LABORATORY CORP OF AMERICA HOLDINGS
Item 1. BUSINESS
Labcorp® is a leading global life sciences company that provides vital information to help doctors, hospitals, pharmaceutical companies, researchers, and patients make clear and confident decisions. By leveraging its strong diagnostics and drug development capabilities, the Company provides insights and accelerates innovations to improve health and improve lives. With over 72,400 employees, the Company serves clients in more than 100 countries.
Through its Labcorp Diagnostics (Dx) and Labcorp Drug Development (DD) segments, the Company provides diagnostic, drug development, and technology-enabled solutions for more than 160 million patient encounters per year, or more than 3 million patients per week. The Company also supports clinical trial activity in approximately 100 countries through its industry-leading central laboratory, preclinical, and clinical development businesses.
The breadth of the Company's offerings has resulted in revenue growth of 23%, and operating income growth of 84%, from 2018 through 2020. The Company believes that its diversified service offerings across drug development and diagnostics also help to balance the impact of changes in the global economic and healthcare systems, and the influence of unplanned events such as the COVID-19 pandemic.
For the period ended December 31, 2020, the Company generated revenues of $13,978.5 million, diluted earnings per share of $15.88, and had a total operating cash flow of $2,135.3 million.
The Company believes that science, technology and innovation are behind its successes and are foundational to its future. The Company's commitment to leading with science and innovation enables it to improve the health and lives of people around the world.
Rebranding
In December 2020, the Company announced an evolution of its brand identity, to highlight the pivotal role the Company plays in healthcare and showcase the power of the Company’s combined diagnostic and drug development offerings through one powerful brand. As part of the rebranding, the Company introduced a new company logo and has begun associating its business unit brands with the Labcorp name. The Company’s drug development segment, formerly referred to as Covance Drug Development, became Covance by Labcorp for a transition period, and by mid-2021 is expected to transition to Labcorp Drug Development. The Company's diagnostics segment, formerly referred to as LabCorp Diagnostics, is transitioning to the Labcorp name and new logo during 2021.
Enterprise Strategy
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.
The Company believes that it can continue to expand its role in the rapidly evolving healthcare environment by advancing the following strategic priorities:
1.Leveraging the Power of the Company’s Combined Capabilities
The combination of Dx’s and DD’s core capabilities and scientific and technological expertise uniquely enables the Company to create compelling solutions for clients. The Company’s combined strengths allow it to help biopharmaceutical and medical device partners design better clinical studies, execute those studies faster through enhanced patient recruitment, take greater advantage of virtual and hybrid study options, and satisfy post-market surveillance requirements. For example, the Company can advance companion and complementary diagnostics and other precision medicine innovations that match patients with targeted treatments based on genomics and other individual characteristics because of its experience, resources and data in both drug development and diagnostics. Through comprehensive integration of those capabilities, the Company has a unique opportunity to extend its position as a market leader in the development and commercialization of new therapies and tests, by providing data, insights, and answers for doctors, drug developers, and the public.
2. Advancing the Company's Leadership Position in Oncology
Oncology continues to receive significant investment in research and treatment, but despite decades of focus and research, it is still an area of great unmet medical need. The Company believes the diagnosis and treatment of cancer is expected to be the fastest-growing therapeutic area for the near future.
As oncology's standard of care trends towards the adoption of precision medicine, providers are relying on advanced testing to identify patients who will benefit from new, targeted treatments that are more effective, and usually have fewer side effects, than traditional treatments like chemotherapy. The Company is expanding its leadership through strategic partnerships in oncology testing, major customer wins in late-stage clinical trials, and the recruitment of leaders in the field to further build the
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Company's oncology team. In addition, the Company’s strong connections with patients, physicians, and health systems, along with its extensive data, are powerful tools to support the Company's leadership role in diagnosing and treating cancer and its goal of improving patient outcomes.
3. Integrating Artificial Intelligence, Data, Digitalization and Analytics Across the Company's Business
Advances in technology have impacted nearly every business, and healthcare more than most. By maximizing the use of technology, and in particular advances in artificial intelligence, data, digitalization, and analytics, the Company strives to improve operating efficiency and create new, differentiated products and services that the Company believes will help its customers and will deliver better care to patients.
Artificial intelligence helps the Company to better predict trends, such as where and when demand for certain tests is likely to change, which supports more efficient use of supplies, staffing adjustments, and the Company’s advanced logistics to route testing to the most appropriate laboratories to deliver results quickly. Artificial intelligence capabilities and advanced logistics have played an important role in the Company’s response to the demand for COVID-19 polymerase chain reaction (PCR) testing.
The Company creates, and has access to, significant volumes of data. By applying advanced analytics, the Company can help its customers improve their processes and reach better outcomes. The Company’s repository of test results help study sponsors assess patients' eligibility for clinical trials more quickly and accurately, enroll those patients faster, shorten the time needed for regulatory submission, and accelerate the availability of new medicines.
Digitalization is affecting every aspect of the Company’s business. For example, healthcare providers now have multiple ways to retrieve and analyze their patients' health data; MCOs have various tools to manage their membership; consumers can more readily access testing and their results to have more control over their care; and decentralized clinical trials can help remove barriers that have slowed or prevented studies from being conducted in the past. As the Company experienced in 2020, digitalization also allowed many of the Company’s employees to quickly shift from working in traditional offices to working remotely in response to COVID-19.
4. Putting Customers at the Center of All the Company Does
Labcorp serves a broad range of customers, including 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. The Company prioritizes a consistent, coordinated focus across all aspects of the Company's operations, placing the customer at the center of its services, with the objective of becoming the customer's primary partner for solutions to their needs. Customer feedback, communication of best-practices and lessons learned, and robust employee training with respect to the needs of its customers are all methods that the Company employs to provide a top customer experience.
The introduction of the Company’s new branding is intended to send a clear signal of who the Company is, what it does, and how it is differentiated from its competitors. It is the Company's goal that the Labcorp brand represents a promise to its customers about how they will be treated, and the levels of service, quality, and innovation that the Company will deliver.
5. Evaluate and Execute on High-Growth Opportunities
The Company has a long history of disciplined use of capital to invest in the growth of the business. The Company has made significant investments in the deployment of new technologies through both licensing and internal research and development, strategic and fold-in acquisitions, and establishing collaborative partnerships with other leading companies and organizations that share the Company’s goals and expectations.
The Company continually evaluates its business and the broader healthcare and life sciences markets to proactively identify and assess:
•potential growth opportunities;
•business areas that might not support continued growth and should be revamped or divested;
•acquisition targets that meet its criteria for quality, value, and return on investment;
•new products that would successfully integrate with or extend the Company’s offerings; and
•a balanced formula for capital allocation.
Through continued focus on these priorities, the Company expects to be in the optimal position to make tough, disciplined choices that maximize shareholder value, better protect the Company from market fluctuations and outside impacts, and fuel significant, profitable revenue growth.
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COVID-19 Response
The Company has been intensely focused on supporting the fight against COVID-19 since the earliest stages of the pandemic.
Diagnostic Testing and Clinical Trial Leadership
In tandem with the first confirmed cases, the Company began preparations to be able to offer diagnostic testing to identify cases of COVID-19, working closely with diagnostic manufacturers and suppliers, and with regulators and public health authorities.
On March 5, 2020, the Company became the first commercial laboratory in the U.S. to launch PCR testing for COVID-19, and the Company received Emergency Use Authorization (EUA) from the U.S. Food and Drug Administration (FDA) on March 16, 2020. That was the first of a steady series of innovations introduced by the Company to rapidly expand COVID-19 test capacity, options, access, and efficiency. These COVID-19 innovations include:
•the first FDA EUA for an at-home collection kit on its Pixel by Labcorp® platform;
•the first digital COVID-19 service, which is also available through healthcare providers from the Company’s Labcorp at Home offering;
•early participation in COVID-19 research projects in collaboration with partners that included Adaptive Biotechnologies, Microsoft, and Pacific Biosciences;
•introduction of new test options to increase test capacity, throughput, and efficiency to maximize use of supplies, including the introduction of a new method to extract RNA from samples using heat and technology; and
•the increased use of robotics and automation in the PCR testing process.
The Company has steadily increased its COVID-19 test capacity, from several thousand PCR tests per day in early March to 275,000 per day by the end of 2020. The Company performed over 31 million PCR tests and nearly 4 million antibody tests in 2020.
As a result, the Company developed an expertise and understanding of COVID-19 that led to it becoming a leader in supporting clinical trials of potential treatments and vaccines for the virus. By the end of 2020, the Company had won approximately 440 COVID-19 trial and study opportunities, from small nonclinical programs to late-stage clinical trials.
Base Business Normalization
In the initial months of the COVID-19 pandemic, the Company experienced a significant drop in its non-COVID-19 business (Base Business) as patients avoided routine medical care and most elective and non-emergency procedures were postponed. This decline, coupled with the suspension of most global clinical trial activity resulted in a negative impact to the Company's Base Business in the latter part of the first quarter and initial part of the second quarter of 2020. By the end of the second quarter of 2020, however, the Company experienced a steady recovery in its Base Business, which continued through the third quarter of 2020. During the fourth quarter, the Dx Base Business volume recovery flattened with volumes below prior year in the high single digits. Throughout 2020, the Company's PCR and antibody COVID-19 testing (COVID-19 Testing) has helped to more than offset the pressure experienced in the Base Business.
COVID-19 Outlook
COVID-19 has had, and continues to have, an extensive impact on the global health and economic environments. The Company is closely monitoring the impact of the COVID-19 pandemic on all aspects of the business, given the continued unpredictability and the corresponding government restrictions and customer behavior.
While the Company anticipates that COVID-19 will continue to have a significant impact on its business through 2021 and potentially beyond, the Company expects that the rollout of COVID-19 vaccines will likely lead to a gradual decline in the demand for COVID-19 Testing. As a result, COVID-19 Testing demand is not predicted to match 2020 levels. However, the Company believes that other diagnostic testing should continue to expand, and both COVID-19 and non-COVID-19 drug development activity is expected to grow in 2021.
Capital Allocation
The Company believes it has a strong track record of deploying capital to investments that enhance the Company's business and return capital to shareholders.
During 2020, the Company invested $267.6 million in strategic business acquisitions. The acquisitions have expanded the Company’s service offerings, expanded its customer and revenue mix, and strengthened and broadened the scope of its geographic presence. The Company continues to evaluate acquisition opportunities that leverage the Company’s core
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competencies, complement existing scientific and technological capabilities, increase the Company’s presence in key geographic, therapeutic and strategic areas, and meet or exceed the Company’s financial criteria.
During 2020, the Company purchased 0.6 million shares of its common stock at an average price of $178.85 for a total cost of $100.0 million. After making these purchases in the first quarter, the Company temporarily suspended its share repurchase program as a part of the fiscal measures it took in response to the uncertainty of the COVID-19 pandemic, to preserve liquidity and financial flexibility. The Company reinstated its share repurchase program in the fourth quarter but made no additional purchases in 2020. At the end of 2020, the Company had a remaining authorization with no expiration date to purchase an additional $800.0 million of Company common stock.
During 2020, capital expenditures were $381.7 million and the Company also repaid $412.2 million of its Senior Notes. The Company expects capital expenditures in 2021 to be approximately 4.0% of revenues, primarily in connection with projects to support growth in the Company's core businesses, facility expansion and updates, projects related to both ongoing and new LaunchPad initiatives, and further acquisition integration initiatives.
The Company will continue to evaluate all opportunities for strategic deployment of capital in light of market conditions.
Seasonality and External Factors
The Company experiences seasonality across its business. For example, testing volume generally declines during the year-end holiday period and other major holidays and can also decline due to inclement weather or natural disasters. Declines in testing volume reduce revenues, operating margins and cash flows. Operations are also impacted by changes in the global economy, exchange rate fluctuations, political and regulatory changes, the progress of ongoing studies and the startup of new studies, as well as the level of expenditures made by the biopharmaceutical industry in R&D. In 2020, as discussed in more detail elsewhere in Item 1, COVID-19 had significant impact on the Company. This impact included both the effect of the Company’s response to the virus through its testing and drug development services and the effect of COVID-19 on the global economy and how that affected demand for the Company’s non-COVID-19 services.
In 2020, approximately 10.7% of the Company's revenues were billed in currencies other than the U.S. dollar, with the Swiss franc, British pound, Canadian dollar, and the euro representing the largest components of its currency exposure. Given the seasonality and changing economic factors impacting the business, comparison of the results for successive quarters may not accurately reflect trends or results for the full year.
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 Annual Report, which include additional financial information about the Company. This Annual 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. Risk Factors
Investors should carefully consider all of the information set forth in this Annual 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.
Risks Related to the COVID-19 Pandemic
The effects of the outbreak of the COVID-19 pandemic could have material adverse impacts on the Company’s business, results of operations, cash flows, and financial position.
