.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable.
The Company maintains cash and cash equivalents with various major financial institutions. The total cash and cash equivalent balances that exceeded the balances insured by the Federal Deposit Insurance Commission, were approximately $335.0 and $423.0 at December 31, 2019, and 2018, respectively.
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LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
Substantially all of the Company’s accounts receivable are with companies in the healthcare or biopharmaceutical industry and individuals. However, concentrations of credit risk are mitigated due to the number of the Company’s customers as well as their dispersion across many different geographic regions.
Although LCD has receivables due from U.S. and state governmental agencies, the Company does not believe that such receivables represent a credit risk since the related healthcare programs are funded by U.S. and state governments, and payment is primarily dependent upon submitting appropriate documentation. Accounts receivable balances (gross) from Medicare and Medicaid were $81.4 and $88.8 at December 31, 2019, and 2018, respectively.
For the Company's operations in Ontario, Canada, the Ontario Ministry of Health and Long-Term Care (Ministry) determines who can establish a licensed community medical laboratory and caps the amount that each of these licensed laboratories can bill the government sponsored healthcare plan. The Ontario government-sponsored healthcare plan covers the cost of commercial laboratory testing performed by the licensed laboratories. The provincial government discounts the annual testing volumes based on certain utilization discounts and establishes an annual maximum it will pay for all community laboratory tests. The agreed-upon reimbursement rates are subject to Ministry review at the end of year and can be adjusted (at the government's discretion) based upon the actual volume and mix of test work performed by the licensed healthcare providers in the province during the year. The capitated accounts receivable balances from the Ontario government sponsored healthcare plan were CAD 3.2 and CAD 0.5 at December 31, 2019, and 2018, respectively.
The portion of the Company's accounts receivable due from patients comprises the largest portion of credit risk. At December 31, 2019, and 2018, receivables due from patients represented approximately 21.1% and 21.5% of the Company's consolidated gross accounts receivable, respectively. The Company applies assumptions and judgments including historical collection experience for assessing collectability and determining allowances for doubtful accounts for accounts receivable from patients.
Earnings per Share
Basic earnings per share is computed by dividing net earnings attributable to Laboratory Corporation of America Holdings by the weighted average number of common shares outstanding. Diluted earnings per share is computed by dividing net earnings including the impact of dilutive adjustments by the weighted average number of common shares outstanding plus potentially dilutive shares, as if they had been issued at the earlier of the date of issuance or the beginning of the period presented. Potentially dilutive common shares result primarily from the Company’s outstanding stock options, restricted stock awards, performance share awards, and shares issuable upon conversion of zero-coupon subordinated notes.
The following represents a reconciliation of basic earnings per share to diluted earnings per share:
The following table summarizes the potential common shares not included in the computation of diluted earnings per share because their impact would have been antidilutive:
Stock Compensation Plans
The Company measures stock compensation cost for all equity awards at fair value on the date of grant and recognizes compensation expense over the service period for awards expected to vest. The fair value of restricted stock units is determined based on the number of shares granted and the quoted price of the Company’s common stock on the grant date. The grant date fair value of performance awards is based on a Monte Carlo simulated fair value for the relative (as compared to the peer companies) total shareholder return component of the performance awards. Such value is recognized as expense over the service period, net of estimated forfeitures and the Company's determination of whether it is probable that the performance targets will be achieved. At the end of each reporting period, the Company reassesses the probability of achieving performance targets. The estimation of equity awards that will ultimately vest requires judgment and the Company considers many factors when estimating expected forfeitures,
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LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
including types of awards, employee class, and historical experience. Forfeitures are recognized as a reduction of compensation expense in earnings in the period in which they occur.
See Note 15 Stock Compensation Plans for assumptions used in calculating compensation expense for the Company’s stock compensation plans.
Cash Equivalents
Cash and cash equivalents consist of highly liquid instruments, such as commercial paper, time deposits, and other money market instruments, substantially all of which have maturities when purchased of three months or less.
Supplies Inventory
Inventories, consisting primarily of purchased laboratory and customer supplies and finished goods, are stated at the lower of cost (first-in, first-out) or net realizable value. Supplies accounted for $228.3 and $200.1 and finished goods accounted for $16.4 and $37.2 of total inventory at December 31, 2019, and 2018, respectively.
Property, Plant and Equipment
Property, plant and equipment are recorded at cost. Depreciation and amortization expense is computed on all classes of assets based on their estimated useful lives, as indicated below, using the straight-line method.
Leasehold improvements are amortized over the shorter of their estimated useful lives or the term of the related leases. Expenditures for repairs and maintenance are charged to operations as incurred. Retirements, sales and other disposals of assets are recorded by removing the cost and accumulated depreciation from the related accounts with any resulting gain or loss reflected in the consolidated statements of operations.
Capitalized Software Costs
The Company capitalizes purchased software which is ready for service and capitalizes software development costs incurred on significant projects starting from the time that the preliminary project stage is completed and the Company commits to funding a project until the project is substantially complete and the software is ready for its intended use. Capitalized costs include direct material and service costs and payroll and payroll-related costs. Research and development (R&D) costs and other computer software maintenance costs related to software development are expensed as incurred. Capitalized software costs are amortized using the straight-line method over the estimated useful life of the underlying system ranging from three to ten years, generally five years. Amortization begins once the underlying system is substantially complete and ready for its intended use.
Long-Lived Assets
The Company assesses goodwill and indefinite-lived intangibles for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable.
Management performed its annual goodwill and intangible asset impairment testing as of the beginning of the fourth quarter of 2019. The Company elected to perform the qualitative assessment for goodwill and intangible assets for the domestic LCD reporting units, a quantitative assessment for the CDD reporting units and a quantitative assessment for the Canadian reporting unit and its indefinite-lived assets consisting of acquired Canadian licenses.
In the qualitative assessment, the Company considered relevant events and circumstances for each reporting unit, including (i) current year results, ii) financial performance versus management’s annual and five-year strategic plans, iii) changes in the reporting unit carrying value since prior year, (iv) industry and market conditions in which the reporting unit operates, (v) macroeconomic conditions, including discount rate changes, and (vi) changes in products or services offered by the reporting unit. If applicable, performance in recent years was compared to forecasts included in prior valuations. Based on the results of the qualitative assessment, the Company concluded that it was not more likely than not that the carrying values of the goodwill and intangible assets were greater than their fair values, and that further quantitative testing was not necessary.
In 2019, the Company utilized a combination of income and market approaches to determine the fair value of the CDD reporting units and an income approach to determine the fair value of the Canadian reporting unit and its indefinite-lived assets consisting of acquired Canadian licenses. Based upon the results of the quantitative assessments, the Company concluded that the fair values of the goodwill and intangible assets, including the indefinite-lived Canadian licenses, was greater than the carrying value.
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LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
The Company will continue to monitor the financial performance of and assumptions for one of the CDD reporting units for which a combination of income and market approaches was performed in 2019 and where the fair value exceeded carrying value by approximately 10%. Goodwill for this reporting unit as of December 31, 2019, was $2.2 billion. Management's impairment analysis for this reporting unit utilized significant judgments and assumptions related to the market comparable method analysis, such as selected market multiples, and related to cash flow projections, such as revenue and terminal growth rates, projected operating margin,and the discount rate. A significant increase in the discount rate, decrease in the revenue and terminal growth rate, or decreased operating margin, or substantial reductions in end markets and volume assumptions could have a negative impact on the estimated fair value of this reporting unit. A future impairment charge for goodwill or intangible assets could have a material effect on the Company's consolidated financial position and results of operations. Management notes that a 1% change in the discount rate would reduce the headroom to approximately 1%.
Long-lived assets, other than goodwill and indefinite-lived assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable. Recoverability of assets to be held and used is determined by the Company at the level for which there are identifiable cash flows by comparison of the carrying amount of the assets to future undiscounted net cash flows before interest expense and income taxes expected to be generated by the assets. Impairment, if any, is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets (based on market prices in an active market or on discounted cash flows). Assets to be disposed of are reported at the lower of the carrying amount or fair value.
Intangible Assets
Intangible assets are amortized on a straight-line basis over the expected periods to be benefited, as set forth in the table below, such as legal life for patents and technology and contractual lives for non-compete agreements.
Debt Issuance Costs
The costs related to the issuance of debt are capitalized, netted against the related debt for presentation purposes and amortized to interest expense over the terms of the related debt.
Professional Liability
The Company is self-insured (up to certain limits) for professional liability claims arising in the normal course of business, generally related to the testing and reporting of laboratory test results. The Company estimates a liability that represents the ultimate exposure for aggregate losses below those limits. The liability is based on assumptions and factors for known and incurred but not reported claims, including the frequency and payment trends of historical claims.
Income Taxes
The Company accounts for income taxes utilizing the asset and liability method. Under this method deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and for tax loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company does not recognize a tax benefit unless the Company concludes that it is more likely than not that the benefit will be sustained on audit by the taxing authority based solely on the technical merits of the associated tax position. If the recognition threshold is met, the Company recognizes a tax benefit measured at the largest amount of the tax benefit that the Company believes is greater than 50% likely to be realized. The Company records interest and penalties in income tax expense.
Derivative Financial Instruments
Interest rate swap agreements, which have been used by the Company from time to time in the management of interest rate exposure, are accounted for at fair value.
The Company’s zero-coupon subordinated notes contained two features that were considered to be embedded derivative instruments under authoritative guidance in connection with accounting for derivative instruments and hedging activities. On
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LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
December 19, 2019, the Company redeemed any remaining outstanding zero-coupon notes that did not convert. The Company believes these embedded derivatives had no fair value at December 31, 2018.
Cross currency swap agreements, which have been used by the Company to hedge exposure of its net investment in a foreign subsidiary denominated in non-U.S. currency, are accounted for at fair value.
See Note 19 Derivative Instruments and Hedging Activities for the Company’s objectives in using derivative instruments and the effect of derivative instruments and related hedged items on the Company’s financial position, financial performance and cash flows.
Fair Value of Financial Instruments
Fair value measurements for financial assets and liabilities are determined based on the assumptions that a market participant would use in pricing an asset or liability. A three-tiered fair value hierarchy draws distinctions between market participant assumptions based on (i) observable inputs such as quoted prices in active markets (Level 1), (ii) inputs other than quoted prices in active markets that are observable either directly or indirectly (Level 2) and (iii) unobservable inputs that require the Company to use present value and other valuation techniques in the determination of fair value (Level 3).
Research and Development
The Company expenses R&D costs as incurred.
Foreign Currencies
For subsidiaries outside of the U.S. that operate in a local currency environment, income and expense items are translated to U.S. dollars at the monthly average rates of exchange prevailing during the period, assets and liabilities are translated at period-end exchange rates and equity accounts are translated at historical exchange rates. Translation adjustments are accumulated in a separate component of shareholders’ equity in the consolidated balance sheets and are included in the determination of comprehensive income in the consolidated statements of comprehensive earnings and consolidated statements of changes in shareholders’ equity. Transaction gains and losses are included in the determination of net income in the consolidated statements of operations.
New Accounting Pronouncements
In June 2016, the FASB issued a new accounting standard intended to provide financial statement users with more decision-useful information about expected credit losses and other commitments to extend credit held by the reporting entity. The standard replaces the incurred loss impairment methodology in current Generally Accepted Accounting Principles (GAAP) with one that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The update is effective on January 1, 2020. The Company does not expect the adoption of this standard to have a material impact on the consolidated financial statements.
In August 2018, the FASB issued a new accounting standard to remove, modify, and add to the disclosure requirements on fair value measurements. The standard is effective on January 1, 2020. The Company does not expect the adoption of this new standard to have a material impact on the consolidated financial statements.
