filings.toolsItem 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in millions)
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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
| Years Ended December 31, | ||||||||||
| 2019 | 2018 | Change | ||||||||
| LCD | $ | 7,000.1 | $ | 7,030.8 | (0.4 | )% | ||||
| CDD | 4,578.1 | 4,313.1 | 6.1 | % | ||||||
| Intercompany eliminations | (23.4 | ) | (10.5 | ) | 122.9 | % | ||||
| Total | $ | 11,554.8 | $ | 11,333.4 | 2.0 | % |
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
| Years Ended December 31, | ||||||||||
| 2019 | 2018 | Change | ||||||||
| Cost of revenues | $ | 8,302.3 | $ | 8,157.0 | 1.8 | % | ||||
| Cost of revenues as a % of revenues | 71.9 | % | 72.0 | % |
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
| Years Ended December 31, | ||||||||||
| 2019 | 2018 | Change | ||||||||
| Selling, general and administrative expenses | $ | 1,624.5 | $ | 1,570.9 | 3.4 | % | ||||
| SG&A as a % of revenues | 14.1 | % | 13.9 | % |
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
| Years Ended December 31, | ||||||||||
| 2019 | 2018 | Change | ||||||||
| LCD | $ | 102.0 | $ | 104.0 | (1.9 | )% | ||||
| CDD | 141.2 | 127.7 | 10.6 | % | ||||||
| Amortization of intangibles and other assets | $ | 243.2 | $ | 231.7 | 5.0 | % |
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
| Years Ended December 31, | ||||||||||
| 2019 | 2018 | Change | ||||||||
| Restructuring and other charges | $ | 54.6 | $ | 48.1 | 13.5 | % |
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
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
| Years Ended December 31, | ||||||||||
| 2019 | 2018 | Change | ||||||||
| Interest expense | $ | 240.7 | $ | 244.2 | (1.4 | )% |
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
| Years Ended December 31, | ||||||||||
| 2019 | 2018 | Change | ||||||||
| Equity method income, net | $ | 9.8 | $ | 11.6 | (15.5 | )% |
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
| Years Ended December 31, | ||||||||||
| 2019 | 2018 | Change | ||||||||
| Other, net | $ | (3.2 | ) | $ | 167.7 | 101.9 | % |
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
| Years Ended December 31, | |||||||
| 2019 | 2018 | ||||||
| Income tax expense | $ | 280.0 | $ | 384.4 | |||
| Income tax expense as a % of income before tax | 25.3 | % | 30.3 | % |
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.
Operating Results by Segment
| Years Ended December 31, | ||||||||||
| 2019 | 2018 | Change | ||||||||
| LCD operating income | $ | 1,086.0 | $ | 1,166.7 | (6.9 | )% | ||||
| LCD operating margin | 15.5 | % | 16.6 | % | (1.1 | )% | ||||
| CDD operating income | $ | 411.5 | $ | 303.6 | 35.5 | % | ||||
| CDD operating margin | 9.0 | % | 7.0 | % | 2.0 | % | ||||
| General corporate expenses | $ | (167.3 | ) | $ | (144.6 | ) | 15.7 | % | ||
| Total operating income | $ | 1,330.2 | $ | 1,325.7 | 0.3 | % |
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:
| For the Year Ended December 31, | |||||||||||
| 2019 | 2018 | 2017 | |||||||||
| Net cash provided by operating activities | $ | 1,444.7 | $ | 1,305.4 | $ | 1,498.1 | |||||
| Net cash (used in) provided by investing activities | (1,283.1 | ) | 206.7 | (2,228.7 | ) | ||||||
| Net cash (used in) provided by financing activities | (252.7 | ) | (1,389.9 | ) | 593.2 | ||||||
| Effect of exchange rate on changes in cash and cash equivalents | 1.8 | (12.0 | ) | 20.5 | |||||||
| Net change in cash and cash equivalents | $ | (89.3 | ) | $ | 110.2 | $ | (116.9 | ) |
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
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,
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.
| Contractual Cash Obligations | |||||||||||||||||||
| Payments Due by Period | |||||||||||||||||||
| 2021 - | 2023 - | 2025 and | |||||||||||||||||
| Total | 2020 | 2022 | 2024 | thereafter | |||||||||||||||
| Operating lease obligations | $ | 913.0 | $ | 196.2 | $ | 271.1 | $ | 155.8 | $ | 289.9 | |||||||||
| Contingent future licensing payments (a) | 23.1 | 3.5 | 13.8 | 4.8 | 1.0 | ||||||||||||||
| Minimum royalty payments | 28.0 | 3.3 | 14.6 | 9.7 | 0.4 | ||||||||||||||
| Purchase obligations | 93.9 | 42.2 | 51.7 | — | — | ||||||||||||||
| Finance lease obligations | 162.4 | 15.8 | 26.5 | 23.3 | 96.8 | ||||||||||||||
| Scheduled interest payments on Senior Notes | 1,955.2 | 220.8 | 381.0 | 307.6 | 1,045.8 | ||||||||||||||
| Scheduled interest payments on Term Loan (d) | 12.8 | 9.6 | 3.2 | — | — | ||||||||||||||
| Long-term debt (e) | 6,247.9 | 415.9 | 1,375.0 | 1,300.0 | 3,157.0 | ||||||||||||||
| Total contractual cash obligations (b) (c) | $ | 9,436.3 | $ | 907.3 | $ | 2,136.9 | $ | 1,801.2 | $ | 4,590.9 |
| (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
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:
| • | 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
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
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
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.
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.
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. |
| • | 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. |
| • | 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%.
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; |
| 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; |
| 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.
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