The Company is closely monitoring the impact of the COVID-19 pandemic on all aspects of its business. In the second half of March 2020, daily volume for routine tests started to decline as a result of decreased consumer demand driven by a significant reduction in physician office visits, the cancellation of elective medical procedures, and the negative impacts on discretionary spending resulting from the economic downturn, among other factors. In addition, the performance of the Company’s drug development business was challenged by COVID-19 due to actions that clients have taken and are taking that slowed clinical trial progress and the associated testing as well as restrictions in trial site access in certain countries and interruptions in the supply chain. Given the continued unpredictability pertaining to the COVID-19 pandemic and the corresponding government restrictions and customer behavior, the impact on the Company's business continues to be uncertain and depends on a number of evolving factors that the Company may not be able to predict or effectively respond to.
The further spread of COVID-19, including the rise of variants, and the Company’s initiatives to help limit the spread of the illness, will impact the Company’s ability to carry out its business as usual, which could materially adversely impact its business and financial condition. The Company has incurred additional costs in order to provide for the safety of its employees and the continuity of its operations, including increased frequency of deep cleaning and sanitation at each of its physical locations, additional safety training and processes, enhanced hygiene practices and materials, flexible and remote working where possible, and allowing for greater social distancing for the Company’s employees who must work on-site. Additionally, the Company has made a number of changes at the Company’s patient service centers for the comfort and safety of the patients, many of which have also increased costs for the Company. For example, the Company has set aside the first business hour of every day for vulnerable patients, launched a mobile check-in process that allows patients to wait for their appointment from within their car or other nearby location, and increased sanitation and disinfection in check-in areas, waiting rooms, bathrooms, and hallways with CDC-approved disinfectants.
The Company faces increased cybersecurity risks due to the number of employees that are working remotely in regions impacted by stay-at-home orders. Increased levels of remote access create additional opportunities for cybercriminals to exploit vulnerabilities, and employees may be more susceptible to phishing and social engineering attempts. The Company may also be subject to increased cyber-attacks, such as phishing attacks by threat actors using the attention placed on the pandemic as a method for targeting the Company's personnel. In addition, technological resources may be strained due to the number of remote users.
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Adverse changes in government and third-party payer regulations, reimbursement, or coverage policies (or in the interpretation of current regulations) relating to COVID-19 testing could materially impact the Company's results of operations, cash flows and financial position.
The Company expects to continue to incur additional costs, which may be significant, as it continues to implement operational changes in response to this pandemic. Further, the COVID-19 outbreak has disrupted and could continue to disrupt the Company’s supply chain, including by impacting its ability to secure test collection supplies, equipment and testing supplies for its facilities, personal protective equipment for its employees in its testing locations, patient service centers, and drug development clinics. For similar reasons, the COVID-19 pandemic has also adversely impacted, and may continue to adversely impact, third parties that are critical to the Company’s business, including vendors, suppliers, and business partners. These developments, and others that are difficult or impossible to predict, could materially impact the Company’s business, financial results, cash flows, and financial position.
During 2020, the Company diverted resources to developing and enhancing the accessibility of COVID-19 testing, while at the same time taking certain steps with respect to its business strategy in order to increase cash flexibility. For example, the Company temporarily suspended its share repurchase program, applied a heightened threshold to acquisition activity, and delayed some of its non-COVID-19 related capital expenditures. These measures, and any other measures the Company has taken and will continue to take to mitigate COVID-19, may be insufficient to ensure the financial stability of the Company, or may have other adverse impacts on the Company’s business, results of operations, cash flows, and financial position. Additionally, if the pandemic continues for an extended period of time, the Company may be forced to prioritize its application of resources to the continued mitigation of COVID-19, at the expense of other potentially profitable opportunities or initiatives, such as through the development of new products or selected business acquisitions.
If the Company does not respond appropriately to the ongoing COVID-19 pandemic, or if the Company’s customers do not perceive its response to be adequate, the Company could suffer damage to its reputation, which could adversely affect its business.
On March 11, 2020, the outbreak of COVID-19 was declared a global pandemic and containment and mitigation measures were recommended; six days prior to this characterization, the Company announced the availability of its Labcorp 2019 Novel Coronavirus (COVID-19) PCR test, which detects the presence of the underlying virus that causes COVID-19, for use with patients who meet current guidance for evaluation of infection with COVID-19. On April 9, 2020, the Company announced an agreement to collaborate on a comprehensive U.S.-based COVID-19 patient data registry. The Company also launched a self-collection kit for its COVID-19 PCR test under an emergency use authorization from the FDA, expanded availability of antibody tests to detect antibodies to the virus that causes COVID-19, and launched a series of innovations to increase test capacity, throughput, and efficiency to maximize the use of supplies. The Company performed approximately 35 million COVID-19 tests in 2020, which represents about 31 million PCR tests and over 4 million antibody tests. As of February 25, 2021, the Company has the capacity to perform 275,000 PCR tests per day, but the Company's testing capacity is dependent on access to multiple testing platforms and the availability of equipment and testing supplies and key personnel. The Company's central laboratory business has also seen a significant increase in demand for sample collection supplies and kits and for clinical trials testing, which has put some pressure on the Company's supply chain and caused some delays in delivery of kit orders and clinical trial testing result delivery. Despite the Company's efforts to obtain adequate clinical trial kit and testing supplies and expand its capacity to make clinical trials collection kits and perform clinical trials testing, the Company may not be successful in meeting the increased demand, and the Company’s customers and other stakeholders may perceive the Company’s responses to the pandemic as insufficient, inadequate or not equivalent to or better than competitors, including with respect to the availability of testing, collection kits, and the amount of time it takes for delivery of test results or fulfillment of kit orders. Factors that may be out of the Company’s control, such as the availability of equipment, supplies, and key personnel and geographical changes in demand, may impact the Company’s ability to meet customer demand and the Company's other responses to the COVID-19 pandemic, and may have an adverse effect on the Company’s operations. Any such disruptions could result in negative publicity, and the Company could suffer damage to its reputation, which could adversely affect its business, results of operations, cash flows, and financial position.
The success of the Company is dependent in part on the efforts of its management team and employees, and the COVID-19 pandemic could divert or hinder the Company’s human capital resources, which may adversely affect the Company’s operations.
The Company’s management team and employees have been acutely focused on efforts to respond to and mitigate COVID-19, including developing COVID-19 Testing. The Company has been continuously working to increase the number of tests that can be performed and improve the time for delivering test results. The Company’s management team is also working closely with federal and state authorities, health officials, and other key constituencies to make testing available to patients who meet the CDC criteria for who should be tested, and HHS guidance for prioritization of testing. These response efforts have required, and will continue to require, a large investment of time and resources that would otherwise be focused on the
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development and growth of the Company. Further, the Company's ability to maintain and expand testing capacity depend upon maintaining and expanding its employee population. If the Company’s management team or employees become unavailable due to illness or from other related factors, its operations could be materially adversely affected.
The ongoing COVID-19 pandemic has created significant volatility, uncertainty, and economic disruption that could have an adverse impact on the Company’s financial position.
While the Company believes that it maintains a solid financial position, including a strong balance sheet, investment grade ratings, and significant access to credit, the sweeping nature of the ongoing COVID-19 pandemic has created cascading effects, all of which are difficult to predict. The Company may also experience greater than normal impact due to fluctuations in foreign exchange rates and interest rates, decreased sales volumes, changes in employment rates and health insurance coverage, the speed of the anticipated recovery, the ability of its customers to pay for its services, and governmental and business reactions to the pandemic, all of which are highly uncertain and cannot be predicted. In March of 2020, the Company implemented several measures in order to increase cash flexibility in light of these economic uncertainties, including temporarily suspending its share repurchase program, applying a heightened threshold to acquisition activity, and delaying some of its non-COVID-19 related capital expenditures. In October of 2020, the Company reinstituted its share repurchase program. If the pandemic creates further disruptions or turmoil in the credit and financial markets, the Company’s ability to access capital on favorable terms and continue to meet its liquidity needs in the future could be adversely impacted which may have other adverse impacts on the Company’s business, results of operations, cash flows, and financial position.
Risks Related to Regulatory and Compliance Matters
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 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 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 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, may be implemented from time to time. Reimbursement for pathology services performed by Dx 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 Dx'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 Dx'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 authorities may take a contrary position with respect to the Eliminating Kickbacks in Recovery Act, given the 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 CLIA, 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
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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.
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:
•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;
•a patient’s rights to access, amend and receive an accounting of certain disclosures of PHI;
•the content of notices of privacy practices for PHI;
•administrative, technical and physical safeguards required of entities that use or receive PHI; and
•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, including pursuant to an action brought by a private party for the wrongful use or disclosure of health information or other personal information.
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 EU's General Data Protection Regulation (GDPR), which took effect May 25, 2018, created a range of 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. 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 regions where the Company does business, including in Asia, Latin America, 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.
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 potential 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
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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, 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 laws could have a significant adverse effect on the business or results of operations.
Failure to comply with the regulations of pharmaceutical and medical device 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 DD and have a material adverse effect upon the Company.
The operation of DD'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 Annual Report. The business operations of DD’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 DD must comply. If DD does not comply, DD 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 effect upon the Company.
Additionally, certain DD services and activities must conform to current good manufacturing practice (cGMP), as further described in Item 1 of Part I of this Annual Report. Failure to maintain compliance with GLP, GCP, or cGMP 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 DD, including suspension of its laboratory operations, which could have a material adverse effect upon the Company.
Actions of animal rights activists may have an adverse effect on the Company.
DD'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 DD's inventory, harm its reputation, or result in other liability.
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 DD’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 DD’s reputation or have an adverse effect on DD'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 DD and have a material adverse effect upon the Company.
The conduct of animal research at DD’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),
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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 DD conducts animal research, including the EU and China. DD 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 DD’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 DD that may include fines, suspension and/or revocation of animal research licenses, or confiscation of research animals.
U.S. 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. Dx’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 reform 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 CMS, 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 the potential for future increased regulation of the Company’s LDTs in the future 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.
As previously discussed in Item 1 of Part I of this Annual 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.
Risks Related to the Company's Business
General or macro-economic factors in the U.S. and globally may have a material adverse effect upon the Company, and a significant deterioration in the economy could negatively impact testing volumes, drug development services,
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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. For additional risks, see “Risk Factors - Risks Related to the COVID-19 Pandemic” in Part I - Item 1A.
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.
Dx'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, 2020, such capitated contracts accounted for approximately $319.0 million, or 3.4%, of Dx'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 has also experienced delays in the pricing and implementation of coding and billing changes among various payers, including Medicaid, Medicare and commercial carriers. While some delays were expected, payer policy changes in coverage have had a negative impact on revenue, revenue per requisition, and margins and cash flows. In 2020, limited coding and billing changes were implemented beyond those specifically related to COVID-19 Testing. While limited changes are expected to be implemented in 2021, the Company typically expects some delays in pricing and reimbursement as new codes are introduced.
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
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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 Dx cannot offset additional reductions in the payments it receives for 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 Dx, 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 and 2020. For 2018-2020, a test price could not be reduced by more than 10% per year.As a result of provisions included within the CARES Act, PAMA rate reductions for 2021 have been suspended, and therefore the Company will not experience any incremental reimbursement rate impact due to PAMA in 2021. For 2022-2024, 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 2022. Under current law as revised in the CARES Act, the next data reporting period for CDLTs (based on data collected in 2019) will occur during the first quarter of 2022, and new CLFS rates for CDLTs will be established based on that data beginning in 2023, subject to the previously described phase-in limits. The subsequent data reporting period for CDLTs (based on data collected in 2023) will occur during the first quarter of 2025, and new CLFS rates for CDLTs will be established based on that data beginning in 2026. CLFS rates for 2025 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 2020, the Company realized a net reduction in reimbursement of approximately $72.01 million from all payers affected by the CLFS (approximately $107.0 million in 2019). Unless implementation of PAMA is further delayed or changed, an additional reduction of approximately $100.0 million is expected for 2021, 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 DD provides.
DD 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 DD 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 DD’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 CROs, including DD, 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 DD both in the U.S. and other countries. New laws or regulations may create a risk of liability, increase DD costs or limit service offerings through DD.
Increased competition, including price competition, could have a material adverse effect on the Company’s revenues and profitability.
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As further described in Item 1 of Part I of this Annual Report, both Dx and DD 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. Dx 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. DD’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. DD’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 Dx’s and DD’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.
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
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marketing point-of-care of 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 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.
Operations may be disrupted and adversely impacted by the effects of adverse weather, other natural disasters, geopolitical events, public health crises, and other events outside of the Company's control.
Natural disasters, such as adverse weather, fires, earthquakes, power shortages and outages, geopolitical events, 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 ability to utilize 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. For additional risks, see “Risk Factors - Risks Related to the COVID-19 Pandemic” in Part I - Item 1A.
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, cyber attacks, 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.
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
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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.