In August 2018, the FASB issued a new accounting standard to remove, modify, and add to the disclosure requirements on defined benefit pension and other postretirement plans. The standard is effective on January 1, 2021, with early adoption permitted. The Company is currently evaluating the impact this new standard will have on the consolidated financial statements.
In August 2018, the FASB issued a new accounting standard to align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The standard is effective on January 1, 2020. The Company does not expect the adoption of this standard to have a material impact on the consolidated financial statements.
In December 2019, the FASB issued a new accounting standard to simplify accounting for income taxes and remove, modify, and add to the disclosure requirements of income taxes. The standard is effective January 1, 2021, with early adoption permitted. The Company is currently evaluating the impact this new standard will have on the consolidated financial statements.
In January 2020, the FASB issued a new accounting standard to clarify the interaction of the accounting for equity securities and investments accounted for under the equity method of accounting and the accounting for certain forward contracts and purchased options. This standard is effective January 1, 2021. The Company is currently evaluating the impact this new standard will have on the consolidated financial statements.
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LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
Reclassifications and Revisions
In conjunction with the adoption of the new lease standard, the Company reclassified the capital lease asset balance of $44.4 at December 31, 2018 from Property, plant and equipment, net to Other assets.
2.
REVENUES
Description of Revenues
The Company's revenue by segment payers/customer groups for the years ended December 31, 2019, 2018 and 2017 is as follows:
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LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
The following is a description of the current revenue recognition policies of the Company:
LCD
LCD is an independent clinical laboratory business. It offers a comprehensive menu of frequently requested and specialty diagnostic tests through an integrated network of primary and specialty laboratories across the U.S. In addition to diagnostic testing along with occupational and wellness testing for employers and forensic DNA analysis, LCD also offered a range of other testing services.
Within the LCD segment, a revenue transaction is initiated when LCD receives a requisition order to perform a diagnostic test. The information provided on the requisition form is used to determine the party that will be billed for the testing performed and the expected reimbursement. LCD recognizes revenue and satisfies its performance obligation for services rendered when the testing process is complete and the associated results are reported. Sales are distributed among four payer portfolios - clients, patients, Medicare and Medicaid and third-party. LCD considers negotiated discounts and anticipated adjustments, including historical collection experience for the payer portfolio, when sales are recorded.
The following are descriptions of the LCD payer portfolios:
Clients
Client payers represent the portion of LCD’s revenue related to physicians, hospitals, health systems, accountable care organizations (ACOs), employers and other entities where payment is received exclusively from the entity ordering the testing service. Generally, client sales are recorded on a fee-for-service basis at LCD’s client list price, less any negotiated discount. A portion of client billing is for laboratory management services, collection kits and other non-testing services or products. In these cases, revenue is recognized when services are rendered or delivered.
Patients
This portfolio includes revenue from uninsured patients and member cost-share for insured patients (e.g., coinsurance, deductibles and non-covered services). Uninsured patients are billed based upon LCD’s patient list fee schedules, net of any discounts negotiated with physicians on behalf of their patients. LCD bills insured patients as directed by their health plan and after consideration of the fees and terms associated with an established health plan contract.
Medicare and Medicaid
This portfolio relates to fee-for-service revenue from traditional Medicare and Medicaid programs. Revenue from these programs is based on the fee schedule established by the related government authority. In addition to contractual discounts, other adjustments including anticipated payer denials are considered when determining revenue. Any remaining adjustments to revenue are recorded at the time of final collection and settlement. These adjustments are not material to LCD’s results of operations in any period presented.
Third-Party
Third-party includes revenue related to MCOs. The majority of LCD's third-party revenue is reimbursed on a fee-for-service basis. These payers are billed at LCD's established list price and revenue is recorded net of contractual discounts. The majority of LCD’s MCO sales are recorded based upon contractually negotiated fee schedules with sales for non-contracted MCOs recorded based on historical reimbursement experience.
In addition to contractual discounts, other adjustments including anticipated payer denials are considered when determining revenue. Any remaining adjustments to revenue are recorded at the time of final collection and settlement. These adjustments are not material to LCD’s results of operations in any period presented.
Third-party reimbursement is also received through capitation agreements with MCOs and independent physician associations (IPAs). Under capitated agreements, revenue is recognized based on a negotiated per-member, per-month payment for an agreed upon menu of tests, or based upon the proportionate share earned by LCD from a capitation pool. When the agreed upon reimbursement is based solely on an established rate per member, revenue is not impacted by the volume of testing performed. Under a capitation pool arrangement, the aggregate value of an established rate per member is distributed based on the volume and complexity of the procedures performed by laboratories participating in the agreement. LCD recognizes revenue monthly, based upon the established capitation rate or anticipated distribution from a capitated pool.
CDD
CDD is a CRO business that provides end-to-end drug development services from early-stage research to clinical trial management and beyond. CDD provides these services predominantly to biopharmaceutical and medical device companies worldwide. Because CDD's client base generally consumes these drug development services across the entire portfolio of CDD pre-clinical and clinical services offerings, there is little variability in the customer base of any particular CDD service offering. The nature of CDD’s
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obligations include agreements to provide preclinical services, to manage a full clinical trial, provide services for a specific phase of a trial, or provide research products to the customer. Generally, the amount of the transaction price estimated at the beginning of the contract is equal to the amount expected to be billed to the customer. Other payments may also factor into the calculation of transaction price, such as volume-based rebates that are retroactively applied to prior transactions in the period.
Historically, a majority of CDD’s revenues have been earned under contracts that range in duration from a few months to a few years, but can extend in duration up to five years or longer. Occasionally, CDD also has entered into minimum volume arrangements with certain customers. Under these types of arrangements, if the annual minimum dollar value of a service commitment is not reached, the customer is required to pay CDD for the shortfall. Annual minimum commitment shortfalls are not recognized until the end of the period when the amount has been determined and agreed to by the customer.
CDD recognizes revenue either as services are performed or as products are delivered, depending on the nature of the work contracted. If performance is completed at a specific point in time, the Company evaluates the nature of the agreement to determine when the good or service is transferred into the customer’s control.
Service contracts generally take the form of fee-for-service or fixed-price arrangements subject to pricing adjustments based on changes in scope. In cases where performance spans multiple accounting periods, revenue is recognized as services are performed, measured on a proportional-performance basis, using either input or output methods that are specific to the service provided. In an output method, revenue is determined by dividing the actual units of output achieved by the total units of output required under the contract and multiplying that percentage by the total contract value. The total contract value, or total contractual payments, represents the aggregate contracted price for each of the agreed upon services to be provided. When using an input method, revenue is recognized by dividing the actual units of input incurred by the total units of input budgeted in the contract, and multiplying that percentage by the total contract value. In each situation, the Company believes that the methods used most accurately depict the progress of the Company towards completing its obligations. Billing schedules and payment terms are generally negotiated on a contract-by-contract basis. In some cases, CDD bills the customer for the total contract value in progress-based installments as certain non-contingent billing milestones are reached over the contract duration. These milestones include, but are not limited to, contract signing, initial dosing, investigator site initiation, patient enrollment and/or database lock. The term “billing milestone” relates only to a billing trigger in a contract whereby amounts become billable and payable in accordance with a negotiated predetermined billing schedule throughout the term of a project. These billing milestones are generally not performance-based (i.e., there is no potential additional consideration tied to specific deliverables or performance). In other cases, billing and payment terms are tied to the passage of time (e.g., monthly billings). In either case, the total contract value and aggregate amounts billed to the customer would be the same at the end of the project.
Proportional performance contracts typically contain a single service (e.g., management of a clinical study) and therefore no allocation of the contract price is required. Fee-for-service contracts are typically priced based on transaction volume. Since the volume of activities in a fee-for-service contract is unspecified, the contract price is entirely variable and is allocated to the time period in which it is earned. For contracts that include multiple distinct goods and services, CDD allocates the contract price to the goods and services based on a customer price list, if available. If a price list is not available, CDD will estimate the transaction price using either market prices or an “expected cost plus margin” approach.
While CDD attempts to negotiate terms that provide for billing and payment of services prior or within close proximity to the provision of services, this is not always possible. While a project is ongoing, cash payments are not necessarily representative of aggregate revenue earned at any particular point in time, as revenues are recognized when services are provided, while amounts billed and paid are in accordance with the negotiated billing and payment terms.
In some cases, payments received are in excess of revenue recognized. For example, a contract invoicing schedule may provide for an upfront payment of 10% of the full contract value upon contract signing, but at the time of signing performance of services has not yet begun. Payments received in advance of services being provided are deferred as contract liabilities on the balance sheet. As the contracted services are subsequently performed and the associated revenue is recognized, the contract liability balance is reduced by the amount of revenue recognized during the period.
In other cases, services may be provided and revenue recognized before the customer is invoiced. In these cases, revenue recognized will exceed amounts billed, and the difference, representing a contract asset, is recorded for the amount that is currently not billable to the customer pursuant to contractual terms. Once the customer is invoiced, the contract asset is reduced for the amount billed, and a corresponding account receivable is recorded. All contract assets are billable to customers within one year from the respective balance sheet date.
Most contracts are terminable with or without cause by the customer, either immediately or upon notice. These contracts often require payment to CDD of expenses to wind-down the study or project, fees earned to date and, in some cases, a termination fee
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or a payment to CDD of some portion of the fees or profits that could have been earned by CDD under the contract if it had not been terminated early. Termination fees are included in revenues when services are performed and realization is assured.
The following are descriptions of the full range of drug development services provided by CDD:
Preclinical services include fee-for-service activities such as bioanalytical testing services, and proportional performance activities such as toxicology studies. Until June 3, 2019, preclinical services also included the sale of research models. See Note 3 Business Acquisitions and Dispositions to the Consolidated Financial Statements for more information. Revenue for sale of research models was recognized at a point in time, typically upon shipment, when control transferred to the customer. Revenue for bioanalytical testing services is recognized at a point in time upon communication of results to the customer. Revenue for proportional performance activities, including toxicology studies, is recognized using an input-based measure of progress in which revenue is recognized as expenses are incurred for the research models, labor hours, and other costs attributable to the study.
Through its central laboratory, CDD produces and supplies specimen collection kits that are utilized in clinical studies, and provides transportation, project management, data management, and laboratory testing services on an as-needed basis throughout the duration of its customers’ clinical studies. Revenue for central laboratory services is recognized using an output-based measure of progress based on volume of activities in each period. CDD also provides long-term specimen storage services, for which revenue is recognized using an input-based measure of progress based on costs incurred.
CDD provides clinical development and commercialization services, including clinical pharmacology services, full management of Phase II through IV clinical studies, and market access solutions. Revenue for clinical pharmacology services, which includes first-in-human trials, is recognized using an output-based measure of progress based on bed nights. Revenue for full service clinical studies is recognized using an input-based measure of progress based on costs incurred (including pass-through costs such as investigator grants and reimbursable out-of-pocket expenses). Revenue for market access solutions is recognized using various methods. Revenue for fee-for-service arrangements, such as reimbursement consulting hotlines and patient assistance programs, is recognized using an output method based on transaction volume which corresponds to the amount charged to the customer. For consulting services billed based on time and materials, revenue is recognized using the right to invoice practical expedient.
Contract costs
CDD incurs sales commissions in the process of obtaining contracts with customers, which are recoverable through the service fees in the contract. Sales commissions that are payable upon contract award are recognized as assets and amortized over the expected contract term, along with related payroll tax expense. The amortization of commission expense is based on the weighted average contract duration for all commissionable awards in the respective business in which the commission expense is paid, which approximates the period over which goods and services are transferred to the customer. The amortization period of sales commissions ranges from approximately 12-57 months, depending on the business. For businesses that enter primarily short-term contracts, the Company applies the practical expedient which allows costs to obtain a contract to be expensed when incurred if the amortization period of the assets that would otherwise have been recognized is one year or less. Amortization of assets from sales commissions is included in selling, general, and administrative expense.