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. Dx has a well-established base of relationships with those systems and networks, including collaborative agreements. Dx'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.
Unproductive labor environments, 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.
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 depend 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.
Global economic conditions and government and regulatory changes, including, but not limited to, the U.K.'s exit from the European Union (EU) could adversely impact the Company’s business and results of operations.
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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 EU (often referred to as Brexit). The EU and the U.K. reached an agreement in December 2020.
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.
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 services to customers and, therefore, could have a material adverse effect on the Company's financial condition, results of operations, and cash flows.
Risks Related to Financial Matters
The Company bears financial risk for contracts that, including 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 DD’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:
•failure of products to satisfy safety requirements;
•unexpected or undesired results of the products;
•insufficient clinical trial subject enrollment;
•insufficient investigator recruitment;
•a customer's decision to terminate the development of a product or to end a particular study; and
•DD’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 DD.
A significant increase in Dx's or DD'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, Dx 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 administrative policies that can further increase patient costs. Dx expects this trend to continue. A material increase in Dx’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 DD 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 DD’s days sales outstanding could have an adverse effect on the Company’s business, including potentially decreasing its cash flows.
DD’s revenues depend on the biopharmaceutical industry.
DD’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 DD’s customers in these industries may also affect DD. 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, DD could be materially adversely affected.
Foreign currency exchange fluctuations could have an adverse effect on the Company’s business.
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The Company has business and operations outside the U.S., and DD 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, DD 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 DD's results of operations, financial condition and cash flows.
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.
The Company’s level of indebtedness could adversely affect the Company’s liquidity, results of operations and business.
At December 31, 2020, indebtedness on the Company's outstanding Senior Notes totaled approximately $5,450.0 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, 2020. 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.
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:
•changes in the general global economy;
•exchange rate fluctuations;
•the commencement, completion, delay or cancellation of large projects or contracts or groups of projects;
•the progress of ongoing projects;
•weather;
•the timing of and charges associated with completed acquisitions or other events; and
•changes in the utilization 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.
Risks Related to Technology and Cybersecurity
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.
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
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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.
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 are developing and deploying 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
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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 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.
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 cyber attack affecting these third parties, like the AMCA Incident, could also harm the Company's business, results of operations and reputation.
Risks Related to Legal Matters
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 its 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 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.
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.
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Contract research services in the drug development industry create liability risks.
In contracting to work on drug development trials and studies, DD faces a range of potential liabilities, including:
•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;
•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;
•Risks that animals in DD’s facilities may be infected with diseases that may be harmful and even lethal to themselves and humans despite preventive measures contained in DD's business policies, including those for the quarantine and handling of imported animals; and
•Errors and omissions during a trial or study that may undermine the usefulness of a trial or study, or data from the trial or study or that may delay the entry of a drug to the market.
DD 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 DD 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 DD against liability arising from certain of its own actions. DD 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 DD is not successful in limiting its liability or in the event that the damages and costs exceed DD's insurance coverage. DD may also be required to agree to contract provisions with clinical trial sites or its customers related to the conduct of clinical trials, and DD 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 DD will be able to maintain sufficient insurance coverage on acceptable terms.
Item 1B. UNRESOLVED STAFF COMMENTS
None.
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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 (Dx) 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 Dx's principal operating and administrative facilities as of December 31, 2020.
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
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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Labcorp Drug Development (DD) operates on a global scale. The table below summarizes certain information as to DD's principal operating and administrative facilities as of December 31, 2020.
Location
Nature of Occupancy
Primary Facilities:
Mechelen, Belgium Leased
Beijing, China Leased
Shanghai, China (2) Owned/Leased
Muenster, Germany Owned
Pune, India Leased
Bangalore, India Leased
Singapore Leased
Geneva, Switzerland Owned
Eye, United Kingdom Owned
Harrogate, United Kingdom Owned
Huntingdon, 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. LEGAL PROCEEDINGS
See Note 16 Commitments and Contingencies to the Consolidated Financial Statements.
Item 4. MINE SAFETY DISCLOSURES
Not applicable.
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PART II
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 24, 2021, there were approximately 1,398 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, 2015, in each of the Company’s common stock, the Standard & Poor’s, or S&P Composite-500 Stock Index and the S&P 500 Health Care Index, or Peer Group, and assuming that all dividends were reinvested.
Comparison of 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, 2020, by or on behalf of the Company:
At the end of 2019, the Company had outstanding authorization from the board of directors to purchase $900.0 of Company common stock. During three months ended March 31, 2020, the Company purchased 0.6 shares of its common stock at an average price of $178.85 for a total cost of $100.0. When the Company repurchases shares, 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. The Company reinstated its share repurchase program in October 2020 following the temporary suspension of stock repurchases beginning in March 2020 as a result of the anticipated impact of the COVID-19 pandemic. At the end of 2020, the Company had outstanding authorization from the board of directors to purchase up to $800.0 of the Company's common stock. The repurchase authorization has no expiration date.
Item 6. SELECTED FINANCIAL DATA (in millions, except per share amounts)
Not applicable.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in millions)
General
During the year ended December 31, 2020, the Company's revenues grew by 21.0%, due to organic growth of 19.0%, acquisitions of 1.8% and favorable foreign currency translation of 0.4%, partially offset by the disposition of a business of 0.2%. The 19.0% increase in organic revenues includes the 24.1% contribution from PCR and antibody COVID-19 testing (COVID-19 Testing), partially offset by the 5.1% reduction in the Company's organic Base Business due to the pandemic. Base Business includes the Company's business operations except for COVID-19 Testing. The decline in the organic Base Business includes the negative impact of the U.S. Protecting Access to Medicare Act of 2014 (PAMA) of 0.6%.
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.
In March 2020, COVID-19 was declared a pandemic. COVID-19 has had and continues to have an extensive impact on the global health and economic environments. Given the continued unpredictability of the COVID-19 pandemic and the corresponding government restrictions and customer behavior, there are a wide-range of feasible financial results for 2021. Throughout 2020, the Company's COVID-19 Testing has helped to offset the pressure experienced in the Base Business. To date, the Company has performed more than 18 million PCR and 3.0 million antibody COVID-19 tests and as of February 25, 2021, has the capacity to perform 275,000 PCR and 300,000 antibody tests per day, subject to the availability of equipment and testing supplies and key personnel.
During 2020, the Company recorded goodwill and other asset impairment charges of $462.1, $450.5 within DD and $11.6 within Dx, as a result of the COVID-19 pandemic. The Company concluded that the fair value was less than carrying value for two of its reporting units and recorded goodwill impairment of $418.7 and $3.7 for DD and Dx, respectively. Additional impairment of identifiable intangible and tangible assets of $31.5 and $7.9 was recorded for DD and Dx, respectively, for impairment of a tradename, software, customer relationships, technology assets, and a note receivable.
There remains significant uncertainty regarding the duration and severity of the pandemic and its impact on the Company’s business, results of operations and financial position for 2021. For more information regarding the risks associated with COVID-19 and its impact on the Company’s business, see Risk Factors in Part I - Item 1A. The Company expects Phase II of Dx’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 in 2021, and one-third of the total savings have been realized in each of 2019 and 2020.
PAMA, which went into effect on January 1, 2018, resulted in a net reduction of revenue of approximately $72.0 and $107.0 in 2020 and 2019, respectively from all payers affected by the Clinical Lab Fee Schedule.
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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 2019 results and comparison with 2018 results refer to “Management's Discussion and Analysis of Financial Conditions and Results of Operations” in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2019.
Years ended December 31, 2020 and 2019
Revenues
The 21.0% increase in revenues for the year ended December 31, 2020, as compared with the corresponding period in 2019 was primarily due to organic growth of 19.0%, acquisitions of 1.8% and favorable foreign currency translation of 0.4%, partially offset by the disposition of a business of 0.2%. The 19.0% increase in organic revenues includes the 24.1% contribution from COVID-19 Testing, partially offset by the 5.1% reduction in the Company's organic Base Business, which the Company believes was due to the pandemic. The decline in the organic Base Business includes the negative impact of PAMA of 0.6%.
Dx revenues for the year ended December 31, 2020, were $9,253.4, an increase of 32.2% over revenues of $7,000.1 in the corresponding period in 2019. The increase in revenues was due to organic growth of 30.9% and acquisitions of 1.3%. The 30.9% increase in organic revenue was due to a 39.8% contribution from COVID-19 Testing, partially offset by an 8.9% decline of the organic Base Business which includes a 1.0% negative impact from PAMA.
Total volume, measured by requisitions, increased by 7.8% as organic volume increased by 6.5% and acquisition volume contributed growth of 1.3%. The organic volume growth is due to demand for COVID-19 Testing of 21.2%, partially offset by a 14.7% reduction of organic Base Business. Price/mix increased by 24.4% due to COVID-19 Testing of 18.6% and Base Business of 5.8%. The Base Business price includes the negative impact from PAMA of 1.0%.
DD revenues for the year ended December 31, 2020, were $4,877.7, an increase of 6.5% over revenues of $4,578.1 in the corresponding period in 2019. The increase in revenues was due to the benefit of acquisitions of 2.6%, favorable foreign currency translation of 0.9% and organic growth of 3.5%, partially offset by a business disposition of 0.5%. The increase in organic revenue was primarily driven by COVID-19 PCR testing through its Central Laboratories unit along with broad based demand including COVID-19 vaccine and therapeutic work, partially offset by the negative impact from the pandemic. The pandemic continues to cause delays in clinical trial progression and associated testing, reductions in investigator site access, as well as interruptions to the supply chain.
Cost of Revenues
Cost of revenues (primarily laboratory, labor and distribution costs) increased 8.7% in 2020 as compared with 2019 primarily due to organic growth and acquisitions. Cost of revenues as a percentage of revenues decreased to 64.6% in 2020 as compared to 71.9% in 2019. This decrease was primarily due to the impact of COVID-19 Testing on revenues and LaunchPad savings, partially offset by PAMA and higher personnel costs (primarily driven by merit increases and one additional payroll day that predominantly impacted Dx).
During 2020, the Company incurred special charges of $1.9 of acquisition and divestiture related costs, $36.5 in COVID-related costs, and $1.1 related to miscellaneous other items. Additionally, the Company recorded COVID-19 related accounts receivable reserves of $17.0, which are recorded as a reduction of revenues. Excluding these charges, cost of revenues as a percentage of revenues were 64.2% for the year ended December 31, 2020.
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Labor and testing supplies for the year ended December 31, 2020, comprise approximately 73.0% of the Company’s cost of revenues. Cost of revenues has increased over the two-year period ended December 31, 2020, primarily due to the impact of acquisitions, overall growth in the Company's volume, including COVID-19 Testing, and increases in merit-based labor costs.
Selling, General and Administrative Expenses
Selling, general and administrative expenses as a percentage of revenues decreased to 12.4% in 2020 compared to 14.1% in 2019. The decrease in selling, general and administrative expenses as a percentage of revenues is primarily due to the contribution of COVID-19 Testing on revenues and less acquisition activity.
During 2020, the Company incurred special charges of $28.3 of acquisition and divestiture related costs, $10.4 in COVID-related costs, $14.6 in management transition costs, and $1.3 of non-capitalized costs associated with the implementation of a major system as part of its LaunchPad business process improvement initiative, partially offset by $2.7 related to miscellaneous other items. These items increased selling, general and administrative expenses by $51.9. Excluding these charges, selling, general and administrative expenses as a percentage of revenues were 12.0% for the year ended December 31, 2020. The decrease in selling, general and administrative expenses as a percentage of revenues is primarily due to leveraging the Company's infrastructure on higher revenue, partially offset by a $15.0 initial contribution to establish the Labcorp Charitable Foundation which supports the Company's strategic mission to improve health and improve lives with contributions focused on health and welfare, education and community.
During 2019, the Company incurred special charges of $69.2 of acquisition and divestiture related costs, $15.2 in management transition costs, 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 $11.7 in other miscellaneous items. These items increased selling, general and administrative expenses by $82.9. Excluding these charges, selling, general and administrative expenses as a percentage of revenues were 13.3% for the year ended December 31, 2019.
Goodwill and Other Asset Impairments
During 2020, the Company recorded goodwill and other asset impairment charges of $462.1, $450.5 within DD and $11.6 within Dx. The Company concluded that the fair value was less than carrying value for two of its reporting units and recorded goodwill impairment of $418.7 and $3.7 for DD and Dx, respectively. Additional impairment of identifiable intangible and tangible assets of $31.8 and $7.9 was recorded for DD and Dx, respectively, for impairment of a tradename, software, customer relationships, technology assets and a note receivable.
Amortization Expense
The increase in amortization of intangibles and other assets from 2019 through 2020 primarily reflects the impact of acquisitions partially offset by impairment of intangible assets recorded in fiscal 2020, and includes $27.5 of amortization acceleration of certain intangible assets related to the Covance trade name as a result of the Company's rebranding initiative.
Restructuring and Other Charges
During 2020, the Company recorded net restructuring charges of $40.6; $15.3 within Dx and $25.3 within DD. The charges were comprised of $14.1 in severance and other personnel costs $17.4 for facility, operating lease right-of-use and equipment
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impairments, and $18.9 in facility closures and general integration activities. The charges were offset by the reversal of previously established liability of $0.6 and $9.2 in unused severance costs and facility-related costs, respectively.
During 2019, the Company recorded net restructuring charges of $54.6; $26.7 within Dx and $27.9 within DD. 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.
Interest Expense
The decrease in interest expense for 2020 as compared with the corresponding period in 2019 is primarily due to the repayment of debt and lower interest rates.
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 Dx segment. The decrease in income for 2020 as compared with the corresponding period in 2019 was primarily due to the impairment of an equity method investment and the decreased profitability of the Company's joint ventures.
Other, Net
The change in Other, net for the year ended December 31, 2020, as compared to the year ended December 31, 2019, was primarily due to an increase in the write-off or write down of certain of the Company's investments due to the negative impact of the COVID-19 global pandemic partially offset by lower foreign currency transaction losses. Foreign currency transaction losses of $10.1 and $11.1 were recognized for the years ended December 31, 2020 and 2019, respectively.
Income Tax Expense
In 2020, the Company's effective tax rate of 29.8% was unfavorable as compared to 2019 due to impairment charges which were not deductible and or generated tax assets which require a valuation allowance, and the geographic mix of earnings.
The Company considers substantially all of its foreign earnings to be permanently reinvested overseas.
Operating Results by Segment
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Dx operating income was $2,634.9 for the year ended December 31, 2020, an increase of 142.6% over operating income of $1,086.0 in the corresponding period of 2019 and an increase of 1,300 basis points in operating margin year-over-year. The increase in operating income and margin were primarily due to the increase in COVID-19 Testing and LaunchPad savings, partially offset by a reduction in Base Business (primarily due to the pandemic), higher personnel costs and PAMA. The Company remains on track to deliver approximately $200.0 of net savings from its three-year, Phase II of Dx’s LaunchPad initiative by the end of 2021.
DD operating income was $37.3 for the year ended December 31, 2020, a decrease of 90.9% from operating income of $411.5 in the corresponding period of 2019 and a decrease of 820 basis points in operating margin year-over-year. The decrease in operating income and margin were primarily due to the negative impact of COVID-19, specifically goodwill and other asset impairment of $450.5, and higher personnel costs, partially offset by organic demand, acquisitions, and LaunchPad savings. The Company achieved its goal to deliver $150.0 of net savings from its three-year DD 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 $226.8 for the year ended December 31, 2020, an increase of 35.6% over corporate expenses of $167.3 in the corresponding period of 2019. The increase in corporate expenses in 2020 is primarily due to higher personnel costs, including executive transition costs, COVID-19 related expenses and funding of the Labcorp Charitable Foundation.
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, 2019 compared to the year ended December 31, 2018 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 the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2019.
In summary the Company's cash flows were as follows:
Cash and Cash Equivalents
Cash and cash equivalents at December 31, 2020 and 2019 totaled $1,320.8 and $337.5, 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, 2020, the Company's operations provided $2,135.3 of cash as compared to $1,444.7 in 2019. The $690.6 increase in cash provided from operations in 2020 as compared with the corresponding 2019 period was primarily due to higher cash earnings, partially offset by increased working capital to support growth. Working capital increased primarily due to the increase in accounts receivable and supplies inventory as a result of the revenue growth, offset by increases in income tax payable as a result of a significant increase in taxable income during the fourth quarter and an increase in accrued payroll tax balances due to the deferral of 2020 U.S. payroll taxes as part of the CARES Act stimulus.
Cash Flows from Investing Activities
Net cash used by investing activities for the year ended December 31, 2020 was $643.2 as compared to net cash used by investing activities of $1,283.1 for the year ended December 31, 2019. The $639.9 decrease in net cash used by investing activities for the year ended December 31, 2020, was primarily due to a year over year decrease of $608.4 in cash paid for acquisitions. The Company had proceeds of $7.7 from the sale of assets and disposition of businesses during 2019 in
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comparison to $42.1 during 2020. Capital expenditures were $381.7 and $400.2 for the years ended December 31, 2020 and 2019, respectively. Capital expenditures in 2020 were 2.7% of revenues, primarily in connection with projects to support growth in the Company's core businesses, projects related to LaunchPad, and further DD acquisition integration initiatives. The Company intends to continue to pursue acquisitions to drive 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 2021 to be approximately 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 Dx business, LaunchPad's expansion within the DD business, and further acquisition integration initiatives.
Cash Flows from Financing Activities
Net cash used in financing activities for the year ended December 31, 2020 was $517.4 compared to cash used in financing activities of $252.7 for the year ended December 31, 2019. This movement in cash within financing activities for 2020, as compared to 2019, was primarily a result of $412.2 net financing payments and $100.0 in share repurchases in 2020 compared to $198.5 in net financing receipts more than offset by $450.0 in share repurchases in 2019.
On August 17, 2020 the Company redeemed the remaining $412.2 of its 4.625% Senior Notes due November 15, 2020, using available cash on hand. The Company exited the remaining fixed-to-variable interest rate swap agreement in August 2020, in connection with this redemption and recorded a gain of $1.6 on the extinguishment. The gain was included in Other, net on the Consolidated Statement of Operations.
On June 3, 2019, the Company entered into a new $850.0 term loan facility in addition to the $577.0 balance then outstanding on its existing $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, and to repay $348.3 outstanding under the 2017 term loan credit facility.
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 and $151.7 within 2020.
The Company continues to evaluate its outstanding debt portfolio to take advantage of market conditions that would allow the Company to reduce its interest rate or financing risk and provide a lower long-term borrowing cost.
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 facility and the revolving credit facility at December 31, 2020. In May 2020, in order to obtain increased financial covenant flexibility, the Company and its lenders entered into amendments to the term loan facility and the revolving credit facility to increase the maximum leverage ratio to 5.0x debt to last twelve months EBITDA for the three month periods ending June 30, September 30 and December 31, 2020, and 4.5x for the period ended March 31, 2021. From and including the period ending June 30, 2021, the maximum leverage ratio reverts back to 4.0x. The amendments also provide that during any period in which the Company's leverage ratio exceeds 4.5x debt to last twelve months EBITDA (i) the Company will be prohibited from consummating share repurchases, subject to limited exceptions, (ii) borrowings under the revolving credit facility will accrue interest at a per annum rate equal to, at the Company's election, either a LIBOR rate plus a margin of 1.25% or a base rate plus a margin of 0.25%, (iii) the facility fee that the Company is required to pay on the aggregate commitments under the revolving credit facility will be 0.25% per annum, and (iv) borrowings under the term loan facility will accrue interest at a per annum rate equal to, at the Company's election, either a LIBOR rate plus a margin of 1.175% or a base rate plus a margin of 0.175%. The Company's leverage ratio did not exceed 4.5x debt to last twelve months EBITDA as of December 31, 2020.
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At the end of 2019, the Company had outstanding authorization from the board of directors to purchase up to $900.0 of Company common stock. During 2020, the Company repurchased 0.6 shares of its common stock at an average price of $178.85 for a total cost of $100.0. At the end of 2020, the Company had outstanding authorization from the board of directors to purchase $800.0 of Company common stock. The repurchase authorization has no expiration date.
During 2019, the Company settled notices to convert $8.6 aggregate principal amount at maturity of its zero-coupon subordinated notes due 2021 (the zero-coupon notes) with a conversion value of $16.6. The total cash used for these settlements was $8.2 and the Company also issued 0.1 additional shares of common stock. As a result of these conversions in 2019, the Company also reversed approximately $2.0 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 paid 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 $57.1 and $37.2 reserve for unrecognized tax benefits, including interest and penalties, at December 31, 2020, and 2019, respectively, which is included in Note 14 Income Taxes to Consolidated Financial Statements.
(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, 2020.
(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, 2020, the Company provided letters of credit aggregating approximately $77.4, primarily in connection with certain insurance program which are renewed annually.
The contractual value of the noncontrolling interest put in the Company's Ontario subsidiary totaled $16.2 and $15.8 at December 31, 2020, and 2019, 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.
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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
Dx
Within the Dx segment, a revenue transaction is initiated when Dx 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. Dx 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. Dx considers negotiated discounts and anticipated adjustments, including historical collection experience for the payer portfolio, when sales are recorded.
The following are descriptions of the Dx payer portfolios:
Clients
Client payers represent the portion of Dx’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 Dx’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 Dx’s patient fee schedules, net of any discounts negotiated with physicians on behalf of their patients. Dx 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 Dx’s results of operations in any period presented.
Third-Party
Third-party includes revenue related to MCOs. The majority of Dx's third-party revenue is reimbursed on a fee-for-service basis. These payers are billed at Dx's established list price and revenue is recorded net of contractual discounts. The majority of Dx’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 Dx 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
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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. Dx recognizes revenue monthly, based upon the established capitation rate or anticipated distribution from a capitated pool.
Dx has a formal process to estimate implicit price concessions for uncollectable accounts. The majority of Dx'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 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 collectability 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 Dx's results of operations in any period presented.
DD
The nature of DD’s obligations includes 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 DD'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, DD 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 DD 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.
DD 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, DD 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, DD allocates the contract price to the goods and services based on a customer price list, if available. If a price list is not available, DD will estimate the transaction price using either market prices or an “expected cost plus margin” approach.
While DD 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.
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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 DD of expenses to wind down the study or project, fees earned to date and, in some cases, a termination fee or a payment to DD of some portion of the fees or profits that could have been earned by DD 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 revenue recognition models of the drug development services provided by DD:
Preclinical services include fee-for-service activities such as bioanalytical testing services, and proportional performance activities such as toxicology studies. Revenue for sale of research models is 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, DD 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. DD also provides long-term specimen storage services, for which revenue is recognized using an input-based measure of progress based on costs incurred.
DD 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 is 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 requires 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 DD 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.
DD endeavors to assess and monitor the creditworthiness of its customers to which it grants credit terms in the ordinary course of business. DD 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 accounts 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
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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 of the current year 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 various businesses and related assets for approximately $267.6 in cash (net of cash acquired). The purchase consideration for all acquisitions has been allocated to the estimated fair market value of the net assets acquired, including approximately $121.3 in identifiable intangible assets and a residual amount of non-tax-deductible goodwill of approximately $166.2. 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.
Pension Expense
The Company sponsors both funded and unfunded defined benefit pension plans which provide benefits based on various criteria such as years of service and salary. The Company maintained two plans in the United States, three plans in the United Kingdom and one in Germany.
The two plans in the United States (U.S. Plans) were closed to new entrants and the accrual of service credits at the end of 2009. The U.K. pension plans were closed to new entrants and the accrual of service credits for one plan as of December 31, 2002 and the accrual of service credits for the other two plans as of December 31, 2019. The German plan is closed to new entrants but participants continue to accrue service credits. The U.K. and German plans are aggregated for disclosure as the Non-U.S. Plans.
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 are summarized below:
Weighted average assumptions used to determine net periodic benefit costs are as follows:
Weighted average assumptions used to determine net periodic benefit obligations are as follows:
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 2020 retirement plan expense of $1.9 for the U.S Plans. A one percentage point decrease or increase in the discount rate would have resulted in a respective increase or decrease in 2020 retirement plan expense of $2.1 for the Non-U.S. Plans.
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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 2020 pension expense of $2.5 for the U.S. Plans. A one percentage point increase or decrease in the expected return on plan assets would have resulted in a corresponding change in 2020 pension expense of $4.8 for the Non-U.S. Plans.
Net pension cost for 2020 was $11.0 as compared with $13.8 in 2019. The decrease in pension expense was due to market performance partially offset by lower discount rates. Pension expense for the U.S. Plans is expected to decrease to $6.5 in 2021 primarily due to the impact of strong asset returns in 2020, and the $30.0 contribution made in December 2020, offset by lower discount rates in certain plans. Pension expense for the Non-U.S. Plans is expected to decrease by approximately $0.2 in 2021, primarily due to lower service cost partially offset by a lower discount rate in 2021.
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
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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.
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. Based upon the revised forecasted revenues and operating income following the declaration of the COVID-19 global pandemic, management concluded there was a triggering event and updated its annual 2019 goodwill impairment testing as of March 31, 2020, for certain of its DD and Dx reporting units. Based on the quantitative impairment assessment performed in the same manner as the Company's annual quantitative assessment, the Company concluded that the fair value was less than carrying value for two of its reporting units, including one where the 2019 fair value exceeded carrying value by approximately 10.0%, and recorded a goodwill impairment of $418.7 for the DD segment and $3.7 for the Dx segment.