CDD incurs costs to fulfill contracts with customers, which are recoverable through the service fees in the contract. Contract fulfillment costs include software implementation costs and setup costs for certain market access solutions. These costs are recognized as assets and amortized over the expected term of the contract to which the implementation relates, which is the period over which services are expected to be provided to the customer. This period typically ranges from 24-60 months. Amortization of deferred contract fulfillment costs is included in cost of goods sold.
Amortization related to sales commission assets and associated payroll taxes for the year ended December 31, 2019, 2018, and 2017 was $21.2, $16.9 and $14.3, respectively. Amortization related to deferred contract fulfillment costs for the years ended December 31, 2019, 2018 and 2017 was $8.7, $4.4 and $0.3, respectively. Impairment expense related to contract costs was immaterial to the Company’s consolidated statement of operations. The Company applies the practical expedient to not recognize the effect of financing in its contracts with customers, when the difference in timing of payment and performance is one year or less.
Receivables, Unbilled Services and Unearned Revenue
Unbilled services are comprised primarily of unbilled receivables, but also include contract assets. A contract asset is recorded when a right to payment has been earned for work performed, but billing and payment for that work is determined by certain
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contractual milestones, whereas unbilled receivables are billable upon the passage of time. While CDD attempts to negotiate terms that provide for billing and payment of services prior or in close proximity to the provision of services, this is not always possible and there are fluctuations in the level of unbilled services and unearned revenue from period to period. The following table provides information about receivables, unbilled services, and unearned revenue (contract liabilities) from contracts with customers for the CDD segment:
Revenue recognized during the period, that was included in the unearned revenue balance at the beginning of the period, for the year ended December 31, 2019, and 2018, was $250.2 and $204.0, respectively. Bad debt expense on receivables, for the year ended December 31, 2019 was immaterial to the Company’s consolidated statement of operations.
Performance Obligations Under Long-Term Contracts
Long-term contracts at the Company consist primarily of fully managed clinical studies within the CDD segment. The amount of existing performance obligations under such long-term contracts unsatisfied as of December 31, 2019, and 2018, was $4,520.8 and $3,784.7, respectively. The Company expects to recognize approximately 35.0% of the remaining performance obligations as of December 31, 2019, as revenue over the next 12 months, and the balance thereafter. The Company's long-term contracts generally range from 1 to 8 years.
The Company applied the practical expedient and does not disclose information about remaining performance obligations that have original expected durations of one year or less. The Company also did not disclose information about remaining performance obligations when the variable consideration was related to a wholly unsatisfied performance obligation within a series of obligations.
Within CDD, revenue of $88.9 and $21.0 was recognized during the year ended December 31, 2019, and December 31, 2018, respectively, from performance obligations that were satisfied in previous periods. This revenue comes from adjustments related to changes in scope and estimates in full service clinical studies.
3. BUSINESS ACQUISITIONS AND DISPOSITIONS
On June 3, 2019, the Company's CDD segment acquired Envigo's nonclinical contract research services business, expanding CDD's global nonclinical drug development capabilities with additional locations and resources. Additionally, the Company divested the CRP business, which was a part of the CDD segment, to Envigo. As part of this sale, CDD entered into a multi-year, renewable supply agreement with Envigo. The Company paid cash consideration of $601.0, received a floating rate secured note of $110.0, and recorded a loss on the sale of CRP of $12.2. The Company funded the transaction through a new term loan facility.
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The preliminary valuation of acquired assets and assumed liabilities as of June 3, 2019, include the following:
The preliminary purchase consideration for Envigo has been allocated to the estimated fair market value of the net assets acquired, including approximately $141.4 in identifiable intangible assets and a residual amount of non-tax-deductible goodwill of approximately $379.3. The amortization period for intangible assets acquired is 11 years for customer relationships.
The Envigo transaction contributed $124.2 and $17.9 of revenues and operating income, respectively, during the year ended December 31, 2019. The divested CRP business contributed operating income of $5.5 and $13.2 for the years ended December 31, 2019 and 2018, respectively.
The purchase price allocation for the Envigo transaction is still preliminary and subject to change. The areas of the purchase price allocation that are not yet finalized relate primarily to goodwill, and the impact of finalizing deferred taxes. Accordingly, adjustments may be made as additional information is obtained about the facts and circumstances that existed as of the valuation date. The Company expects these purchase price allocations to be finalized by the second quarter of 2020. Any adjustments will be recorded in the period in which they are identified.
During the year ended December 31, 2019, the Company also acquired various businesses and related assets for approximately $286.4 in cash (net of cash acquired). The purchase consideration for all acquisitions year to date has been allocated to the estimated fair market value of the net assets acquired, including approximately $184.3 in identifiable intangible assets and a residual amount of non-tax-deductible goodwill of approximately $115.1. The amortization periods for intangible assets acquired from these businesses range from 12 to 15 years for customer relationships. These acquisitions were made primarily to extend the Company's geographic reach in important market areas, enhance the Company's scientific differentiation and to expand the breadth and scope of the Company's CRO services. The excess of the fair value of the consideration conveyed over the fair value of the net assets acquired was recorded as goodwill. The goodwill reflects the Company's expectations to utilize the acquired businesses’ workforce and established relationships and the benefits of being able to leverage operational efficiencies with favorable growth opportunities in these markets. A summary of the net assets acquired in 2019 for these businesses is included below:
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Unaudited Pro Forma Information
The Company completed the Envigo acquisition on June 3, 2019. Had the Envigo acquisition as well as the aggregate of the Company's other 2019 acquisitions been completed as of January 1, 2017, the Company's pro forma results would have been as follows:
During the year ended December 31, 2018, the Company acquired various businesses and related assets for approximately $117.8 in cash (net of cash acquired). The purchase consideration for all acquisitions year to date has been allocated to the estimated fair market value of the net assets acquired, including approximately $67.8 in identifiable intangible assets and a residual amount of non-tax-deductible goodwill of approximately $70.5. These acquisitions were made primarily to extend the Company's geographic reach in important market areas, enhance the Company's scientific differentiation and to expand the breadth and scope of the Company's CRO services. The excess of the fair value of the consideration conveyed over the fair value of the net assets acquired was recorded as goodwill. The goodwill reflects the Company's expectations to utilize the acquired businesses’ workforce and established relationships and the benefits of being able to leverage operational efficiencies with favorable growth opportunities in these markets.
On April 30, 2018, the Company entered into a definitive agreement to sell the CFS business, a global provider of innovative product design and product integrity services for end-user segments that span the global food supply chain, for an all-cash purchase price of $670.0. The transaction closed on August 1, 2018, and a net gain of $258.3 was recorded in Other, net in the consolidated statement of operations.
The Company also divested its forensic testing services business in the U.K. and the U.S. on August 7, 2018, and December 31, 2018, respectively, resulting in losses of $48.9 and $24.5, respectively, recorded in Other, net in the consolidated statement of operations.
Operating income for the Company's businesses divested in 2018 was $7.6 and $12.9, for the years ended December 31, 2018, (which includes divested operations through their respective disposal dates) and December 31, 2017, respectively.
4. RESTRUCTURING AND OTHER CHARGES
During 2019, the Company recorded net restructuring charges of $54.6; $26.7 within LCD and $27.9 within CDD. The charges were comprised of $32.9 in severance and other personnel costs and $24.9 in facility-related costs primarily associated with general integration activities. The charges were offset by the reversal of previously established liability of $1.7 in unused severance and $1.5 in unused facility-related costs.
During 2018, the Company recorded net restructuring charges of $48.1; $20.5 within LCD and $27.6 within CDD. The charges were comprised of $40.3 in severance and other personnel costs and $11.8 in facility-related costs primarily associated with general
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integration activities. The charges were offset by the reversal of previously established liability of $2.0 in unused severance and $2.0 in unused facility-related costs. The Company also recorded $2.3 in impairment to land held for sale which is included in amortization expense.
During 2017, the Company recorded net restructuring charges of $70.9; $16.8 within LCD and $54.1 within CDD. The charges were comprised of $36.1 in severance and other personnel costs, $18.8 in facility-related costs primarily associated with general integration activities, and an asset impairment loss of $20.9 related to the termination of a software development project within the CDD segment and the forgiveness of indebtedness for LCD customers in areas heavily impacted by hurricanes experienced during the third quarter of 2017. The charges were offset by the reversal of previously established liability of $0.5 in unused severance and $4.4 in unused facility-related costs.
The following represents the Company’s restructuring activities for the period indicated:
The non-current portion of the restructuring liabilities is expected to be paid out over 4.4 years. Cash payments and other adjustments include the reclassification of profit sharing, pension, and holiday accrual.
5. LEASES
The Company has operating and finance leases for patient service centers, laboratories and testing facilities, clinical facilities, general office spaces, vehicles, and office and laboratory equipment. Leases have remaining lease terms of less than a year to 15 years, some of which include options to extend the leases for up to 15 years.
The components of lease expense were as follows:
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Supplemental cash flow information related to leases was as follows:
Supplemental balance sheet information related to leases was as follows:
Maturities of lease liabilities are as follows:
Rental expense for short term leases with a term less than one year for the year ended December 31, 2019, amounted to $10.6. The Company has variable lease payments that do not depend on a rate or index, primarily for purchase volume commitments, which are recorded as variable cost when incurred. Total variable payments for the year ended December 31, 2019, were $20.8. As of December 31, 2019, the Company has entered into approximately 3 additional operating leases, for patient service centers, that have not yet commenced and are not significant to the overall lease portfolio. These operating leases will commence in 2020 with lease terms ranging from 5 to 9 years.
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The Company leases various facilities and equipment under non-cancelable lease arrangements. Future minimum rental commitments for leases with non-cancelable terms of one year or more at December 31, 2018 under Accounting Standard Codification 840 are as follows:
Rental expense, which includes rent for real estate, equipment and automobiles under operating leases,under ASC 842 amounted to $393.1 for the year ended December 31, 2019. Rent expense, which includes rent for real estate, equipment and automobiles under operating leases under ASC 840 amounted to $358.7 and $313.8 for the years ended December 31, 2018 and 2017, respectively.
6. JOINT VENTURE PARTNERSHIPS AND EQUITY METHOD INVESTMENTS
At December 31, 2019, the Company had investments in the following unconsolidated joint venture partnerships and equity method investments:
The joint venture partnerships are governed by agreements that mandate unanimous agreement between partners on all major business decisions as well as providing other participating rights to each partner. The equity method investments represent the Company’s purchase of ownership interests in clinical diagnostic companies. The investments are accounted for under the equity method of accounting as the Company does not have control of these investments. The Company has no material obligations or guarantees to, or in support of, these unconsolidated investments and their operations.
The Company’s investment in one of its Alberta joint venture partnerships at December 31, 2019, includes $34.0 of value assigned to that partnership’s Canadian license to conduct diagnostic testing services in the province. Substantially all of the joint venture's revenue is received as reimbursement from the Alberta government's healthcare programs (AHS). While the Canadian license provides the joint venture the ability to conduct diagnostic testing in Alberta, it does not guarantee that the provincial government will continue to reimburse diagnostic laboratory testing in future years at current levels. A decision by the provincial government to limit or reduce its reimbursement of laboratory diagnostic services would have a negative impact on the profits and cash flows the Company derives from the joint venture. In August 2016, AHS and the Canadian partnership reached an agreement to extend the contract for five additional years through March 2022, with the intent to have the services provided pursuant to the contract transferred to AHS at the end of the five-year period. In consideration of AHS acquiring the assets and assuming liabilities in accordance with the parties’ agreement, AHS will pay CAD 50.0 to the partnership when the transfer is effective, subject to a working capital adjustment. The Company is amortizing the value of the partnership's Canadian license to its residual value over the remaining term of the agreement. In December 2019, AHS issued a Request for Expression of Interest, that seeks to gauge market interest from private third parties for the provision of community lab services in Alberta. The Canadian partnership submitted a response indicating its interest in providing lab services.
7. ACCOUNTS RECEIVABLE
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8. PROPERTY, PLANT AND EQUIPMENT, NET
Depreciation expense and amortization of property, plant and equipment was $321.5, $311.5 and $306.8 for 2019, 2018 and 2017, respectively, including software depreciation of $90.4, $92.7, and $85.6 for 2019, 2018 and 2017, respectively.
9. GOODWILL AND INTANGIBLE ASSETS
The changes in the carrying amount of goodwill (net of accumulated amortization) for the years ended December 31, 2019 and 2018 are as follows:
The components of identifiable intangible assets are as follows:
A summary of amortizable intangible assets acquired during 2019, and their respective weighted average amortization periods are as follows:
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Amortization of intangible assets, including amortization of the Canadian license recorded in other assets, was $243.2, $231.7 and $216.5 in 2019, 2018 and 2017, respectively. The Company recorded purchase accounting adjustments and impairment losses through amortization expense of $0.4, $4.5, and $3.0 in 2019, 2018 and 2017, respectively. Amortization expense of intangible assets is estimated to be $243.2 in fiscal 2020, $234.0 in fiscal 2021, $228.0 in fiscal 2022, $224.8 in fiscal 2023, $219.6 in fiscal 2024, and $2,315.7 thereafter.
10. ACCRUED EXPENSES AND OTHER
11. OTHER LIABILITIES
12. DEBT
Short-term borrowings and current portion of long-term debt at December 31, 2019, and 2018 consisted of the following:
Long-term debt at December 31, 2019, and 2018 consisted of the following:
Credit Facilities
On June 3, 2019, the Company entered into a new $850.0 term loan (the 2019 Term Loan). The 2019 Term Loan will mature
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on June 3, 2021. Proceeds of the 2019 Term Loan were used to repay approximately $250.0 of the 2017 Term Loan and to fund the acquisition of Envigo's nonclinical research services business.
The 2019 Term Loan accrues interest at a per annum rate equal to, at the Company's election, either a LIBOR rate plus a margin ranging from 0.55% to 1.175%, or a base rate determined according to a prime rate or federal funds rate plus a margin ranging from 0.0% to 0.175%. As of December 31, 2019, the effective interest rate on the 2019 Term Loan was 2.59%.
On September 15, 2017, the Company entered into a new $750.0 term loan (the 2017 Term Loan). The 2017 Term Loan accrued interest at a per annum rate equal to, at the Company's election, either a LIBOR rate plus a margin ranging from 0.875% to 1.50%, or a base rate determined according to a prime rate or federal funds rate plus a margin ranging from 0.0% to 0.50%. The 2017 Term Loan was fully repaid in 2019.
The Company also maintains a senior revolving credit facility consists of a five-year revolving facility in the principal amount of up to $1,000.0, with the option of increasing the facility by up to an additional $350.0, subject to the agreement of one or more new or existing lenders to provide such additional amounts and certain other customary conditions. The revolving credit facility also provides for a subfacility of up to $100.0 for swing line borrowings and a subfacility of up to $150.0 for issuances of letters of credit. The Company is required to pay a facility fee on the aggregate commitments under the revolving credit facility, at a per annum rate ranging from 0.10% to 0.25%. The revolving credit facility is permitted to be used for general corporate purposes, including working capital, capital expenditures, funding of share repurchases and certain other payments, acquisitions, and other investments. There were no balances outstanding on the Company's current revolving credit facility at December 31, 2019, or December 31, 2018. As of December 31, 2019, the effective interest rate on the revolving credit facility was 2.74%. The credit facility expires on September 15, 2022.
Under the Company's term loan facilities and the revolving credit facility, the Company is subject to negative covenants limiting subsidiary indebtedness and certain other covenants typical for investment grade-rated borrowers and the Company is required to maintain certain leverage ratios. The Company was in compliance with all covenants in its term loans and the revolving credit facility at December 31, 2019, and December 31, 2018.
The Company’s availability of $923.7 at December 31, 2019, under its revolving credit facility is reduced by the amount of the Company's outstanding letters of credit.
Zero-Coupon Convertible Subordinated Notes
During 2019 and 2018, the Company settled notices to convert $8.6 and $0.3 aggregate principal amount at maturity of its zero-coupon subordinated notes with a conversion value of $16.6 and $0.7, respectively. The total cash used for these settlements was $8.2 and $0.3 and the Company also issued 0.1 and 0.0 additional shares of common stock, respectively. As a result of these conversions in 2019 and 2018, the Company also reversed approximately $2.0 and $0.2, respectively, of deferred tax liability to reflect the tax benefit realized upon issuance of the shares. On December 19, 2019, the Company redeemed all remaining outstanding zero-coupon notes that did not convert. The Company had $8.6 aggregate principal amount at maturity of zero-coupon convertible subordinated notes due 2021 outstanding at December 31, 2018.
Senior Notes
On November 25, 2019, the Company issued $1,050.0 in debt securities, consisting of $400.0 aggregate principal amount of 2.300% Senior Notes due 2024 and $650.0 aggregate principal amount of 2.950% Senior Notes due 2029. The net proceeds from the new Senior Notes were used to redeem of all of the outstanding $500.0 principal amount of its 2.625% Senior Notes due February 1, 2020, redeem $187.9 of the outstanding 4.625% Senior Notes due November 15, 2020 in a tender offer, and to repay $348.3 outstanding under the Company's term loan credit facilities. The Company recorded a loss of $4.0 on the extinguishment of the 2.625% Senior Notes and part of the outstanding 4.625% Senior Notes.
During the first quarter of 2018, the Company entered into six U.S. dollar (USD) to Swiss Franc cross-currency swap agreements with an aggregate notional value of $600.0 and which were accounted for as a hedge against its net investment in a Swiss subsidiary. Of the notional value, $300.0 was due to mature in 2022 and $300.0 was due to mature in 2025. These cross currency swaps maturing in 2022 and 2025 were settled on December 10, 2018 in cash.
During the fourth quarter of 2018, the Company entered into six new USD to Swiss Franc cross-currency swap agreements with an aggregate notional value of $600.0 and which are accounted for as a hedge against its net investment in a Swiss subsidiary. Of the notional value, $300.0 matures in 2022 and $300.0 matures in 2025. These cross currency swaps maturing in 2022 and 2025 are included in other long-term assets with an aggregate fair value of $0.2 and $3.0, respectively, as of December 31, 2019. Changes in the fair value of the cross-currency swaps are charged or credited through accumulated other comprehensive income in the Consolidated Balance Sheet until the hedged item is recognized in earnings.
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The scheduled payments of long-term debt at the end of 2019 are summarized as follows:
13. PREFERRED STOCK AND COMMON SHAREHOLDERS’ EQUITY
The Company is authorized to issue up to 265.0 shares of common stock, par value $0.10 per share. Common shares issued and outstanding are summarized in the following table:
The Company is authorized to issue up to 30.0 shares of preferred stock, par value $0.10 per share. There were no preferred shares outstanding as of December 31, 2019 and 2018.
The changes in common shares issued and held in treasury are summarized below:
The Company’s treasury shares are recorded at aggregate cost. During 2019, the board of directors approved the retirement of all current treasury shares and future shares received in settlement of tax liabilities related to restricted stock vesting.
Share Repurchase Program
On February 6, 2019, the board of directors replaced the Company’s existing share repurchase plan with a new plan authorizing repurchase of up to $1,250.0 of the Company’s shares. The repurchase authorization has no expiration date. During 2019, the Company purchased 2.9 shares of its common stock at an average price of $154.94 for a total cost of $450.0, of which $100.0 was repurchased prior to the new plan in February 2019. At the end of 2019, the Company had outstanding authorization from its board of directors to purchase $900.0 of Company common stock. When the Company repurchases shares for retirement, the amount paid to repurchase the shares in excess of the par or stated value is allocated to additional paid-in capital unless subject to limitation or the balance in additional paid-in-capital is exhausted. Remaining amounts are recognized as a reduction in retained earnings.
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Accumulated Other Comprehensive Earnings
The components of accumulated other comprehensive earnings are as follows:
(a) The amortization of prior service cost is included in the computation of net periodic benefit cost. Refer to Note 17 Pension and Postretirement Plans for additional information regarding the Company's net periodic benefit cost.
14. INCOME TAXES
The sources of income before taxes, classified between domestic and foreign entities are as follows:
The provisions (benefits) for income taxes in the accompanying consolidated statements of operations consist of the following:
A net benefit of $1.6, $10.2 and $16.9 in excess stock-based compensation was recorded directly to income tax expense in the years ended December 31, 2019, 2018 and 2017 respectively. The gross benefit was reduced by the Internal Revenue Code Section 162(m) disallowance for non-deductible stock compensation of $30.0, $5.9 and $2.0 for the years ended December 31, 2019, 2018, and 2017, respectively. The 2019 Section 162(m) disallowance includes the accelerated expensing of stock-based compensation for executive retirement.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
The effective tax rates on earnings before income taxes are reconciled to statutory U.S. income tax rates as follows:
In December 2017, the U.S. enacted the Tax Cuts and Jobs Act (TCJA), which made widespread changes to the Internal Revenue Code. The TCJA, among other things, reduced the U.S. federal corporate tax rate from 35.0% to 21.0% beginning January 1, 2018, requires companies to pay a repatriation tax on earnings of certain foreign subsidiaries that were previously not subject to U.S. tax, and created new income taxes on certain foreign sourced earnings. Also on December 22, 2017, the U.S. Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 118 (SAB 118), which provided companies with additional guidance on how to account for the TCJA in its financial statements, allowing companies utilize a one year measurement period. At December 31, 2017, the Company had not completed the accounting for the tax effects of enactment of the TCJA; however, a reasonable estimate on the re-measurement of the Company's existing deferred tax balances, the deferred tax revaluation for unremitted foreign earnings, and the one-time repatriation tax was made. For these items, in accordance with SAB 118, a provisional net benefit was recognized, totaling $519.0, which is included as a component of income tax expense from continuing operations. The Company continued to assess the impact of TCJA throughout the 2018 calendar year and finalized the SAB 118 provisional estimate in the fourth quarter of 2018. For 2018, the Company recorded a total tax expense of $45.0, $14.8 related to the repatriation tax and $30.1 for the remeasurement of deferred taxes. Overall a net benefit of $474.0 was recorded for TCJA tax provisions effective as of the end of 2018. As additional regulations or guidance in relation to the TCJA are issued, the Company will analyze and record the necessary impacts during the quarter in which this occurs.
The TCJA includes provisions relating to global low-taxed intangible income (GILTI). The Company finalized its decision on accounting policy during the fourth quarter of 2018. The Company will account for GILTI as a periodic charge in the period it arises. The Company recorded $11.8 and $13.0 in 2019 and 2018 for GILTI, which is included as a component of income tax expense from continuing operations.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows:
The table below provides a rollforward of the valuation allowance.
The Company has U.S. federal tax loss carryforwards of approximately $209.5, which expire periodically through 2036, as well as post 2017 carryovers of $6.1 that are limited to 80% of taxable income and have an indefinite carryover. The utilization of tax loss carryforwards is limited due to change of ownership rules; however, at this time, the Company expects to fully utilize substantially all U.S. federal tax loss carryforwards with the exception of approximately $3.9 for which a full valuation allowance has been provided. The Company has U.S. state tax loss carryforwards of $594.1, which also expire periodically through 2038, and on which a valuation allowance of $311.4 has been provided. In addition to federal and state tax loss carryforwards, the Company has other federal and state attribute carryforwards of $252.5. These attribute carryforwards have indefinite lives and a valuation allowance of $209.6. The Company has foreign tax loss carryforwards of $116.9 which have an indefinite life and on which a valuation allowance of $26.7 has been provided, as well as foreign tax loss carryforwards of $443.8 which expire in 2034 that have a full valuation allowance. In addition to the foreign net operating losses, the Company has a foreign capital loss carryforward of $6.9. The foreign capital loss carryforward has an indefinite life and has a full valuation allowance.