Management performed its annual goodwill and intangible asset impairment testing as of the beginning of the fourth quarter of 2020. The Company elected to perform the qualitative assessment for goodwill and intangible assets for the domestic Dx reporting units and certain DD reporting units, a quantitative assessment for two of the DD 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 2020, the Company utilized a combination of the market and income approaches to determine the fair value of the DD 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 2020 will
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prove to be accurate predictions of the future, if, for example, (i) the businesses do not perform as projected, (ii) overall economic conditions in 2020 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. Management's impairment analysis for certain reporting units 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 certain reporting units. 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.
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 that 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 10.7% and 12.7% of the Company's revenues for the year ended December 31, 2020 and 2019, 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 2020 and 2019, the most significant 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 2020 by approximately $9.1. Gross accumulated currency translation adjustments recorded as a separate component of shareholders’ equity were $264.1 and $104.4 at December 31, 2020, and 2019, 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, 2020, the Company had 31 open foreign exchange forward contracts with various amounts maturing monthly through January 2021 with a notional value totaling approximately $601.2. 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.
The Company is party to USD to Swiss Franc cross-currency swap agreements with a 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 its 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, 2020, and 2019, the Company had approximately $375.0 and $375.0, respectively, of unhedged variable rate debt under the 2019 term loan credit facility.
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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. The Company exited the remaining fixed-to-variable interest rate swap agreement in August 2020, in connection with the redemption of the remaining $412.2 of its 4.625% Senior Notes due November 15, 2020, and recorded a gain of $1.6 on the extinguishment.
On December 19, 2019, the Company redeemed any remaining outstanding zero-coupon subordinated notes due 2021 (the zero-coupon notes) that had not previously converted.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company required in this item are set forth beginning on page of this Annual Report on Form 10-K.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
Item 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
As of the end of the period covered by this Annual 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 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
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, 2020, 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, 2020. 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
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Treadway Commission (COSO). Based on this assessment, the Company's management determined that, as of December 31, 2020, 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.
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, 2020, as stated in its report, which is included herein immediately preceding the Company’s audited financial statements.
Item 9B. OTHER INFORMATION
None.
PART III
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 2021 (the 2021 Proxy Statement) under the caption Election of Directors. Information regarding executive officers is incorporated by reference to the Company’s 2021 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 2021 Proxy Statement under the captions Corporate Governance and Delinquent Section 16(a) Reports, respectively. Information concerning the Company's code of ethics is incorporated by reference to the Company's 2021 Proxy Statement under the caption Corporate Governance Policies and Procedures.
Item 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to information in the 2021 Proxy Statement under the captions “Executive Compensation” and “Director Compensation.”
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 2021 Proxy Statement under the captions “Security Ownership of Certain Beneficial Holders and Management,” “Compensation Discussion and Analysis” and “Executive Compensation.”
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this item is incorporated by reference to information in the 2021 Proxy Statement under the captions “Board Independence” and “Related Party Transactions.”
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is incorporated by reference to information in the 2021 Proxy Statement under the caption “Fees to Independent Registered Public Accounting Firm.”
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PART IV
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) List of documents filed as part of this Annual 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
3.1 Amended and Restated Certificate of Incorporation of the Company dated May 24, 2001 (incorporated herein by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-3, filed with the Commission on October 19, 2001, File No. 333-71896).
3.2 Amended and Restated By-Laws of the Company, adopted and effective July 7, 2020 (incorporated by reference herein to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2020. and Restated By-Laws of the Company.
4.1 Specimen of the Company’s Common Stock Certificate (incorporated herein by reference to Exhibit 4.1 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001).
4.2 Indenture, dated as of November 19, 2010, between the Company and U.S. Bank National Association, as trustee (incorporated herein by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on November 19, 2010).
4.3 Second Supplemental Indenture, dated as of November 19, 2010, between the Company and U.S. Bank National Association, as trustee, including the form of the 2020 Notes (incorporated herein by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K filed on November 19, 2010).
4.4 Third Supplemental Indenture, dated as of August 23, 2012, between the Company and U.S. Bank National Association, as trustee, including the form of the 2017 Notes (incorporated herein by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on August 23, 2012).
4.5 Fourth Supplemental Indenture, dated as of August 23, 2012, between the Company and U.S. Bank National Association, as trustee, including the form of the 2022 Notes (incorporated herein by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K filed on August 23, 2012).
4.6 Fifth Supplemental Indenture, dated as of November 1, 2013, between the Company and U.S. Bank National Association, as trustee, including the form of the 2018 Notes (incorporated herein by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on November 1, 2013).
4.7 Sixth Supplemental Indenture, dated as of November 1, 2013, between the Company and U.S. Bank National Association, as trustee, including the form of the 2023 Notes (incorporated herein by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K filed on November 1, 2013).
4.8 Seventh Supplemental Indenture, dated as of January 30, 2015, between the Company and U.S. Bank National Association, as trustee, including the form of the 2020 Notes (incorporated herein by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on January 30, 2015).
4.9 Eighth Supplemental Indenture, dated as of January 30, 2015, between the Company and U.S. Bank National Association, as trustee, including the form of the 2022 Notes (incorporated herein by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K filed on January 30, 2015).
4.10 Ninth Supplemental Indenture, dated as of January 30, 2015, between the Company and U.S. Bank National Association, as trustee, including the form of the 2025 Notes (incorporated herein by reference to Exhibit 4.4 to the Company’s Current Report on Form 8-K filed on January 30, 2015).
4.11 Tenth Supplemental Indenture, dated as of January 30, 2015, between the Company and U.S. Bank National Association, as trustee, including the form of the 2045 Notes (incorporated herein by reference to Exhibit 4.5 to the Company’s Current Report on Form 8-K filed on January 30, 2015).
4.12 Eleventh Supplemental Indenture, dated as of August 22, 2017, between the Company and U.S. Bank National Association, as trustee, including the form of the 2024 Notes (incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on August 22, 2017).
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4.13 Twelfth Supplemental Indenture, dated as of August 22, 2017, between the Company and U.S. Bank National Association, as trustee, including the form of the 2027 Notes (incorporated by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K filed on August 22, 2017).
4.14 Thirteenth Supplemental Indenture, dated as of November 25, 2019, between the Company and U.S. Bank National Association, as trustee, including the form of the 2024 Notes (incorporated herein by reference to Exhibit 4.2 to the Company's Current Report on Form 8-K filed on November 25, 2019).
4.15 Fourteenth Supplemental Indenture, dated as of November 25, 2019, between the Company and U.S. Bank National Association, as trustee, including the form of the 2029 Notes (incorporated herein by reference to Exhibit 4.3 to the Company's Current Report on Form 8-K filed on November 25, 2019).
4.16* Description of the Registrant's securities registered pursuant to Section 12 of the Securities Exchange Act of 1934.
10.1+
National Health Laboratories Incorporated Pension Equalization Plan (incorporated herein by reference to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1992).
10.2+
Laboratory Corporation of America Holdings Amended and Restated New Pension Equalization Plan (incorporated herein by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2004).
10.3+
First Amendment to the Laboratory Corporation of America Holdings Amended and Restated New Pension Equalization Plan (incorporated herein by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2004).
10.4+
Second Amendment to the Laboratory Corporation of America Holdings Amended and Restated New Pension Equalization Plan (incorporated herein by reference to Exhibit 10.4 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004).
10.5+
Laboratory Corporation of America Holdings Deferred Compensation Plan (incorporated herein by reference to Exhibit 10.22 the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004).
10.6+
First Amendment to the Laboratory Corporation of America Holdings Deferred Compensation Plan (incorporated herein by reference to Exhibit 10.23 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004).
10.7+
Second Amendment to the Laboratory Corporation of America Holdings Deferred Compensation Plan (incorporated herein by reference to Exhibit 10.8 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2005).
10.8+
Third Amendment to the Laboratory Corporation of America Amended and Restated New Pension Equalization Plan (incorporated herein by reference Exhibit 10.6 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2005).
10.9+
Third Amendment to the Laboratory Corporation of America Holdings Deferred Compensation Plan (incorporated herein by reference to Exhibit 10.28 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006).
10.10+
Fourth Amendment to the Laboratory Corporation of America Holdings Deferred Compensation Plan (incorporated herein by reference to Exhibit 10.34 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007).
10.11+
Laboratory Corporation of America Holdings 2008 Stock Incentive Plan (incorporated herein by reference to Annex III to the Company’s Definitive Proxy Statement on Schedule 14A filed on March 25, 2008).
10.12+
Amendment to Laboratory Corporation of America Holdings 2008 Stock Incentive Plan (incorporated herein by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on May 7, 2008).
10.13+
Laboratory Corporation of America Holdings 2012 Omnibus Incentive Plan (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on May 2, 2012).
10.14 Second Amended and Restated Credit Agreement, dated as of September 15, 2017, (originally dated as of December 21, 2011), among the Company, Bank of America, N.A. as Administrative Agent, Swing Line Lender and L/C Issuer, Wells Fargo Bank, National Association as Syndication Agent and L/C Issuer, Credit Suisse AG, Cayman Islands Branch as Documentation Agent and L/C Issuer, the Bank of Tokyo-Mitsubishi UFJ, LTD., Barclays Bank PLC, Credit Suisse AG, Cayman Islands Branch, KeyBank National Association, PNC Bank, National Association, TD Bank, N.A., and U.S. Bank National Association, as Documentation Agents, Merrill Lynch, Pierce, Fenner & Smith Incorporated, Wells Fargo Securities, LLC and Credit Suisse Securities (USA) LL as Joint Lead Arrangers and Joint Book Managers, and the lenders named therein (incorporated herein by reference to Exhibit 10.3 to the Company’s Annual Report on Form 10-Q filed on November 2, 2017).
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10.15 Amendment No. 1, dated as of May 7, 2020, to the Second Amended and Restated Credit Agreement, dated September 15, 2017 (originally dated as of December 21, 2011), among the Company, Bank of America, N.A. as administrative agent, and the lenders party thereto (incorporated herein by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q filed on May 8, 2020).
10.16+
Laboratory Corporation of America Holdings 2016 Omnibus Incentive Plan (incorporated by reference herein to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on May 16, 2016).
10.17+
Laboratory Corporation of America Holdings 2016 Employee Stock Purchase Plan (incorporated by reference herein to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on May 16, 2016).
10.18 Term Loan Credit Agreement, dated June 3, 2019, by and among Laboratory Corporation of America Holdings, Bank of America, N.A., as administrative agent, and the lenders party thereto (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on June 3, 2019).
10.19 Amendment No. 1, dated as of May 7, 2020, to the Term Loan Credit Agreement, dated June 3, 2019, among the Company, Bank of America, N.A. as administrative agent, and the lenders party thereto. (incorporated herein by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on May 8, 2020).
10.20+
Executive Employment Agreement, dated June 4, 2019, by and between Laboratory Corporation of America Holdings and Adam H. Schechter (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on June 5, 2019).
10.21*+
Amended and Restated Master Senior Executive Severance Plan.
16.1 Letter of PricewaterhouseCoopers LLP, dated November 5, 2020 (incorporated by reference to Exhibit 16.1 to the Company’s Current Report on Form 8-K filed on November 5, 2020).
21* List of Subsidiaries of the Company
23.1* Consent of PricewaterhouseCoopers LLP, an independent registered public accounting firm
24.1* Power of Attorney of Kerrii B. Anderson
24.2* Power of Attorney of Jean-Luc Bélingard
24.3* Power of Attorney of Jeffrey A. Davis
24.4* Power of Attorney of D. Gary Gilliland, M.D., Ph.D.
24.5* Power of Attorney of Garheng Kong, M.D., Ph.D.
24.6* Power of Attorney of Peter M. Neupert
24.7* Power of Attorney of Richelle P. Parham
24.8* Power of Attorney of R. Sanders Williams, M.D.
31.1* Certification by the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a)
31.2* Certification by the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a)
32* Written Statement of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350)
101.INS* Inline XBRL Instance Document - The instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH* Inline XBRL Taxonomy Extension Schema
101.CAL* Inline XBRL Taxonomy Extension Calculation Linkbase
101.DEF* Inline XBRL Taxonomy Extension Definition Linkbase
101.LAB* Inline XBRL Taxonomy Extension Label Linkbase
101.PRE* Inline XBRL Taxonomy Extension Presentation Linkbase
104* Cover Page Interactive Data File (embedded within the Inline XBRL document)
* Filed or furnished herewith, as required
+ Management contracts or compensatory plans or arrangements
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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 Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.
LABORATORY CORPORATION OF AMERICA HOLDINGS
Registrant
By: /s/ ADAM H. SCHECHTER
Adam H. Schechter
President and Chief Executive Officer
Dated: February 25, 2021
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Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of the registrant on February 25, 2021 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.
* 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 Annual 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
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, 2020 and 2019, 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, 2020, 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, 2020, 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, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020 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, 2020, 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.