The valuation allowance decreased from $156.9 in 2018 to $145.4 in 2019 primarily due to issuance of final guidance for tax laws affecting anticipated utilization of state NOLs.
Unrecognized income tax benefits were $31.7 and $18.0 at December 31, 2019, and 2018, respectively. It is anticipated that the amount of the unrecognized income tax benefits will change within the next 12 months; however, these changes are not expected to have a significant impact on the results of operations, cash flows or the financial position of the Company.
The Company recognizes interest and penalties related to unrecognized income tax benefits in income tax expense. Accrued interest and penalties related to uncertain tax positions totaled $5.5 and $8.7 as of December 31, 2019, and 2018, respectively. During the years ended December 31, 2019, 2018 and 2017, the Company recognized $2.0, $1.8 and $2.3, respectively, in interest and penalties expense, which was offset by a benefit from reversing previous accruals for interest and penalties of $5.8, $0.5 and $4.3, respectively. During 2019, the Company paid interest of $0.2, and $0.8 was added to the accrued interest from the opening balance sheet of an acquisition.
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LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
The following table shows a reconciliation of the unrecognized income tax benefits, excluding interest and penalties, from uncertain tax positions for the years ended December 31, 2019, 2018 and 2017:
As of December 31, 2019, and 2018, $31.7 and $18.0, respectively, are the approximate amounts of unrecognized income tax benefits that, if recognized, would favorably affect the effective income tax rate in any future periods.
The Company has substantially concluded all U.S. federal income tax matters for years through 2015. Substantially all material state and local and foreign income tax matters have been concluded through 2013 and 2010, respectively.
The Internal Revenue Service concluded the examination of Covance Inc.'s 2013 federal consolidated income tax return in the third quarter of 2018. There were no material changes as a result of the audit. The Company is appealing a Canada Revenue Agency assessment related to the 2014 income tax return. The Company believes adequate reserves have been established for the assessment. The Company has various state and foreign income tax examinations ongoing throughout the year. The Company believes adequate provisions have been recorded related to all open tax years.
As a result of the TCJA, the Company was effectively taxed on all of its previously unremitted foreign earnings. The TCJA also enacts a territorial tax system that allows, for the most part, tax-free repatriation of foreign earnings. The Company still considers the earnings of its foreign subsidiaries to be permanently reinvested, but if repatriation were to occur the Company would be required to accrue U.S. taxes, if any, and applicable withholding taxes as appropriate. The Company has unremitted earnings and profits of $601.4 and $490.1 that are permanently reinvested in its foreign subsidiaries as of December 31, 2019, and 2018, respectively. A determination of the amount of the unrecognized deferred tax liability related to these undistributed earnings is not practicable due to the complexity and variety of assumptions necessary based on the manner in which the undistributed earnings would be repatriated.
15. STOCK COMPENSATION PLANS
Stock Incentive Plans
There are currently 9.8 shares authorized for issuance under the Laboratory Corporation of America Holdings 2016 Omnibus Incentive Plan (the Plan), and at December 31, 2019 there were 6.3 additional shares available for grant under the Plan. The Plan was approved by shareholders at the 2016 annual meeting.
Stock Options
The following table summarizes grants of non-qualified options made by the Company to officers, key employees, and non-employee directors under all plans. Stock options are generally granted at an exercise price equal to or greater than the fair market price per share on the date of grant. Also, for each grant, options vest ratably over a period of three years on the anniversaries of the grant date, subject to their earlier expiration or termination.
Changes in options outstanding under the plans for the period indicated were as follows:
The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the Company’s closing stock price on the last trading day of 2019 and the exercise price, multiplied by the number of in-the-money options) that
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
would have been received by the option holders had all option holders exercised their options on December 31, 2019. The amount of intrinsic value will change based on the fair market value of the Company’s stock.
Cash received by the Company from option exercises, the actual tax benefit realized for the tax deductions and the aggregate intrinsic value of options exercised from option exercises under all share-based payment arrangements during the years ended December 31, 2019, 2018, and 2017 were as follows:
The following table shows the weighted average grant-date fair values of options issued during the respective year and the weighted average assumptions that the Company used to develop the fair value estimates:
The Black Scholes model incorporates assumptions to value stock-based awards. The risk-free interest rate for periods within the contractual life of the option is based on a zero-coupon U.S. government instrument over the contractual term of the equity instrument. Expected volatility of the Company’s stock is based on historical volatility of the Company’s stock. The Company estimates expected option terms through an analysis of actual, historical post-vesting exercise, cancellation and expiration behavior by employees and projected post-vesting activity of outstanding options. Groups of employees and non-employee directors that have similar exercise behavior with regard to option exercise timing and forfeiture rates are considered separately for valuation purposes. For 2019, 2018 and 2017, expense related to the Company’s stock option plan totaled $5.9, $3.5 and $0.9, respectively, and is included in selling, general and administrative expenses. The Company did not grant any options to employees during 2017.
Restricted Stock, Restricted Stock Units and Performance Shares
The Company grants restricted stock, restricted stock units and performance shares (non-vested shares) to officers and key employees and grants restricted stock and restricted stock units to non-employee directors. Restricted stock and units typically vest annually in equal one third increments beginning on the first anniversary of the grant. A performance share grant in 2017 represents a three-year award opportunity for the period 2017-2019, and if earned, vests fully (to the extent earned) in the first quarter of 2020. A performance share grant in 2018 represents a three-year award opportunity for the period of 2018-2020 and, if earned, vests fully (to the extent earned) in the first quarter of 2021. A performance share grant in 2019 represents a three-year award opportunity for the period of 2019-2021 and, if earned, vests fully (to the extent earned) in the first quarter of 2022. Performance share awards are subject to certain earnings per share, revenue and total shareholder return targets, the achievement of which may increase or decrease the number of shares which the grantee earns and therefore receives upon vesting. Unearned restricted stock and performance share compensation is amortized to expense, when probable, over the applicable vesting periods. For 2019, 2018 and 2017, total restricted stock, restricted stock unit and performance share compensation expense was $91.2, $80.1 and $100.8, respectively, and is included in selling, general and administrative expenses.
The following table shows a summary of non-vested shares for the year ended December 31, 2019:
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LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
As of December 31, 2019, there was $112.2 of total unrecognized compensation cost related to non-vested stock options, restricted stock, restricted stock unit and performance share-based compensation arrangements granted under the Company's stock incentive plans. That cost is expected to be recognized over a weighted average period of 2.2 years and will be included in selling, general and administrative expenses.
Employee Stock Purchase Plan
Under the 2016 Employee Stock Purchase Plan, the Company is authorized to issue 1.8 shares of common stock. The plan permits substantially all employees to purchase a limited number of shares of Company stock at 85% of market value. The Company issues shares to participating employees semi-annually in January and July of each year. Approximately 0.2 shares were purchased by eligible employees in each of 2019, 2018 and 2017, respectively, under either the 2016 Employee Stock Purchase Plan or the prior plan, which began in 1997 and was amended in 1999, 2004, 2008 and 2012. For 2019, 2018 and 2017, expense related to the Company’s employee stock purchase plan was $9.9, $8.0 and $8.0, respectively.
The Company uses the Black-Scholes model to calculate the fair value of the employee’s purchase right. The fair value of the employee’s purchase right and the assumptions used in its calculation are as follows:
16. COMMITMENTS AND CONTINGENT LIABILITIES
The Company is involved from time to time in various claims and legal actions, including arbitrations, class actions, and other litigation (including those described in more detail below), arising in the ordinary course of business. Some of these actions involve claims that are substantial in amount. These matters include, but are not limited to, intellectual property disputes; commercial and contract disputes; professional liability claims; employee-related matters; and inquiries, including subpoenas and other civil investigative demands, from governmental agencies, Medicare or Medicaid payers and MCOs reviewing billing practices or requesting comment on allegations of billing irregularities that are brought to their attention through billing audits or third parties. The Company receives civil investigative demands or other inquiries from various governmental bodies in the ordinary course of its business. Such inquiries can relate to the Company or other parties, including physicians and other health care providers. The Company works cooperatively to respond to appropriate requests for information.
The Company also is named from time to time in suits brought under the qui tam provisions of the False Claims Act and comparable state laws. These suits typically allege that the Company has made false statements and/or certifications in connection with claims for payment from U.S. federal or state healthcare programs. The suits may remain under seal (hence, unknown to the Company) for some time while the government decides whether to intervene on behalf of the qui tam plaintiff. Such claims are an inevitable part of doing business in the healthcare field today.
The Company believes that it is in compliance in all material respects with all statutes, regulations and other requirements applicable to its commercial laboratory operations and drug development support services. The healthcare diagnostics and drug development industries are, however, subject to extensive regulation, and the courts have not interpreted many of the applicable statutes and regulations. Therefore, the applicable statutes and regulations could be interpreted or applied by a prosecutorial, regulatory or judicial authority in a manner that would adversely affect the Company. Potential sanctions for violation of these statutes and regulations include significant civil and criminal penalties, fines, the loss of various licenses, certificates and authorizations, additional liabilities from third-party claims, and/or exclusion from participation in government programs.
Many of the current claims and legal actions against the Company are in preliminary stages, and many of these cases seek an indeterminate amount of damages. The Company records an aggregate legal reserve, which is determined using calculations based on historical loss rates and assessment of trends experienced in settlements and defense costs. In accordance with FASB Accounting Standards Codification Topic 450 “Contingencies,” the Company establishes reserves for judicial, regulatory, and arbitration matters outside the aggregate legal reserve if and when those matters present loss contingencies that are both probable and estimable and would exceed the aggregate legal reserve. When loss contingencies are not both probable and estimable, the Company does not establish separate reserves.
The Company is unable to estimate a range of reasonably probable loss for the proceedings described in more detail below in which damages either have not been specified or, in the Company's judgment, are unsupported and/or exaggerated and (i) the
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
proceedings are in early stages; (ii) there is uncertainty as to the outcome of pending appeals or motions; (iii) there are significant factual issues to be resolved; and/or (iv) there are novel legal issues to be presented. For these proceedings, however, the Company does not believe, based on currently available information, that the outcomes will have a material adverse effect on the Company's financial condition, though the outcomes could be material to the Company's operating results for any particular period, depending, in part, upon the operating results for such period.
As previously reported, the Company responded to an October 2007 subpoena from the U.S. Department of Health & Human Services Office of Inspector General's regional office in New York. On August 17, 2011, the U.S. District Court for the Southern District of New York unsealed a False Claims Act lawsuit, United States of America ex rel. NPT Associates v. Laboratory Corporation of America Holdings, which alleges that the Company offered UnitedHealthcare kickbacks in the form of discounts in return for Medicare business. The Plaintiff's Third Amended Complaint further alleges that the Company's billing practices violated the False Claims Acts of 14 states and the District of Columbia. The lawsuit seeks actual and treble damages and civil penalties for each alleged false claim, as well as recovery of costs, attorney's fees, and legal expenses. Neither the U.S. government nor any state government has intervened in the lawsuit. The Company's Motion to Dismiss was granted in October 2014 and Plaintiff was granted the right to replead. On January 11, 2016, Plaintiff filed a motion requesting leave to file an amended complaint under seal and to vacate the briefing schedule for the Company's Motion to Dismiss while the government reviews the amended complaint. The Court granted the motion and vacated the briefing dates. Plaintiff then filed the Amended Complaint under seal. The Company will vigorously defend the lawsuit.
In addition, the Company has received various other subpoenas since 2007 related to Medicaid billing. In October 2009, the Company received a subpoena from the State of Michigan Department of Attorney General seeking documents related to its billing to Michigan Medicaid. The Company cooperated with this request. In October 2013, the Company received a Civil Investigative Demand from the State of Texas Office of the Attorney General requesting documents related to its billing to Texas Medicaid. The Company cooperated with this request. On October 5, 2018, the Company received a second Civil Investigative Demand from the State of Texas Office of the Attorney General requesting documents related to its billing to Texas Medicaid. The Company is cooperating with this request.
On August 31, 2015, the Company was served with a putative class action lawsuit, Patty Davis v. Laboratory Corporation of America, et al., filed in the Circuit Court of the Thirteenth Judicial Circuit for Hillsborough County, Florida. The complaint alleges that the Company violated the Florida Consumer Collection Practices Act by billing patients who were collecting benefits under the Workers' Compensation Statutes. The lawsuit seeks injunctive relief and actual and statutory damages, as well as recovery of attorney's fees and legal expenses. In April 2017, the Circuit Court granted the Company's Motion for Judgment on the Pleadings. The Plaintiff appealed the Circuit Court's ruling to the Florida Second District Court of Appeal. On October 16, 2019, the Court of Appeal reversed the Circuit Court's dismissal, but certified a controlling issue of Florida law to the Florida Supreme Court. On February 17, 2020, the Florida Supreme Court accepted jurisdiction of the lawsuit. The Company will vigorously defend the lawsuit.
In December 2014, the Company received a Civil Investigative Demand issued pursuant to the U.S. False Claims Act from the U.S. Attorney's Office for South Carolina, which requested information regarding alleged remuneration and services provided by the Company to physicians who also received draw and processing/handling fees from competitor laboratories Health Diagnostic Laboratory, Inc. (HDL) and Singulex, Inc. (Singulex). The Company cooperated with the request. On April 4, 2018, the U.S. District Court for the District of South Carolina, Beaufort Division, unsealed a False Claims Act lawsuit, United States of America ex rel. Scarlett Lutz, et al. v. Laboratory Corporation of America Holdings, which alleges that the Company's financial relationships with referring physicians violate federal and state anti-kickback statutes. The Plaintiffs' Fourth Amended Complaint further alleges that the Company conspired with HDL and Singulex in violation of the Federal False Claims Act and the California and Illinois insurance fraud prevention acts by facilitating HDL's and Singulex's offers of illegal inducements to physicians and the referral of patients to HDL and Singulex for laboratory testing. The lawsuit seeks actual and treble damages and civil penalties for each alleged false claim, as well as recovery of costs, attorney's fees, and legal expenses. Neither the U.S. government nor any state government has intervened in the lawsuit. The Company filed a Motion to Dismiss seeking the dismissal of the claims asserted under the California and Illinois insurance fraud prevention statutes, the conspiracy claim, the reverse False Claims Act claim, and all claims based on the theory that the Company performed medically unnecessary testing. On January 16, 2019, the Court entered an order granting in part and denying in part the Motion to Dismiss. The Court dismissed the Plaintiffs’ claims based on the theory that the Company performed medically unnecessary testing, the claims asserted under the California and Illinois insurance fraud prevention statutes, and the reverse False Claims Act claim. The Court denied the Motion to Dismiss as to the conspiracy claim. The Company will vigorously defend the lawsuit.
Prior to the Company's acquisition of Sequenom Inc. (Sequenom) between August 15, 2016, and August 24, 2016, six putative class-action lawsuits were filed on behalf of purported Sequenom stockholders (captioned Malkoff v. Sequenom, Inc., et al., No. 16-cv-02054-JAH-BLM, Gupta v. Sequenom, Inc., et al., No. 16-cv-02084-JAH-KSC, Fruchter v. Sequenom, Inc., et al., No. 16-
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
cv-02101-WQH-KSC, Asiatrade Development Ltd. v. Sequenom, Inc., et al., No. 16-cv-02113-AJB-JMA, Nunes v. Sequenom, Inc., et al., No. 16-cv-02128-AJB-MDD, and Cusumano v. Sequenom, Inc., et al., No. 16-cv-02134-LAB-JMA) in the U.S. District Court for the Southern District of California challenging the acquisition transaction. The complaints asserted claims against Sequenom and members of its board of directors (the Individual Defendants). The Nunes action also named the Company and Savoy Acquisition Corp. (Savoy), a wholly owned subsidiary of the Company, as defendants. The complaints alleged that the defendants violated Sections 14(e), 14(d)(4) and 20 of the Securities Exchange Act of 1934 by failing to disclose certain allegedly material information. In addition, the complaints in the Malkoff action, Asiatrade action, and the Cusumano action alleged that the Individual Defendants breached their fiduciary duties to Sequenom shareholders. The actions sought, among other things, injunctive relief enjoining the merger. On August 30, 2016, the parties entered into a Memorandum of Understanding (MOU) in each of the above-referenced actions. On September 6, 2016, the Court entered an order consolidating for all pre-trial purposes the six individual actions described above under the caption In re Sequenom, Inc. Shareholder Litig., Lead Case No. 16-cv-02054-JAH-BLM, and designating the complaint from the Malkoff action as the operative complaint for the consolidated action. On November 11, 2016, two competing motions were filed by two separate stockholders (James Reilly and Shikha Gupta) seeking appointment as lead plaintiff under the terms of the Private Securities Litigation Reform Act of 1995. On June 7, 2017, the Court entered an order declaring Mr. Reilly as the lead plaintiff and approving Mr. Reilly's selection of lead counsel. The parties agree that the MOU has been terminated. The Plaintiffs filed a Consolidated Amended Class Action Complaint on July 24, 2017, and the Defendants filed a Motion to Dismiss, which remains pending. On March 13, 2019, the Court stayed the action in its entirety pending the U.S. Supreme Court's anticipated decision in Emulex Corp. v. Varjabedian. On April 23, 2019, however, the U.S. Supreme Court dismissed the writ of certiorari in Emulex as improvidently granted. The Company will vigorously defend the lawsuit.
On March 10, 2017, the Company was served with a putative class action lawsuit, Victoria Bouffard, et al. v. Laboratory Corporation of America Holdings, filed in the U.S. District Court for the Middle District of North Carolina. The complaint alleges that the Company's patient list prices unlawfully exceed the rates negotiated for the same services with private and public health insurers in violation of various state consumer protection laws. The lawsuit also alleges breach of implied contract or quasi-contract, unjust enrichment, and fraud. The lawsuit seeks statutory, exemplary, and punitive damages, injunctive relief, and recovery of attorney's fees and costs. In May 2017, the Company filed a Motion to Dismiss Plaintiffs' Complaint and Strike Class Allegations; the Motion to Dismiss was granted in March 2018 without prejudice. On October 10, 2017, a second putative class action lawsuit, Sheryl Anderson, et al. v. Laboratory Corporation of America Holdings, was filed in the U.S. District Court for the Middle District of North Carolina. The complaint contained similar allegations and sought similar relief to the Bouffard complaint, and added additional counts regarding state consumer protection laws. On August 10, 2018, the Plaintiffs filed an Amended Complaint, which consolidated the Bouffard and Anderson actions. On September 10, 2018, the Company filed a Motion to Dismiss Plaintiffs’ Amended Complaint and Strike Class Allegations. On August 16, 2019, the court entered an order granting in part and denying in part the Motion to Dismiss the Amended Complaint, and denying the Motion to Strike the Class Allegations. The Company will vigorously defend the lawsuit.
On December 20, 2018, the Company was served with a putative class action lawsuit, Feckley v. Covance Inc., et al., filed in the Superior Court of California, County of Orange. The complaint alleges that Covance Inc. violated the California Labor Code and California Business & Professions Code by failing to properly pay commissions to employees under a sales incentive compensation plan upon their termination of employment. The lawsuit seeks monetary damages, civil penalties, punitive damages, and recovery of attorney’s fees and costs. On January 22, 2018, the case was removed to the U.S. District Court for the Central District of California. The Company will vigorously defend the lawsuit.
On April 1, 2019, Covance Research Products was served with a Grand Jury Subpoena issued by the Department of Justice (DOJ) in Miami, Florida requiring the production of documents related to the importation into the United States of live non-human primate shipments originating from or transiting through China, Cambodia, and/or Vietnam from April 1, 2014 through March 28, 2019. The Company is cooperating with the DOJ.
On April 22, 2019, the Company was served with a putative class action lawsuit, Kawa Orthodontics LLP, et al. v. Laboratory Corporation of America Holdings, et al., filed in the U.S. District Court for the Middle District of Florida. The lawsuit alleges that on or about February 6, 2019, the defendants violated the U.S. Telephone Consumer Protection Act (TCPA) by sending unsolicited facsimiles to Plaintiff and at least 40 other recipients without the recipients' prior express invitation or permission. The lawsuit seeks the greater of actual damages or the sum of $0.0005 for each violation, subject to trebling under the TCPA, and injunctive relief. The Company filed a motion to dismiss the case on May 28, 2019. In response to the Motion to Dismiss, the Plaintiff filed an amended complaint, which contains additional allegations, including allegations related to another facsimile. On December 16, 2019, the Plaintiff filed a notice withdrawing its Motion for Class Certification and all class allegations in the Amended Complaint. In January 2020, the parties settled the lawsuit.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
On May 14, 2019, Retrieval-Masters Creditors Bureau, Inc. d/b/a American Medical Collection Agency (AMCA), an external collection agency, notified the Company about a security incident AMCA experienced that may have involved certain personal information about some of the Company’s patients (the AMCA Incident). The Company referred patient balances to AMCA only when direct collection efforts were unsuccessful. The Company’s systems were not impacted by the AMCA Incident. Upon learning of the AMCA Incident, the Company promptly stopped sending new collection requests to AMCA and stopped AMCA from continuing to work on any pending collection requests from the Company. AMCA informed the Company that it appeared that an unauthorized user had access to AMCA’s system between August 1, 2018 and March 30, 2019, and that AMCA could not rule out the possibility that personal information on AMCA’s system was at risk during that time period. Information on AMCA’s affected system from the Company may have included name, address, and balance information for the patient and person responsible for payment, along with the patient’s phone number, date of birth, referring physician, and date of service. The Company was later informed by AMCA that health insurance information may have been included for some individuals, and because some insurance carriers utilize the Social Security Number as a subscriber identification number, the Social Security Number for some individuals may also have been affected. No ordered tests, laboratory test results, or diagnostic information from the Company were in the AMCA affected system. The Company notified individuals for whom it had a valid mailing address. For the individuals whose Social Security Number was affected, the notice included an offer to enroll in credit monitoring and identity protection services that will be provided free of charge for 24 months.
Twenty-three putative class action lawsuits were filed against the Company related to the AMCA Incident in various U.S. District Courts. Numerous similar lawsuits have been filed against other health care providers who used AMCA. These lawsuits have been consolidated into a multidistrict litigation in the District of New Jersey. On November 15, 2019, the Plaintiffs filed a Consolidated Class Action Complaint in the U.S. District Court of New Jersey. On January 22, 2020, the Company filed Motions to Dismiss all claims. The consolidated Complaint generally alleges that the Company did not adequately protect its patients' data and failed to timely notify those patients of the AMCA Incident. The Complaint asserts various causes of action, including, but not limited to, negligence, breach of implied contract, unjust enrichment, and the violation of state data protection statutes. The Complaint seeks damages on behalf of a class of all affected Company customers. The Company will vigorously defend the multi-district litigation.