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
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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 (Dx) Net Accounts Receivable
As described in Notes 2 and 7 to the consolidated financial statements, the Dx business’s revenues are distributed among four payer portfolios - clients, patients, Medicare and Medicaid, and third-party. Dx accounts receivable due from these payer portfolios was $1,515.5 million as of December 31, 2020. Management has a formal process to estimate implicit price concessions for uncollectable accounts. Management 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 collectibility of its receivables are considered when determining revenue and the net receivable amount.
The principal considerations for our determination that performing procedures relating to the valuation of Dx net accounts receivable is a critical audit matter are the significant judgment and estimation by management to determine net accounts receivable related to the Dx segment, which led to a high degree of auditor judgment, subjectivity and effort in performing procedures and in evaluating the audit evidence related to the valuation of net Dx 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 Dx net accounts receivable. 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 and collection data 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, Labcorp Drug Development (DD) revenue was $4,877.7 million for the year ended December 31, 2020. Clinical services utilizing the input-based measure of progress account for 50% of DD revenue. The majority of clinical development and commercialization service long-term contracts within the DD segment 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.
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 the significant judgment and estimation by management when developing the costs to complete, including the labor and third party costs to complete the service contracts, which led to a high degree of auditor judgment, subjectivity and effort in performing procedures and in evaluating evidence related to the cost estimates made by management.
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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 estimated costs to complete. These procedures also included, among others, testing management's process for estimating cost to complete the service contracts, testing, for certain 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; and evaluating whether the assumptions used were reasonable by performing a retrospective comparison of current year project costs to historical cost estimates made by management.
Goodwill Impairment Assessment - Two Reporting Units within the DD Segment
As described in Notes 1 and 9 to the consolidated financial statements, the Company’s consolidated goodwill balance was $7,751.5 million as of December 31, 2020, and the goodwill associated with the Company’s DD segment was $3,951.3 million. For the year ended December 31, 2020, the Company recorded goodwill impairment of $418.7 million for one of its reporting units within the DD segment. Management 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. The Company recognizes an impairment charge for the amount by which the reporting unit's carrying amount exceeds its fair value. Fair value of a reporting unit is estimated using both income-based and market-based valuation methods. Management’s impairment analysis for certain reporting units 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 two reporting units within the DD segment is a critical audit matter are the significant judgment by management when developing the fair value estimate of the reporting units, which 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, 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 units. These procedures also included, among others, testing management's process for estimating the fair value of the reporting units 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 selected market multiples, revenue and terminal growth rates, projected operating margin, and the discount rate. 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 (i) the terminal growth rates impacting the reporting units' future cash flows, (ii) the selected market multiple applied to the reporting units' financial information and (iii) the discount rate.
/s/ PricewaterhouseCoopers LLP
Raleigh, North Carolina
February 25, 2021
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 (Labcorp® or the Company) is a leading global life sciences company that provides vital information to help doctors, hospitals, pharmaceutical companies, researchers, and patients make clear and confident decisions. By leveraging its strong diagnostics and drug development capabilities, the Company provides insights and accelerates innovations to improve health and improve lives. With over 72,400 employees, the Company serves clients in more than 100 countries.
The Company reports its business in two segments, Labcorp Diagnostics (Dx) and Labcorp Drug Development (DD). As part of the Company's rebranding initiative announced in December 2020, the Company changed the names of its segments, which were previously referred to as LabCorp Diagnostics and Covance Drug Development. 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 2020, Dx and DD contributed 65% and 35%, respectively, of revenues to the Company, and in 2019 contributed 60% and 40%, 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
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 Company recorded an opening retained earnings adjustment of $7.0 with the adoption of this standard on January 1, 2020.
In August 2018, the FASB issued a new accounting standard to reduce, modify, and add to the disclosure requirements on fair value measurements. The Company adopted this standard effective January 1, 2020. The adoption of this standard did not have a material impact 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 Company adopted this standard effective January 1, 2020. The adoption of this standard did not have a material impact on the consolidated financial statements.
In August 2018, the FASB issued a new accounting standard to modify the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. The Company adopted this standard effective January 1, 2020. The adoption of this standard did not have a material impact on the consolidated financial statements.
Novel Coronavirus (COVID-19) Financial Statement Impact
In March 2020, COVID-19 was declared a pandemic. COVID-19 has had and continues to have an extensive impact on the global health and economic environments. During 2020, the Company recorded goodwill and other asset impairment charges of $462.1, $450.5 within DD and $11.6 within Dx, as a result of the COVID-19 pandemic. The Company concluded that the fair
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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)
value was less than carrying value for two of its reporting units and recorded goodwill impairment of $418.7 and $3.7 for DD and Dx, respectively. Additional impairment of identifiable intangible and tangible assets of $31.8 and $7.9 was recorded for DD and Dx, respectively, for impairment of a tradename, software, customer relationships, technology assets and a note receivable. The Company also impaired certain of the Company's investments by a total of $25.4 during 2020 due to the impact of COVID-19; $7.1 was included in Equity method earnings (loss), net and $18.3 was included in Other, net.
In April 2020, the Company received cash payments of approximately $55.9 from the Public Health and Social Services Emergency Fund for provider relief that was appropriated by Congress to the U.S. Department of Health and Human Services (HHS) in the Coronavirus Aid, Relief, and Economic Security Act (CARES Act Provider Relief Funds). In August 2020, the Company received an additional $76.2 in CARES Act Provider Relief Funds. As the Company's Diagnostic business demonstrated recovery and demand for COVID-19 testing increased, the Company determined that the negative financial impact of COVID-19 which the CARES Act Provider Relief Funds were designed to address no longer applied to the Company. As a result, the Company returned the CARES Act Provider Relief Funds, to the government in the fourth quarter of 2020. There was no impact to the Company's consolidated financial statements as of December 31, 2020 and for the year then ended.
Reimbursable Out-of-Pocket Expenses
DD 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 DD 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, fair value of goodwill and indefinite-lived intangible assets, 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.
The extent to which the COVID-19 pandemic has and will continue to impact the Company’s business and financial results depend on numerous evolving factors including, but not limited to: the magnitude and duration of the COVID-19 pandemic, the impact to worldwide macroeconomic conditions including interest rates, employment rates and health insurance coverage, the speed of the anticipated recovery, and governmental and business reactions to the pandemic. The Company assessed certain accounting matters that generally require consideration of forecasted financial information in context with the information reasonably available to the Company and the unknown future impacts of COVID-19 as of December 31, 2020, and through the date of this Annual Report. The accounting matters assessed included, but were not limited to, the Company’s implicit price concessions and credit losses, equity investments, notes receivable and the carrying value of goodwill and other long-lived assets. The Company’s future assessment of the magnitude and duration of COVID-19, as well as other factors, could result in additional material impacts to the Company’s consolidated financial statements in future reporting periods
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 $1,319.4 and $335.0 at December 31, 2020, and 2019, respectively.
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.
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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)
Although Dx 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 $109.8 and $81.4 at December 31, 2020, and 2019, 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 0.6 and CAD 3.2 at December 31, 2020, and 2019, respectively.
The portion of the Company's accounts receivable due from patients comprises the largest portion of credit risk. At December 31, 2020, and 2019, receivables due from patients represented approximately 13.9% and 21.1% of the Company's consolidated gross accounts receivable, respectively. The Company applies assumptions and judgments including historical collection experience and reasonable and supportable forecasts 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 an 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, 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.
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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)
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 $403.6 and $228.3 and finished goods accounted for $19.6 and $16.4 of total inventory at December 31, 2020, and 2019, respectively. The Company's inventory reserve balance was $20.2 and $0.0, as of December 31, 2020 and 2019, respectively. Once recorded, the reserves are considered permanent adjustments to the carrying value of inventory.
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 that 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. The Company recognizes an impairment charge for the amount by which the reporting unit's carrying amount exceeds its fair value.
Based upon the revised forecasted revenues and operating income following the declaration of the COVID-19 global pandemic, management concluded there was a triggering event and updated its annual 2019 goodwill impairment testing as of March 31, 2020, for certain of its DD reporting units and Dx reporting units. Based on the quantitative impairment assessment performed in the same manner as our annual quantitative assessment, the Company concluded that the fair value was less than carrying value for two of its reporting unit and recorded a goodwill impairment of $418.7 for DD and $3.7 for Dx.
Management performed its annual goodwill and intangible asset impairment testing as of the beginning of the fourth quarter of 2020. The Company elected to perform the qualitative assessment for goodwill and intangible assets for the domestic Dx reporting units and certain DD reporting units, a quantitative assessment for two of the DD 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
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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)
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 the annual 2020 quantitative impairment assessment performed at the beginning of the fourth quarter, the Company utilized a combination of income and market approaches to determine the fair value of two DD 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, as of October 1, 2020, were greater than the carrying values.
Although the Company believes that the current assumptions and estimates used in its goodwill analysis are reasonable, supportable, and appropriate, continued efforts to maintain or improve the performance of these businesses could be impacted by unfavorable or unforeseen changes which could impact the existing assumptions used in the impairment analysis. Various factors could reasonably be expected to unfavorably impact existing assumptions: primarily delays in new customer bookings and the related delay in revenue from new customers, increases in customer termination activity or increases in operating costs. In addition, given the ongoing and rapidly changing nature of the COVID-19 pandemic, there is significant uncertainty regarding the duration and severity of the pandemic as well as any future government restrictions, which may unfavorably impact existing assumptions. Accordingly, there can be no assurance that the estimates and assumptions made for the purposes of the goodwill impairment analysis will prove to be accurate predictions of future performance.
Management's impairment analysis for certain reporting units 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.
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.
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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)
Leases
On January 1, 2019 the Company adopted the new lease accounting standard using the modified retrospective method. Comparative periods were not adjusted and are presented in accordance with the 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. 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. The 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 elected to utilize the short-term lease exemption and not record leases with initial terms of 12 months or less on the balance sheet. 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. 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. See Note 5 Leases to the Consolidated Financial Statements.
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.
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).
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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)
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 August 2018, the FASB issued a new accounting standard to reduce, 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 adoption of this standard is not expected 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 adoption of this standard is not expected to have a material impact 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. The standard is effective January 1, 2021. The adoption of this standard is not expected to have a material impact on the consolidated financial statements.
In March 2020, the FASB issued a new accounting standard to provide optional expedients and exceptions if certain conditions are met for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform. The expedients and exceptions in the standard are effective between March 12, 2020, and December 31, 2022. The Company did not elect to apply any of the expedients or exceptions for the period ended December 31, 2020, and is currently evaluating the impact this new standard will have on the consolidated financial statements.
In August 2020, the FASB issued a new accounting standard to address issues identified as a result of the complexity associated with applying generally accepted accounting principles for convertible instruments and contracts in an entity's own equity. The standard is effective January 1, 2022, with early adoption permitted. The Company is evaluating the impact this new standard will have on the consolidated financial statements.
2. REVENUES
Description of Revenues
Dx attributes revenues to a geographical region based upon where the diagnostic test is performed, while DD attributes revenues to a geographical region based upon where the services are performed. The Company's revenue by segment payers/customer groups for the years ended December 31, 2020, 2019 and 2018 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)
Revenues in the U.S. were $11,192.3 (80.1%), $8,981.3 (77.7%) and $8,843.5 (78.0%) for the years ended December 31, 2020, 2019 and 2018.
The following is a description of the current revenue recognition policies of the Company:
Dx
Dx 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, Dx also offered a range of other testing services.
Within the Dx segment, a revenue transaction is initiated when Dx 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. Dx 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. Dx considers negotiated discounts and anticipated adjustments, including historical collection experience for the payer portfolio, when sales are recorded.
The following are descriptions of the Dx payer portfolios:
Clients
Client payers represent the portion of Dx’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 Dx’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 Dx’s patient list fee schedules, net of any discounts negotiated with physicians on behalf of their patients. Dx 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 Dx’s results of operations in any period presented.
Third-Party
Third-party includes revenue related to MCOs. The majority of Dx's third-party revenue is reimbursed on a fee-for-service basis. These payers are billed at Dx's established list price and revenue is recorded net of contractual discounts. The majority of Dx’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 Dx’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 Dx 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. Dx recognizes revenue monthly, based upon the established capitation rate or anticipated distribution from a capitated pool.
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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)
DD
DD is a CRO business that provides end-to-end drug development services from early-stage research to clinical trial management and beyond. DD provides these services predominantly to biopharmaceutical and medical device companies worldwide. Because DD's client base generally consumes these drug development services across the entire portfolio of DD pre-clinical and clinical services offerings, there is little variability in the customer base of any particular DD service offering. The nature of DD’s obligations includes 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 DD’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, DD 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 DD 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.
DD 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, DD 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, DD allocates the contract price to the goods and services based on a customer price list, if available. If a price list is not available, DD will estimate the transaction price using either market prices or an “expected cost plus margin” approach.
While DD 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
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
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 DD of expenses to wind-down the study or project, fees earned to date and, in some cases, a termination fee or a payment to DD of some portion of the fees or profits that could have been earned by DD 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 DD:
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, DD 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. DD also provides long-term specimen storage services, for which revenue is recognized using an input-based measure of progress based on costs incurred.
DD 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
DD 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.
DD 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.
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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)
Amortization related to sales commission assets and associated payroll taxes for the year ended December 31, 2020, 2019, and 2018 was $23.2, $21.2 and $16.9, respectively. Amortization related to deferred contract fulfillment costs for the years ended December 31, 2020, 2019 and 2018 was $10.1, $8.7 and $4.4, 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 contractual milestones, whereas unbilled receivables are billable upon the passage of time. While DD 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 DD 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, 2020, and 2019, was $262.6 and $250.2, respectively.
Credit Loss Rollforward
With the adoption of the current expected credit loss standard in 2020, the Company estimates future expected losses on accounts receivable, unbilled services and notes receivable over the remaining collection period of the instrument. The rollforward for the allowance for credit losses for the year ended December 31, 2020, is as follows:
Notes and other receivables includes the $70.0 due 2022 from the Envigo transaction which is recorded in Other assets, net.
Performance Obligations Under Long-Term Contracts
Long-term contracts at the Company consist primarily of fully managed clinical studies within the DD segment. The amount of existing performance obligations under such long-term contracts unsatisfied as of December 31, 2020, and 2019, was $5,128.4 and $4,520.8, respectively. The Company expects to recognize approximately 26.0% of the remaining performance obligations as of December 31, 2020, 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 DD, revenue of $80.9 and $88.9 was recognized during the year ended December 31, 2020, and December 31, 2019, 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.
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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)
3. BUSINESS ACQUISITIONS AND DISPOSITIONS
During the year ended December 31, 2020, the Company acquired various businesses and related assets for approximately $267.6 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 $121.3 in identifiable intangible assets and a residual amount of non-tax-deductible goodwill of approximately $166.2. 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 2020 for these businesses is included below:
Unaudited Pro Forma Information for 2020 Acquisitions
Had the aggregate of the Company's 2020 acquisitions been completed as of January 1, 2019, the Company's pro forma results would have been as follows:
On June 3, 2019, the Company's DD segment acquired Envigo's nonclinical contract research services business, expanding DD's global nonclinical drug development capabilities with additional locations and resources. Additionally, the Company divested the CRP business, which was a part of the DD segment, to Envigo. As part of this sale, DD 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 the new term loan facility entered into in 2019 concurrently with the transaction.
The final valuation of acquired assets and assumed liabilities as of June 3, 2019, include the following:
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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 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 $376.6. 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.
During the year ended December 31, 2019, in addition to the Envigo transaction, the Company acquired various businesses and related assets for approximately $286.4 in cash (net of cash acquired). The purchase consideration for all acquisitions 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. 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.
Unaudited Pro Forma Information for 2019 Acquisitions
Had the aggregate of the Company's 2019 acquisitions been completed as of January 1, 2018, the Company's pro forma results would have been as follows:
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.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
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 for the year ended December 31, 2018, (which includes divested operations through their respective disposal dates).
4. RESTRUCTURING AND OTHER CHARGES
During 2020, the Company recorded net restructuring charges of $40.6; $15.3 within Dx and $25.3 within DD. The charges were comprised of $14.1 in severance and other personnel costs $17.4 for facility, operating lease right-of-use and equipment impairments, and $18.9 in facility closures and general integration activities. The charges were offset by the reversal of previously established liability of $0.6 and $9.2 in unused severance costs and facility-related costs, respectively.
During 2019, the Company recorded net restructuring charges of $54.6; $26.7 within Dx and $27.9 within DD. 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 Dx and $27.6 within DD. The charges were comprised of $40.3 in severance and other personnel costs, $11.8 in facility-related costs primarily associated with general 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.
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 4.9 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 13 years, some of which include options to extend the leases for up to 15 years.
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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 components of lease expense were as follows:
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:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
Rent expense for short term leases with a term less than one year for the years ended December 31, 2020 and 2019 amounted to $6.8 and $10.6, respectively. The Company has variable lease payments that do not depend on a rate index, primarily for purchase volume commitments, which are recorded as variable cost when incurred. Total variable payments for the year ended December 31, 2020 and 2019 were $26.7 and $20.8. As of December 31, 2020, the Company has entered into two 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 2021 with lease terms of three years. Rent expense, which includes rent for real estate, equipment and automobiles under operating leases under ASC 840 amounted to $358.7 for the year ended December 31, 2018.
6. JOINT VENTURE PARTNERSHIPS AND EQUITY METHOD INVESTMENTS
At December 31, 2020, 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, 2020, includes $22.4 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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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
8. PROPERTY, PLANT AND EQUIPMENT, NET
Depreciation expense and amortization of property, plant and equipment was $349.3, $321.5 and $311.5 for 2020, 2019 and 2018, respectively, including software depreciation of $84.7, $90.4, and $92.7 for 2020, 2019 and 2018, respectively.
9. GOODWILL AND INTANGIBLE ASSETS
The changes in the carrying amount of goodwill (net of accumulated amortization) for the years ended December 31, 2020 and 2019 are as follows:
The components of identifiable intangible assets are as follows:
During 2020, the Company recorded goodwill and other asset impairment charges of $462.1, $450.5 within DD and $11.6 within Dx. The Company concluded that the fair value was less than the carrying value for two of its reporting units and recorded goodwill impairment of $418.7 and $3.7 for DD and Dx, respectively. Additional impairment of identifiable intangible and tangible assets of $31.8 and $7.9 was recorded for DD and Dx, respectively, for impairment of a tradename, software, customer relationships, and technology assets.
As part of the rebranding initiative, the Company reduced the estimated useful life of its trade name assets to reflect their anticipated use through December 2021. This change in estimated useful life resulted in accelerated amortization of $27.5 in 2020.
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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 amortizable intangible assets acquired during 2020, and their respective weighted average amortization periods are as follows:
Amortization of intangible assets, including amortization of the Canadian license recorded in other assets, was $275.4, $243.2 and $231.7 in 2020, 2019 and 2018, respectively. The Company recorded purchase accounting adjustments and impairment losses through amortization expense of $0.0, $0.4, and $4.5 in 2020, 2019 and 2018, respectively. Amortization expense of intangible assets is estimated to be $365.5 in fiscal 2021, $220.8 in fiscal 2022, $217.8 in fiscal 2023, $213.2 in fiscal 2024, $200.8 in fiscal 2025, and $2,160.5 thereafter.
10. ACCRUED EXPENSES AND OTHER
11. OTHER LIABILITIES
12. DEBT
Short-term borrowings and current portion of long-term debt at December 31, 2020, and 2019 consisted of the following:
Long-term debt at December 31, 2020, and 2019 consisted of the following:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
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 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, 2020, the effective interest rate on the 2019 Term Loan was 0.95%.
On September 15, 2017, the Company entered into a $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 $80.0 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, 2020, or December 31, 2019. As of December 31, 2020, the effective interest rate on the revolving credit facility was 1.12%. 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, 2020, and December 31, 2019. In May 2020, in order to obtain increased financial covenant flexibility, the Company and its lenders entered into amendments to the term loan facility and the revolving credit facility to increase the maximum leverage ratio to 5.0x debt to last twelve months EBITDA for the three month periods ending June 30, September 30 and December 31, 2020, and 4.5x for the period ended March 31, 2021. From and including the period ending June 30, 2021, the maximum leverage ratio reverts back to 4.0x. The amendments also provide that during any period in which the Company's leverage ratio exceeds 4.5x debt to last twelve months EBITDA (i) the Company will be prohibited from consummating share repurchases, subject to limited exceptions, (ii) borrowings under the revolving credit facility will accrue interest at a per annum rate equal to, at the Company's election, either a LIBOR rate plus a margin of 1.25% or a base rate plus a margin of 0.25%, (iii) the facility fee that the Company is required to pay on the aggregate commitments under the revolving credit facility will be 0.25% per annum, and (iv) borrowings under the term loan facility will accrue interest at a per annum rate equal to, at the Company's election, either a LIBOR rate plus a margin of 1.175% or a base rate plus a margin of 0.175%. The Company's leverage ratio did not exceed 4.5x debt to last twelve months EBITDA as of December 31, 2020.
The Company’s availability of $997.0 at December 31, 2020, 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, the Company settled notices to convert $8.6 aggregate principal amount at maturity of its zero-coupon subordinated notes with a conversion value of $16.6. The total cash used for these settlements was $8.2 and the Company also issued 0.1 additional shares of common stock. As a result of these conversions in 2019, the Company also reversed approximately $2.0 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 had not previously converted.
Senior Notes
On August 17, 2020 the Company redeemed the remaining $412.2 of its 4.625% Senior Notes due November 15, 2020, using available cash on hand. The Company exited the remaining fixed-to-variable interest rate swap agreement in August 2020, in connection with this redemption and recorded a gain of $1.6 on the extinguishment. The gain was included in Other, net on the Consolidated Statement of Operations.
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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)
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.
The scheduled payments of long-term debt at the end of 2020 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. 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, 2020 and 2019.
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
During 2020, the Company purchased 0.6 shares of its common stock at an average price of $178.85 for a total cost of $100.0. 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. At the end of 2020, the Company had outstanding authorization from its board of directors to purchase $800.0 of Company common stock. The repurchase authorization has no expiration date. The Company reinstated its share repurchase program in October 2020 following the temporary suspension of stock repurchases beginning in March 2020 due to the COVID-19 pandemic.
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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)
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:
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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 effective tax rates on earnings before income taxes are reconciled to statutory U.S. income tax rates as follows:
On December 22, 2017, the U.S. Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 118 (SAB 118), which allowed companies one year to finalize the tax accounting for the 2017 enacted Tax Cuts and Jobs Act (TCJA) in its financial statements. Under SAB 118, in 2018 the Company recorded a total tax expense of $45.0, $14.8 related to the TCJA repatriation tax and $30.1 for the remeasurement of deferred taxes.
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 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 $185.2, which expire periodically through 2036, as well as post 2017 carryovers of $0.1 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
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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)
allowance has been provided. The Company has U.S. state tax loss carryforwards of $540.3, which also expire periodically through 2038, and on which a valuation allowance of $340.0 has been provided. In addition to federal and state tax loss carryforwards, the Company has other federal and state attribute carry forwards of $288.6. These attribute carryforwards have indefinite lives and a valuation allowance of $229.6. The Company has foreign tax loss carryforwards of $59.1 which have an indefinite life and on which a valuation allowance of $25.9 has been provided, as well as foreign tax loss carryforwards of $502.9 which expire periodically through 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 increased from $145.4 in 2019 to $167.6 in 2020 primarily due to capital loss disallowances during the year that are not expected to be realized for tax purposes and for Swiss net operating losses not expected to be realized as a result of the finalization of the Envigo acquisition.
Unrecognized income tax benefits were $48.8 and $31.7 at December 31, 2020, and 2019, 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 $8.3 and $5.5 as of December 31, 2020, and 2019, respectively. During the years ended December 31, 2020, 2019 and 2018, the Company recognized $4.4, $2.0 and $1.8, respectively, in interest and penalties expense, which was offset by a benefit from reversing previous accruals for interest and penalties of $3.0, $5.8 and $0.5, respectively. As of December 31, 2020 and 2019 interest expense of $1.4, and $0.8, respectively, was added to accrued interest from the opening balance sheet of an acquisition.
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, 2020, 2019 and 2018:
Also included in the balance of unrecognized tax benefits as of December 31, 2020, 2019 and 2018, are $2.1, $0.0 and $0.0, respectively, of tax benefits that, if recognized, would result in adjustments to other tax accounts, primarily deferred taxes. As of December 31, 2020, 2019 and 2018 there are $46.7, $31.7 and $18.0, respectively, of tax benefits that, if recognized would favorably affect the effective income tax rate.
The Company has substantially concluded all U.S. federal income tax matters for years through 2016. Substantially all material state and local and foreign income tax matters have been concluded through 2014 and 2010, respectively.
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 remit applicable withholding taxes as appropriate. The Company has unremitted earnings and profits of $702.4 and $601.4 that are permanently reinvested in its foreign subsidiaries as of December 31, 2020, and 2019, 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.
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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)
15. STOCK COMPENSATION PLANS
Stock Incentive Plans
In 2016, the shareholders approved the Laboratory Corporation of America Holdings 2016 Omnibus Incentive Plan (the Plan). Under the Plan, as of December 31, 2020, there are 9.4 shares authorized for issuance and 5.4 shares available for grant.
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, and have a contractual exercise period of 10 years 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 2020 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on December 31, 2020.
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, 2020, 2019, and 2018 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 2020, 2019 and 2018, expense related to the Company’s stock option plan totaled $3.4, $5.9 and $3.5, respectively, and is included in selling, general and administrative expenses.