Certain governmental entities have requested information from the Company related to the AMCA Incident. The Company has received requests for information from the Office of Civil Rights of the Department of Health and Human Services, and from a multi-state group of state Attorneys General. The Company is cooperating with these requests for information.
Three putative class-action lawsuits related to California wage and hour laws have been served on the Company. On September 21, 2018, the Company was served with a putative class action lawsuit, Alma Haro v. Laboratory Corporation of America, et al., filed in the Superior Court of California, County of Los Angeles. On June 10, 2019, the Company was served with a putative class action lawsuit, Ignacio v. Laboratory Corporation of America, filed in Superior Court of California, County of Los Angeles. On July 1, 2019, the Company was served with a putative class action lawsuit, Jan v. Laboratory Corporation of America, filed in the Superior Court of California, County of Sacramento. All three cases were subsequently removed to the U.S. District Court for the Central District of California, and then consolidated for all pre-trial proceedings. In the lawsuits, Plaintiffs allege that employees were not properly paid overtime compensation, minimum wages, meal and rest break premiums, did not receive compliant wage statements, and were not properly paid wages upon termination of employment. The Plaintiffs assert these actions violate various California Labor Code provisions and constitute an unfair competition practice under California law. The lawsuits seek monetary damages, civil penalties, and recovery of attorney's fees and costs. The Company will vigorously defend the lawsuits.
On July 30, 2019, the Company was served with a class action lawsuit, Mitchell v. Covance, Inc. et al., filed in the U.S. District Court for the Eastern District of Pennsylvania. Plaintiff alleges that certain individuals employed by Covance Inc. and Chiltern International Inc. were misclassified as exempt employees under the Fair Labor Standards Act and the Pennsylvania Minimum Wage Act and were thereby not properly paid overtime compensation. The lawsuit seeks monetary damages, liquidated damages, and recovery of attorney’s fees and costs. On February 3, 2020, the Court denied without prejudice the Plaintiff's motion to conditionally certify a class action. The Company will vigorously defend the lawsuit.
On January 31, 2020, the Company was served with a putative class action lawsuit, Luke Davis and Julian Vargas, et al. v. Laboratory Corporation of America Holdings, filed in the U.S. District Court for the Central District of California. The lawsuit alleges that visually impaired patients are unable to use the Company’s touchscreen kiosks at Company patient service centers in violation of the Americans with Disabilities Act and similar California statutes. The lawsuit seeks statutory damages, injunctive relief, and attorney’s fees and costs. The Company will vigorously defend the lawsuit.
Under the Company's present insurance programs, coverage is obtained for catastrophic exposure as well as those risks required to be insured by law or contract. The Company is responsible for the uninsured portion of losses related primarily to general, professional and vehicle liability, certain medical costs and workers' compensation. The self-insured retentions are on a per-
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
occurrence basis without any aggregate annual limit. Provisions for losses expected under these programs are recorded based upon the Company's estimates of the aggregated liability of claims incurred.
17. PENSION AND POSTRETIREMENT PLANS
Retirement Plans
All employees eligible for the LCD defined-contribution retirement plan (401K Plan) receive a minimum 3% non-elective contribution (NEC) concurrent with each payroll period. Employees are not required to make a contribution to the LCD 401K Plan to receive the NEC. The NEC is non-forfeitable and vests immediately. The LCD 401K Plan also permits discretionary contributions by the Company of 1% and 3% of pay for eligible employees based on service. In 2019, 2018, and 2017, non-elective and discretionary contributions were $52.3, $65.0 and $58.1, while total expense was $65.6, $63.6 and $59.1, respectively.
All of the CDD U.S. employees are eligible to participate in the CDD 401K plan, which is available on a voluntary basis and features a maximum 4.5% Company match, based upon a percentage of the employee’s contributions. Chiltern employees were previously eligible to participate in the Chiltern 401K plan, which featured a maximum 3% Company match, based upon a percentage of the employee's contributions. The Chiltern 401K plan merged into the CDD 401K plan effective January 7, 2019. The Company incurred expense of $73.9, $66.3, and $58.4 for the CDD 401K Plan in 2019, 2018 and 2017, respectively.
The Company also maintains several other small 401K plans associated with companies acquired over the last several years.
Pension Plans
The Company has a defined-benefit retirement plan (Company Plan) and a nonqualified supplemental retirement plan (PEP). Both plans have been closed to new participants since December 31, 2009. Employees participating in the Company Plan and the PEP no longer earn service-based credits, but continue to earn interest credits.
The Company Plan covers substantially all employees employed prior to December 31, 2009. The benefits to be paid under the Company Plan are based on years of credited service through December 31, 2009, interest credits and average compensation. The Company’s policy is to fund the Company Plan with at least the minimum amount required by applicable regulations. The Company made contributions to the Company Plan of $0.0, $28.9 and $16.0 in 2019, 2018 and 2017, respectively.
The PEP covers a portion of the Company’s senior management group. Prior to 2010, the PEP provided for the payment of the difference, if any, between the amount of any maximum limitation on annual benefit payments under the Employee Retirement Income Security Act of 1974 and the annual benefit that would be payable under the Company Plan but for such limitation. Effective January 1, 2010, employees participating in the PEP no longer earn service-based credits. The PEP is an unfunded plan.
Projected pension expense for the Company Plan and the PEP is expected to decrease to $11.8 in 2020. This amount excludes any accelerated recognition of pension cost due to the total lump-sum payouts exceeding certain components of net periodic pension cost in a fiscal year. If such levels were to be met in 2020, the Company projects that it would result in additional pension expense of several million dollars. The actual amount would be determined in the fiscal quarter when the lump-sum payments cross the threshold and would be based upon the plan's funded status and actuarial assumptions in effect at that time.
The Company plans to make contributions of $2.2 to the Company Plan and the PEP during 2020.
The effect on operations for both the Company Plan and the PEP are summarized as follows:
Amounts included in accumulated other comprehensive earnings consist of unamortized net loss of $111.2. The accumulated other comprehensive earnings that are expected to be recognized as components of the defined-benefit plan costs during 2020 are $10.2 related to amortization of the net loss. For the year ended December 31, 2018, the Company recorded a pension settlement charge of $7.5 recorded in Other, net on the Consolidated Statement of Operations as a result of lump sum distributions exceeding $16.5 threshold level for 2018.
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LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
A summary of the changes in the projected benefit obligations of the Company Plan and the PEP are summarized as follows:
The Accumulated Benefit Obligation was $355.5 and $334.6 at December 31, 2019 and 2018, respectively.
A summary of the changes in the fair value of plan assets follows:
The net funded status of the Company Plan and the PEP at December 31:
Weighted average assumptions used in the accounting for the Company Plan and the PEP are summarized as follows:
The Company used the RP-2014 Mortality Tables to estimate life expectancy. The weighted average expected long-term rate of return on assets of the Company Plan and PEP is based on the target asset allocation and the average rate of growth expected for the asset classes invested. The rate of expected growth is derived from a combination of historic returns, current market indicators, the expected risk premium for each asset class over the risk-free rate, and the opinion of professional advisors.
The Company maintains an investment policy for the management of the Company Plan’s assets. The objective of this policy is to build a portfolio designed to achieve a balance between investment return and asset protection by investing in indexed funds that are comprised of equities of high quality companies and in high quality fixed income securities which are broadly balanced and represent all market sectors. The target allocations for plan assets are 50% equity securities, 43% fixed income securities and 7% in other assets. Equity securities primarily include investments in large-cap, mid-cap and small-cap companies located in the U.S. and to a lesser extent international equities in developed and emerging countries. Fixed income securities primarily include U.S. Treasury securities, mortgage-backed bonds and corporate bonds of companies from diversified industries. Other assets include investments in real estate. The weighted average expected long-term rate of return for the Company Plan’s assets is as follows:
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LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES
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(Dollars and shares in millions, except per share data)
The fair values of the Company Plan’s assets at December 31, 2019, and 2018, by asset category are as follows:
a)
This category represents an equity index fund not actively managed that tracks the S&P 500 Index.
b)
This category represents an equity index fund not actively managed that tracks the S&P mid-cap 400 Index.
c)
This category represents an equity index fund not actively managed that tracks the Russell 2000 Index.
d)
This category represents an equity index fund not actively managed that tracks the MSCI ACWI ex USA Index.
e)
This category represents a real estate index fund not actively managed that tracks the Vanguard REIT Index.
f)
This category primarily represents bond index funds not actively managed that track the Northern Trust U.S. Aggregate Index as well as an actively managed strategy which utilizes the Metropolitan West Total Return Bond Index as its primary prospectus benchmark.
g)
This category primarily represents a bond index fund not actively managed that tracks the Northern Trust U.S. TIPS Index.
h)
This category represents a commodities index fund not actively managed that tracks the Dow Jones - UBS Commodity Index.
The following estimated benefit payments under the Company Plan and PEP, which were used in the calculation of projected benefit obligations, are expected to be paid as follows:
In addition to the PEP, as a result of the Covance acquisition, the Company also has a frozen non-qualified Supplemental Executive Retirement Plan (SERP). The SERP, which is not funded, is intended to provide retirement benefits for certain employees
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(Dollars and shares in millions, except per share data)
who were executive officers of Covance prior to the acquisition. Benefit amounts are based upon years of service and compensation of the participating employees. As of December 31, 2018, the SERP was combined with the PEP.
As a result of the Covance acquisition, the Company sponsors two defined-benefit pension plans for the benefit of its employees at two U.K. subsidiaries (U.K. Plans) and one defined-benefit pension plan for the benefit of its employees at a German subsidiary (German Plan), all of which are legacy plans of previously acquired companies. Benefit amounts for all three plans are based upon years of service and compensation. The German Plan is unfunded while the U.K. Plans are funded. The Company’s funding policy has been to contribute annually a fixed percentage of the eligible employee's salary, and additional amounts, at least equal to the local statutory funding requirements. All plans have a measurement date of December 31.
As a result of the Envigo acquisition, the Company assumed a defined benefit pension plan for the benefit of Envigo's U.K. employees (the Envigo plan), which is a legacy plan of a company previously acquired by Envigo. The Envigo plan is a funded plan that is closed to future accrual. The related net pension obligation of $46.6, based on the preliminary valuation of acquired assets and assumed liabilities, is reported under Other liabilities in the Consolidated Balance Sheet as of December 31, 2019. The Company’s funding policy has been to contribute amounts at least equal to the local statutory funding requirements. The Envigo plan has a measurement date of December 31. The U.K. Plans disclosures below are inclusive of the Envigo plan for 2019.
The components of the defined-benefit plan costs for these plans for 2019 and 2018 are as follows:
The weighted average expected long-term rate of return on assets of the U.K Plans is based on the target asset allocation and the average rate of growth expected for the asset classes invested. The rate of expected growth is derived from a combination of historic returns, current market indicators, the expected risk premium for each asset class over the risk-free rate, and the opinion of professional advisors.
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LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES
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(Dollars and shares in millions, except per share data)
The change in the projected benefit obligation and plan assets, the funded status of the plan and a reconciliation of such funded status to the amounts reported in the consolidated balance sheet as of December 31, 2019, and December 31, 2018, is as follows:
On December 31, 2019, the U.K. plans were closed to future accrual, which resulted in an estimated reduction in the projected benefit obligation of the plans of $16.1. The reduction in the projected benefit obligation due to the plan revisions resulted in a
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LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
curtailment gain, which was recorded as a reduction to the unrecognized actuarial losses present in accumulated other comprehensive income as of December 31, 2019.
The Company contributed $11.4 in 2019 to the U.K. Plans and expects to contribute $13.8 in 2020. No contributions were made to the German plan during 2019, nor are any contributions expected to be made in 2020, as the plan is unfunded.