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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)
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 2018 represents a three-year award opportunity for the period 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. A performance share grant in 2020 represents a three-year award opportunity for the period of 2020-2022 and, if earned, vests fully (to the extent earned) in the first quarter of 2023. 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 2020, 2019, and 2018, total restricted stock, restricted stock unit, and performance share compensation expense was $98.1, $91.2 and $80.1, 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, 2020:
As of December 31, 2020, there was $115.5 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 1.8 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 U.S. 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 0.3, 0.2 and 0.2 shares were purchased by eligible employees in 2020, 2019 and 2018, respectively. For 2020, 2019 and 2018, expense related to the Company’s employee stock purchase plan was $10.3, $9.9 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.
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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 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 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 or cash flows 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 cooperated with this request. On January 26, 2021, the Company was notified that a qui tam Petition was pending under seal in the District Court, 250th Judicial District, Travis County, Texas, and that the State of Texas has intervened. The petition remains under seal. If the petition is unsealed and served upon the Company, the Company will vigorously defend the lawsuit.
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
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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)
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 Court held oral arguments on December 9, 2020. 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-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, the 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
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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)
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 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 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.
The Company was served with a shareholder derivative lawsuit, Raymond Eugenio, Derivatively on Behalf of Nominal Defendant, Laboratory Corporation of America Holdings v. Lance Berberian, et al., filed in the Court of Chancery of the State of Delaware on April 23, 2020. The complaint asserts derivative claims on the Company’s behalf against the Company’s board of directors and certain executive officers. The complaint generally alleges that the defendants failed to ensure that the Company utilized proper cybersecurity safeguards and failed to implement a sufficient response to data security incidents, including the AMCA Incident. The complaint asserts derivative claims for breach of fiduciary duty and seeks relief including damages, certain disclosures, and certain changes to the Company’s internal governance practices. On June 2, 2020, the Company filed a Motion to Stay the lawsuit due to its overlap with the multi-district litigation referenced above. On July 2, 2020, the Company filed a Motion to Dismiss. On July 14, 2020, the Court entered an order staying the lawsuit pending the resolution of the multi-district litigation. The lawsuit will be vigorously defended.
Certain governmental entities have requested information from the Company related to the AMCA Incident. The Company received a request for information from the Office for Civil Rights (OCR) of the Department of Health and Human Services. On April 28, 2020, OCR notified the Company of the closure of its inquiry. The Company has also received requests from a multi-state group of state Attorneys General and 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
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars and shares in millions, except per share data)
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 lawsuits 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, the 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. On July 22, 2020, the Court issued an order granting preliminary approval of a settlement resolving all three lawsuits. On November 18, 2020, the Court granted final approval of the settlement and settlement proceeds have been distributed.
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. On March 20, 2020, the Company filed a Motion to Dismiss Plaintiffs' Complaint and to Strike Class Allegations. In August 2020, the Plaintiffs filed an Amended Complaint. The Company will vigorously defend the lawsuit.
On May 14, 2020, the Company was served with a putative class action lawsuit, Jose Bermejo v. Laboratory Corporation of America (Bermejo I) filed in the Superior Court of California, County of Los Angeles Central District, alleging that certain non-exempt California-based employees were not properly compensated for driving time or properly paid wages upon termination of employment. The Plaintiff asserts these actions violate various California Labor Code provisions and Section 17200 of the Business and Professional Code. The lawsuit seeks monetary damages, civil penalties, and recovery of attorney’s fees and costs. On June 15, 2020, the lawsuit was removed to the U.S. District Court for the Central District of California. On June 16, 2020, the Company was served with a Private Attorney General Act lawsuit by the same plaintiff in Jose Bermejo v. Laboratory Corporation of America (Bermejo II), filed in the Superior Court of California, County of Los Angeles Central District, alleging that certain Company practices violated California Labor Code penalty provisions related to unpaid and minimum wages, unpaid overtime, unpaid mean and rest break premiums, untimely payment of wages following separation of employment, failure to maintain accurate pay records, and non-reimbursement of business expenses. The second lawsuit seeks to recover civil penalties and recovery of attorney's fees and costs. On October 28, 2020, the court issued an order staying proceedings in Bermejo II pending resolution of Bermejo I. The second lawsuit seeks to recover civil penalties and recovery of attorney's fees and costs. The Company will vigorously defend both lawsuits.
On August 14, 2020, the Company was served with a Subpoena Duces Tecum issued by the State of Colorado Office of the Attorney General requiring the production of documents related to urine drug testing in all states. The Company is cooperating with this request.
On October 2, 2020, the Company was served with a putative class action lawsuit, Peterson v. Laboratory Corporation of America Holdings, filed in the U.S. District Court for the Northern District of New York, alleging claims for a failure to properly pay service representatives compensation for all hours worked and overtime under the Fair Labor Standards Act, as well as notice and recordkeeping claims under the New York Labor Code. The lawsuit seeks monetary damages, liquidated damages, equitable and injunctive relief, and recovery of attorney's fees and costs. The Company will vigorously defend the lawsuit.
On October 5, 2020, the Company was served with a putative class action lawsuit, Williams v. Labcorp Employer Services, Inc. et al., filed in the Superior Court of California, County of Los Angeles, alleging that certain non-exempt California-based employees were not properly compensated for work and overtime hours, not properly paid meal and rest break premiums, not reimbursed for certain business-related expenses, not properly paid for driving or wait times, and received inaccurate wage statements. The Plaintiff also asserts claims for unfair competition under Section 17200 of the Business and Professional Code. The lawsuit seeks monetary damages, liquidated damages, civil penalties, and recovery of 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
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per-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
Defined Contribution Retirement Plans
The Company has various defined contribution retirement plans (401K Plans). Under these 401K Plans, employees can contribute a portion of their salary to the plan and the Company makes minimum non-elective contributions, discretionary contributions, and matching contributions, depending on the terms of the specific plan. On January 1, 2021, all of the 401K Plans were modified to provide for 100% match of employee contributions up to 5% of their salary. Total expense, for the years ended December 31, 2020, 2019, and 2018, was $141.8, $139.5 and $129.9, respectively.
Defined Benefit Pension Plans
The Company sponsors both funded and unfunded defined benefit pension plans which provide benefits based on various criteria such as years of service and salary. The Company maintained two plans in the United States, three plans in the United Kingdom and one in Germany.
The two plans in the United States (U.S. Plans) were closed to new entrants and the accrual of service credits at the end of 2009. The U.K. pension plans were closed to new entrants and the accrual of service credits for one plan as of December 31, 2002, and the accrual of service credits for the other two plans as of December 31, 2019. The German plan is closed to new entrants but participants continue to accrue service credits. The U.K. and German plans are aggregated for disclosure as the Non-U.S. Plans.
Net Periodic Benefit Costs
The components of the net periodic benefit costs for the defined benefit pension plans are as follows:
Net periodic benefit costs are recorded as a component of Operating income. For the year ended December 31, 2018, the Company recognized a partial plan settlement charge of $7.5 as a component of Other, net.
The amounts recognized in accumulated other comprehensive earnings are as follows:
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Change in Projected Benefit Obligation
The change in the projected benefit obligation as of December 31, 2020, and December 31, 2019, is as follows:
The accumulated benefit obligation as of December 31, 2020 and 2019 was $369.8 and $355.5, respectively for the U.S. Plans and $683.3 and $585.8, respectively for the Non-U.S. Plans. The increase in the projected benefit obligation for the U.S. Plans from December 31, 2019 to December 31, 2020 is primarily due to an increase of $30.8 as a result of discount rate and mortality rate changes partially offset by the net of normal plan progression and experience gains of $16.5. The increase in the projected benefit obligation for the Non-U.S. Plans from December 31, 2019 to December 31, 2020 is primarily due to an increase of $83.2 as a result of discount rate changes and an increase of $25.9 due to foreign currency exchange rate changes, partially offset by the net of normal plan progress and experience gains of $9.8.
Change in Fair Value of Plan Assets
The change in plan assets as of December 31, 2020, and December 31, 2019, is as follows:
Change in Funded Status and Reconciliation of Amounts Recorded in the Balance Sheet
The change in 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, 2020, and December 31, 2019, is as follows:
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Assumptions
Weighted average assumptions used to determine net periodic benefit costs are as follows:
Weighted average assumptions used to determine net periodic benefit obligations are as follows:
The discount rate is determined using the weighted-average yields on high-quality fixed income securities that have maturities consistent with the timing of benefit payments. Lower discount rates increase the size of the benefit obligation and generally increase pension expense in the following year; higher discount rates reduce the size of the benefit obligation and generally reduce subsequent-year pension expense.
The expected return on plan assets is the estimated long-term rate of return that will be earned on the investments used to fund the pension obligations. To determine this rate, the Company considers the composition of plan investments, historical returns earned, and expectations about the future.
The salary increase assumptions are used to estimate the annual rate at which pay of plan participants will grow. If the rate of growth assumed increases, the size of the pension obligations will increase, as will the amount recorded in Accumulated other comprehensive income (loss) in our consolidated Statement of Financial Position and amortized into earnings in subsequent periods.
The Company evaluates other assumptions periodically, such as retirement age, mortality and turnover, and updates them as necessary to reflect our actual experience and expectations for the future. Differences between actual results and assumptions utilized are recorded in Accumulated other comprehensive income each period. These differences are amortized into earnings over the remaining average future service of active participating employees or the expected life of inactive participants, as applicable.
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Plan Assets
The fair values of the assets at December 31, 2020, and 2019, by asset category are as follows:
The fair market value of index funds and pooled investment funds are valued using the net asset value (NAV) unit price provided by the fund administrator. The NAV is based on the value of the underlying assets owned by the fund. The fair value of annuity investments are based on discounted cash flow techniques using unobservable valuation inputs such as discount rates and actuarial mortality tables.
Investment Policies
Plan fiduciaries of various plans set investment policies and strategies, based on consultation with professional advisors, and oversee investment allocation, which includes selecting investment managers and setting long-term strategic targets. The primary strategic investment objectives are balancing investment risk and return and monitoring the plan’s liquidity position in order to meet the near-term benefit payment and other cash needs. Target allocation percentages are established at an asset class level by plan fiduciaries. Target allocation ranges are guidelines, not limitations, and occasionally plan fiduciaries will approve allocations above or below a target range.
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(Dollars and shares in millions, except per share data)
The weighted average asset allocation of the plan assets as of December 31, 2020, by asset category is as follows:
The weighted average target asset allocation of the plan assets is as follows:
Pension Funding and Cash Flows
The Company expects to make approximately $16.5 in required contributions to its defined benefit pension plans during 2021. The Company targets funding the minimum required contributions but may make additional contributions into the pension plans in 2021, depending upon factors such as how the funded status of those plans change or to reduce the administrative costs of the plan.
The estimated benefit payments, which were used in the calculation of projected benefit obligations, are expected to be paid as follows:
Post-employment Retiree Health and Welfare Plan
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 $1.6 and $2.0.
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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 2.3% and 3.2% as of December 31, 2020, and 2019, 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 Deferred Compensation Plans (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 these plans were $89.2 and $76.7 at December 31, 2020, and 2019, respectively. Deferred amounts are the 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, 2020, and 2019 were as follows:
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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, 2020, the carrying value of the noncontrolling interest put increased by $0.4 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 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 Senior Notes, based on market pricing, was approximately $6,121.8 and $6,140.6 as of December 31, 2020, and 2019, 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.
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(Dollars and shares in millions, except per share data)
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. The Company exited the remaining fixed-to-variable interest rate swap agreement in August 2020, in connection with the redemption of the remaining $412.2 of its 4.625% Senior Notes due November 15, 2020, and recorded a gain of $1.6 on the extinguishment. The gain was included in Other, net on the Consolidated Statement of Operations. These derivative financial instruments were accounted for as fair value hedges which increased or decreased the value of the Senior Notes with the offset being recorded as a component of other long-term assets or liabilities, as applicable. As the specific terms and notional amounts of the derivative financial instruments match those of the fixed-rate debt being hedged, the derivative instruments were 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, 2020 and 2019.
Cross Currency Swaps
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 with an aggregate fair value of $26.0 and $14.4 as of December 31, 2020, respectively, are included in other long-term liabilities. These cross currency swaps maturing in 2022 and 2025 with an aggregate fair value of $0.2 and $3.0 as of December 31, 2019, respectively, are included in other long-term assets. 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 $(40.4) for the year ended December 31, 2020, and was recognized as currency translation within the Consolidated Statement of 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, 2020.
The table below presents the fair value of derivatives on a gross basis and the balance sheet classification of those instruments:
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(Dollars and shares in millions, except per share data)
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 gain of $1.6 and $1.6 on the extinguishment of its interest rate swap agreement in the years ended December 31, 2020 and December 31, 2019, respectively, in connection with the redemption 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 year ended December 31, 2018.
20. SUPPLEMENTAL CASH FLOW INFORMATION
21. BUSINESS SEGMENT INFORMATION
The following table is a summary of segment information for the years ended December 31, 2020, 2019, and 2018. 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)