The accumulated benefit obligation for the U.K. Plans and the German Plan was $547.9 and $37.8 at December 31, 2019, respectively. The accumulated benefit obligation for the U.K. Plans and the German Plan was $223.8 and $30.1 at December 31, 2018, respectively.
The amounts recognized in accumulated other comprehensive income for the year ended December 31, 2019, and December 31, 2018, is as follows:
The net actuarial loss for the U.K and German pension plans required to be amortized from accumulated other comprehensive income into net periodic pension cost in 2020 is expected to be $0.1 and $0.3, respectively.
The investment policies for the U.K. Plans are set by the plan trustees, based upon the guidance of professional advisors and after consultation with the Company, taking into consideration the plans’ liabilities and future funding levels. The trustees have set the long-term investment policy largely in accordance with the asset allocation of a broadly diversified investment portfolio. Assets for the U.K. Plans are generally invested within the target ranges as follows:
The weighted average asset allocation of the U.K. Pension Plans as of December 31, 2019, by asset category is as follows:
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LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES
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(Dollars and shares in millions, except per share data)
Investments are made in pooled investment funds. Pooled investment fund managers are regulated by the Financial Conduct Authority in the U.K. and operate under terms which contain restrictions on the way in which the portfolios are managed and require the managers to ensure that suitable internal operating procedures are in place. The trustees have set performance objectives for each fund manager and routinely monitor and assess the managers’ performance against such objectives. Annuities represent annuity buy-in insurance policies purchased by the plan trustees from large, financially sound insurers. The cash flows from the annuities are intended to match the plan’s obligations to specific groups of participants, typically those participants currently receiving benefits.
The fair value of the Company’s U.K. Plans' assets as of December 31, 2019, and December 31, 2018, by asset category, are as follows:
a)
Mutual funds represent pooled investment vehicles offered by investment managers, which are generally comprised of investments in equities, bonds, property and cash. The plans’ trustees hold units in these funds, the value of which is determined by the number of units held multiplied by the unit price calculated by the investment managers. That unit price is derived based on the market value of the securities that comprise the fund, which are determined by quoted prices in active markets. No element of the valuation is based on inputs made by the plans’ trustees.
b)
Annuities represent annuity buy-in insurance policies, whereby the insurer pays the pension payments for the lifetime of the members covered. The annuities are assets of the plan and payments from the insurer are made to the plans’ trustees, who then use those proceeds to pay the pensioners. The cash flows from the annuities are intended to effectively match the payments to the pensioners covered by the policy. As such, these assets are valued actuarially based upon the value of the liabilities with which they are associated. As the valuation of these assets is judgmental, and there are no observable inputs associated with the valuation, these assets are classified as Level 3 in the fair value hierarchy.
Expected future benefit payments are as follows:
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(Dollars and shares in millions, except per share data)
Post-employment Retiree Health and Welfare Plan
As a result of the Covance acquisition, the Company sponsors a post-employment retiree health and welfare plan for the benefit of eligible employees at certain U.S. subsidiaries who retire after satisfying service and age requirements. This plan is funded on a pay-as-you-go basis and the cost of providing these benefits is shared with the retirees.
Post-retirement Medical Plan
The Company assumed obligations under a subsidiary's post-retirement medical plan. Coverage under this plan is restricted to a limited number of existing employees of the subsidiary. This plan is unfunded and the Company’s policy is to fund benefits as claims are incurred. The effect on operations of the post-retirement medical plan is shown in the following table:
Amounts included in accumulated other comprehensive earnings consist of unamortized net loss of $2.0. The accumulated other comprehensive earnings that are expected to be recognized as components of the post-retirement medical plan costs during 2020 are $0.3 related to amortization of the net gain resulting from the shift of Medicare-eligible participants to private exchanges.
A summary of the changes in the accumulated post-retirement benefit obligation follows:
The weighted-average discount rates used in the calculation of the accumulated post-retirement benefit obligation were 3.2% and 4.2% as of December 31, 2019, and 2018, respectively. The healthcare cost trend rate was removed due to the expectation of future funding to be at the same level as the previous year's funding.
The following assumed benefit payments under the Company's post-retirement benefit plan, which reflect expected future service, as appropriate, and which were used in the calculation of projected benefit obligations, are expected to be paid as follows:
Deferred Compensation Plan
The Company has a Deferred Compensation Plan (DCP) under which certain of its executives may elect to defer up to 100.0% of their annual cash incentive pay and/or up to 50.0% of their annual base salary and/or eligible commissions subject to annual limits established by the U.S. government. The DCP provides executives a tax efficient strategy for retirement savings and capital accumulation without significant cost to the Company. The Company makes no contributions to the DCP. Amounts deferred by a participant are credited to a bookkeeping account maintained on behalf of each participant, which is used for measurement and determination of amounts to be paid to a participant, or his or her designated beneficiary, pursuant to the terms of the DCP. The amounts accrued under this plan were $76.7 and $64.2 at December 31, 2019, and 2018, respectively. Deferred amounts are the
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(Dollars and shares in millions, except per share data)
Company's general unsecured obligations and are subject to claims by the Company's creditors. The Company's general assets may be used to fund obligations and pay DCP benefits.
18. FAIR VALUE MEASUREMENTS
The Company’s population of financial assets and liabilities subject to fair value measurements as of December 31, 2019, and 2018 were as follows:
The Company has a noncontrolling interest put related to its Ontario subsidiary that has been classified as mezzanine equity in the Company’s condensed consolidated balance sheets. The noncontrolling interest put is valued at its contractually determined value, which approximates fair value. During the year ended December 31, 2019, the carrying value of the noncontrolling interest put increased by $0.8 for foreign currency translation.
The Company offers certain employees the opportunity to participate in a DCP. A participant's deferrals are allocated by the participant to one or more of 16 measurement funds, which are indexed to externally managed funds. From time to time, to offset the cost of the growth in the participant's investment accounts, the Company purchases life insurance policies, with the Company named as beneficiary of the policies. Changes in the cash surrender value of the life insurance policies are based upon earnings and changes in the value of the underlying investments, which are typically invested in a similar manner to the participants' allocations. Changes in the fair value of the DCP obligation are derived using quoted prices in active markets based on the market price per unit multiplied by the number of units. The cash surrender value and the DCP obligations are classified within Level 2 because their inputs are derived principally from observable market data by correlation to the hypothetical investments.
Contingent accrued earn-out business acquisition consideration liabilities for which fair values are measured as Level 3 instruments. These contingent consideration liabilities were recorded at fair value on the acquisition date and are remeasured quarterly based on the then assessed fair value and adjusted if necessary. The increases or decreases in the fair value of contingent
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consideration payable can result from changes in anticipated revenue levels and changes in assumed discount periods and rates. As the fair value measure is based on significant inputs that are not observable in the market, they are categorized as Level 3.
The carrying amounts of cash and cash equivalents, accounts receivable, income taxes receivable, and accounts payable are considered to be representative of their respective fair values due to their short-term nature. The fair market value of the zero-coupon subordinated notes, based on market pricing, was approximately $0.0 and $16.9 as of December 31, 2019, and 2018, respectively. The fair market value of the Senior Notes, based on market pricing, was approximately $5,281.1 and $5,318.0 as of December 31, 2019, and 2018, respectively. The Company's note and debt instruments are considered Level 2 instruments, as the fair market values of these instruments are determined using other observable inputs.
19. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Company addresses its exposure to market risks, principally the market risk associated with changes in interest rates and currency exchange rates, through a controlled program of risk management that includes, from time to time, the use of derivative financial instruments. Although the Company’s zero-coupon subordinated notes contained features that were considered to be embedded derivative instruments, the Company does not hold or issue derivative financial instruments for trading purposes. The Company does not believe that its exposure to market risk is material to the Company’s financial position or results of operations.
Interest Rate Swap
During the third quarter of 2013, the Company entered into two fixed-to-variable interest rate swap agreements for the 4.625% Senior Notes due 2020 with an aggregate notional amount of $600.0 and variable interest rates based on one-month LIBOR plus 2.298% to hedge against changes in the fair value of a portion of the Company's long-term debt. The Company exited one of these swap arrangements in December 2019 in connection with the redemption of $187.9 of the 4.625% Senior Notes due 2020. These derivative financial instruments are accounted for as fair value hedges of the Senior Notes due 2020. These interest rate swaps are included in other long-term assets or liabilities, as applicable, and added to the value of the Senior Notes. As the specific terms and notional amounts of the derivative financial instruments match those of the fixed-rate debt being hedged, the derivative instruments are assumed to be perfectly effective hedges and accordingly, there is no impact to the Company's consolidated statements of operations. Cash flows from the interest rate swaps are including in operating activities.
Foreign Currency Forward Contracts
The Company periodically enters into foreign currency forward contracts, which are recognized as assets or liabilities at their fair value. These contracts do not qualify for hedge accounting and the changes in fair value are recorded directly to earnings. The contracts are short-term in nature and the fair value of these contracts is based on market prices for comparable contracts. The fair value of these contracts is not significant as of December 31, 2019 and 2018.
Cross Currency Swaps
During the first quarter of 2018, the Company entered into six USD to Swiss Franc cross-currency swap agreements with an aggregate notional value of $600.0 and which were accounted for as a hedge against its net investment in a Swiss subsidiary. Of the notional value, $300.0 were due to mature in 2022 and $300.0 were due to mature in 2025. These cross currency swaps maturing in 2022 and 2025 were settled on December 10, 2018 in cash.
During the fourth quarter of 2018, the Company entered into six new USD to Swiss Franc cross-currency swap agreements with an aggregate notional value of $600.0 and which are accounted for as a hedge against the impact of foreign exchange movements on its net investment in a Swiss Franc functional currency subsidiary. Of the notional value, $300.0 matures in 2022 and $300.0 matures in 2025. These cross currency swaps maturing in 2022 and 2025 are included in other long-term assets as of December 31, 2019. Changes in the fair value of the cross-currency swaps are recorded as a component of the foreign currency translation adjustment in accumulated other comprehensive income in the Consolidated Balance Sheet until the hedged item is recognized in earnings. The cumulative amount of the fair value hedging adjustment included in the current value of the cross currency swaps is $6.0 for the year ended December 31, 2019, and was recognized as currency translation within the Consolidated Statement of
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LABORATORY CORPORATION OF AMERICA HOLDINGS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
Comprehensive Earnings. There were no amounts reclassified from the Consolidated Statement of Comprehensive Earnings to the Consolidated Statement of Operations during the year ended December 31, 2019.
The table below presents the fair value of derivatives on a gross basis and the balance sheet classification of those instruments:
The table below provides information regarding the location and amount of pretax (gains) losses of derivatives designated in fair value hedging relationships:
The Company recognized a $1.6 gain on the exit one of these swap arrangements in December 2019 in connection with the redemption of $187.9 of the 4.625% Senior Notes due 2020. No gains or losses from derivative instruments classified as hedging instruments have been recognized into income for the years ended December 31, 2018 or 2017.
20. SUPPLEMENTAL CASH FLOW INFORMATION
21. BUSINESS SEGMENT INFORMATION
The following table is a summary of segment information for the years ended December 31, 2019, 2018, and 2017. The “management approach” has been used to present the following segment information. This approach is based upon the way the management of the Company organizes segments within an enterprise for making operating decisions and assessing performance. Financial information is reported on the basis that it is used internally by the chief operating decision maker (CODM) for evaluating segment performance and deciding how to allocate resources to segments. The Company’s chief executive officer has been identified as the CODM.
Segment asset information is not presented because it is not used by the CODM at the segment level. Operating earnings (loss) of each segment represents revenues less directly identifiable expenses to arrive at operating income for the segment. General management and administrative corporate expenses are included in general corporate expenses below.
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(Dollars and shares in millions, except per share data)
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22. QUARTERLY DATA (UNAUDITED)
The following is a summary of unaudited quarterly data: