LABCORP HOLDINGS INC. (LH) FY 2021 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in millions)
General
During the year ended December 31, 2021, the Company's revenues grew by 15.3%, due to organic growth of 13.8%, acquisitions of 0.7% and favorable foreign currency translation of 0.9%, partially offset by the disposition of a business of 0.1%. The 13.8% increase in organic revenues includes a 14.0% contribution from Company's organic Base Business and a 0.2% decrease in COVID-19 Testing. Base Business includes the Company's business operations except for COVID-19 Testing.
The Company defines organic growth as the increase in revenue excluding the year over year impact of acquisitions, divestitures, and currency. Acquisition and divestiture impact is considered for a twelve month period following the close of each transaction.
Strategic Review of Company Structure and Capital Allocation Strategy
In March 2021, the Company announced the undertaking of a comprehensive review by its Board and management team of Labcorp's structure and capital allocation strategy. The review reflected the Board's and management team's view that the
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Company's value was not appropriately reflected in its stock price. As a part of this review, the Board and management worked with outside advisors, held extensive discussions with third parties, and considered a wide range of options, including significant acquisitions, divestitures, spinning off businesses, as well as spinning and merging those businesses with strategic partners. Ultimately, the Board unanimously concluded that the Company's existing structure is in the best interest of all stakeholders at this time and represents compelling opportunities to grow and create significant shareholder value. In December 2021, the Company announced the Board's conclusion, as well as actions that the management team and the Board are taking to enhance shareholder returns. These actions include:
•initiating a dividend in the second quarter of 2022, with a target dividend payout ratio of between 15% to 20% of adjusted earnings;
•authorizing a $2,500.0 share repurchase program. As part of this program, $1,000.0 is being repurchased under an accelerated share repurchase plan that is expected to be complete by the end of April 2022. On December 13, 2021, the Company entered into the ASR Agreements with the Financial Institutions to repurchase approximately $1,000.0 in the aggregate of the Common Stock, as part of the Company’s Common Stock repurchase program;
•implementing a new LaunchPad business process improvement initiative, targeting savings of $350.0 over the next three years;
•providing a longer-term outlook in connection with the announcement of the Company's 2021 year-end results in addition to the Company's annual guidance;
•providing additional business insights through enhanced disclosures beginning with Labcorp's results for the first quarter of 2022; and
•continuing a commitment to profitable growth through investments in science, innovation, and new technologies.
Management and the Board are committed to continuing to evaluate all avenues for enhancing shareholder value.
The updated capital allocation plan enables the Company to continue investment in key growth areas, including oncology, Alzheimer's disease, autoimmune disorders, and women's health. This plan is designed to fuel growth through innovation by using Labcorp's unparalleled data and insights to bring scientific advancements—both Labcorp-developed and those of other scientists—to market at scale. It reflects the Board's confidence in the Company's strong balance sheet and cash flow generation profile, as well as the Board's commitment to deploying capital to enhance value for shareholders, patients, providers, and pharmaceutical customers worldwide.
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 2020 results and comparison with 2019 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, 2020.
Years ended December 31, 2021 and 2020
Revenues
| Years Ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | ||||||||
| Dx | $ | 10,363.6 | $ | 9,253.4 | 12.0 | % | ||||
| DD | 5,845.5 | 4,877.7 | 19.8 | % | ||||||
| Intercompany eliminations | (88.2) | (152.6) | (42.2) | % | ||||||
| Total | $ | 16,120.9 | $ | 13,978.5 | 15.3 | % |
The 15.3% increase in revenues for the year ended December 31, 2021, as compared with the corresponding period in 2020 was primarily due to organic growth of 13.8%, acquisitions of 0.7% and favorable foreign currency translation of 0.9%, partially offset by the disposition of a business of 0.1%. The 13.8% increase in organic revenues includes a 14.0% contribution from the Company's organic Base Business and a 0.2% decrease in COVID-19 Testing.
Dx revenues for the year ended December 31, 2021, were $10,363.6, an increase of 12.0% over revenues of $9,253.4 in the corresponding period in 2020. The increase in revenues was due to organic growth of 10.9%, acquisitions of 0.7%, and foreign currency translation of 0.4%. The 10.9% increase in organic revenue was due to a 11.2% contribution from organic Base Business, partially offset by a 0.3% decline in COVID-19 Testing.
Dx total volume, measured by requisitions, increased by 10.9% as organic volume increased by 10.5% and acquisition volume contributed growth of 0.5%. The organic volume growth is due to demand for organic Base Business of 10.5%, partially offset by a 0.1% reduction of COVID-19 Testing. Price/mix increased by 1.1% due to organic Base Business of 0.6%,
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acquisitions of 0.3%, and favorable foreign currency translation of 0.4%, partially offset by a 0.2% decline from COVID-19 Testing.
DD revenues for the year ended December 31, 2021, were $5,845.5, an increase of 19.8% over revenues of $4,877.7 in the corresponding period in 2020. The increase in revenues was due to organic Base Business growth of 19.2%, the benefit of acquisitions of 0.7%, favorable foreign currency translation of 1.8%, partially offset by lower COVID-19 Testing performed through its Central Laboratories business of 1.6% and a business disposition of 0.2%.
Cost of Revenues
| Years Ended December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | ||||||
| Cost of revenues | $ | 10,496.6 | $ | 9,025.7 | 16.3 | % | ||
| Cost of revenues as a % of revenues | 65.1 | % | 64.6 | % |
Cost of revenues increased 16.3% in 2021 as compared with 2020 and increased as a percentage of revenues to 65.1% in 2021 as compared to 64.6% in 2020. This increase was primarily due to COVID-19 Testing partially offset by Base Business recovery.
Selling, General and Administrative Expenses
| Years Ended December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | ||||||
| Selling, general and administrative expenses | $ | 1,952.1 | $ | 1,729.3 | 12.9 | % | ||
| SG&A as a % of revenues | 12.1 | % | 12.4 | % |
Selling, general and administrative expenses as a percentage of revenues decreased to 12.1% in 2021 compared to 12.4% in 2020. The decrease in selling, general and administrative expenses as a percentage of revenues is primarily due to the leveraging of the organic revenue growth and the impact of LaunchPad savings.
During 2021, the Company incurred special charges of $25.1 of acquisition and divestiture related costs, $13.3 in COVID-related costs, $6.3 in management transition costs, $18.2 in retention bonuses, $8.6 of non-capitalized costs associated with the implementation of a major system as part of its LaunchPad business process improvement initiative, and $24.3 related to miscellaneous other items. These items increased selling, general and administrative expenses by $95.8. Excluding these charges, selling, general and administrative expenses as a percentage of revenues were 11.5% for the year ended December 31, 2021. The decrease in selling, general and administrative expenses, excluding the above items, as a percentage of revenues is primarily due to leveraging the Company's infrastructure on higher revenue.
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 in other miscellaneous 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.
Goodwill and Other Asset Impairments
| Years Ended December 31, | |||||||||
|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | |||||||
| Goodwill and other asset impairments | $ | — | $ | 462.1 | N/A |
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. There were no goodwill and other asset impairments for the year ended December 31, 2021.
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Amortization Expense
| Years Ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | ||||||||
| Dx | $ | 117.1 | $ | 104.9 | 11.7 | % | ||||
| DD | 252.5 | 170.5 | 48.0 | % | ||||||
| Amortization of intangibles and other assets | $ | 369.6 | $ | 275.4 | 34.2 | % |
The increase in amortization of intangibles and other assets from 2020 through 2021 primarily reflects the impact of acquisitions partially offset by impairment of intangible assets recorded in fiscal 2020. In addition, amortization acceleration of certain intangible assets related to trade names as a result of the Company's rebranding initiative of $88.4 and $27.5 were recognized for the years ended December 31, 2021 and 2020, respectively.
Restructuring and Other Charges
| Years Ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | ||||||||
| Restructuring and other charges | $ | 43.1 | $ | 40.6 | 6.1 | % |
During 2021, the Company recorded net restructuring charges of $43.1; $18.6 within Dx and $24.5 within DD. The charges were comprised of $16.3 in severance and other personnel costs and $28.0 in facility closures, lease terminations, and general integration activities. The charges were offset by the reversal of previously established liability of $0.4 and $0.8 in unused severance costs and facility-related costs, respectively.
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 and $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.
Interest Expense
| Years Ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | ||||||||
| Interest expense | $ | 212.1 | $ | 207.4 | 2.3 | % |
The increase in interest expense for 2021 as compared with the corresponding period in 2020 is primarily due to the costs of redeeming the 3.20% and 3.75% notes and issuing the new senior notes, partially offset by lower debt and lower cost of debt.
Equity Method Income, Net
| Years Ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | ||||||||
| Equity method income, net | $ | 26.5 | $ | 2.9 | 812.6 | % |
Equity method income, net represents the Company's ownership share in joint venture partnerships along with equity investments in other companies in the health care industry. The increase in income for 2021 as compared with the corresponding period in 2020 was primarily due to the write off or write down of certain of the Company's investments in 2020, which was primarily due to the negative impact of the COVID19 global pandemic, and increased profitability of the Company's joint ventures in 2021.
Other, Net
| Years Ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | ||||||||
| Other, net | $ | 42.5 | $ | (32.1) | 231.8 | % |
The change in Other, net for the year ended December 31, 2021, as compared to the year ended December 31, 2020, was primarily due to investment activity. During the year ended December 31, 2021, the Company recorded investment gains of $61.8 which were partially offset by a loss on a sale of a business of $6.2. During the year ended December 31, 2020, the Company adjusted certain investments due to the negative impact of the COVID-19 global pandemic. In addition, foreign currency transaction losses of $4.4 and $10.1 were recognized for the years ended December 31, 2021 and 2020, respectively.
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Income Tax Expense
| Years Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2021 | 2020 | |||||
| Income tax expense | $ | 747.1 | $ | 662.1 | ||
| Income tax expense as a % of income before tax | 23.9 | % | 29.8 | % |
In 2021, the Company's effective tax rate of 23.9% was favorable as compared to the 2020 tax rate of 29.8%. This was primarily related to impairment charges recorded during 2020 that were not deductible, finalization of tax audits, and the geographic mix of earnings.
Operating Results by Segment
| Years Ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | ||||||||
| Dx operating income | $ | 2,988.5 | $ | 2,634.9 | 13.4 | % | ||||
| Dx operating margin | 28.8 | % | 28.5 | % | 0.3 | % | ||||
| DD operating income | $ | 547.7 | $ | 37.3 | 1,371.0 | % | ||||
| DD operating margin | 9.4 | % | 0.8 | % | 8.6 | % | ||||
| General corporate expenses | $ | (276.7) | $ | (226.8) | 22.0 | % | ||||
| Total operating income | $ | 3,259.5 | $ | 2,445.4 | 33.3 | % |
Dx operating income was $2,988.5 for the year ended December 31, 2021, an increase of 13.4% over operating income of $2,634.9 in the corresponding period of 2020 and an increase of 270 basis points in operating margin year-over-year. The increase in operating income and margin were primarily due to a recovery in the Base Business, partially offset by a decrease in COVID-19 Testing and higher personnel costs. The Company achieved its goal to deliver approximately $200 million of net savings from its three-year Diagnostics LaunchPad initiative by the end of 2021.
DD operating income was $547.7 for the year ended December 31, 2021, an increase of 1,371.0% from operating income of $37.3 in the corresponding period of 2020. The increase was primarily due to goodwill and other asset impairments in 2020, and organic Base Business growth and LaunchPad savings, partially offset by lower COVID-19 Testing and higher personnel costs in 2021. The Company continues to develop and execute new LaunchPad programs to support profitable growth in DD.
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 $276.7 for the year ended December 31, 2021, an increase of 22.0% over corporate expenses of $226.8 in the corresponding period of 2020. The increase in corporate expenses in 2021 is primarily due to higher incentive based compensation resulting from the financial performance of the Company.
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 10 Debt to the Company's Consolidated Financial Statements.
Management’s discussion and analysis of cash flows for the year ended December 31, 2020 compared to the year ended December 31, 2019 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, 2020.
In summary the Company's cash flows were as follows:
| For the Year Ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | 2019 | ||||||||
| Net cash provided by operating activities | $ | 3,109.6 | $ | 2,135.3 | $ | 1,444.7 | ||||
| Net cash used for investing activities | (884.6) | (643.2) | (1,283.1) | |||||||
| Net cash used for financing activities | (2,065.8) | (517.4) | (252.7) | |||||||
| Effect of exchange rate on changes in cash and cash equivalents | (7.3) | 8.6 | 1.8 | |||||||
| Net change in cash and cash equivalents | $ | 151.9 | $ | 983.3 | $ | (89.3) |
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Cash and Cash Equivalents
Cash and cash equivalents at December 31, 2021 and 2020 totaled $1,472.7 and $1,320.8, respectively. Cash and cash equivalents consist of highly liquid instruments, such as time deposits and other money market investments, which have original maturities of three months or less.
Cash Flows from Operating Activities
During the year ended December 31, 2021, the Company's operations provided $3,109.6 of cash as compared to $2,135.3 in 2020. The $974.3 increase in cash provided from operations in 2021 as compared with the corresponding 2020 period was primarily due to higher earnings and favorable working capital.
Cash Flows from Investing Activities
Net cash used by investing activities for the year ended December 31, 2021 was $884.6 as compared to net cash used by investing activities of $643.2 for the year ended December 31, 2020. The $241.4 increase in net cash used by investing activities for the year ended December 31, 2021, was primarily due to a year over year increase of $229.3 in cash paid for acquisitions. The Company had proceeds of 42.1 from the sale of assets and disposition of businesses during 2020 in comparison to $87.3 during 2021. Capital expenditures were $460.4 and $381.7 for the years ended December 31, 2021 and 2020, respectively. Capital expenditures in 2021 were 2.9% of revenues, primarily in connection with projects to support growth in the Company's core businesses. 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 2022 to be approximately 4.0% of revenues, primarily in connection with projects to support growth in the Company's core businesses, facility updates, projects related to LaunchPad, and further acquisition integration initiatives.
Cash Flows from Financing Activities
Net cash used in financing activities for the year ended December 31, 2021 was $2,065.8 compared to cash used in financing activities of $517.4 for the year ended December 31, 2020. This movement in cash within financing activities for 2021, as compared to 2020, was primarily a result of $1,668.5 in share repurchases in 2021 compared to $100.0 in 2020.
On May 26, 2021, the Company issued new senior notes representing $1,000.0 in debt securities and consisting of $500.0 aggregate principal amount of 1.55% senior notes due 2026 and $500.0 aggregate principal amount of 2.70% senior notes due 2031. Interest on these notes is payable semi-annually in arrears on June 1 and December 1 of each year, commencing on December 1, 2021. Net proceeds from the offering of these notes were $989.4 after deducting underwriting discounts and other expenses of the offering. The net proceeds were used to redeem, prior to maturity, the Company's outstanding 3.20% senior notes due February 1, 2022 and 3.75% senior notes due August 23, 2022.
During the second quarter of 2021, the Company entered into fixed-to-variable interest rate swap agreements for its 2.70% senior notes due 2031 with an aggregate notional amount of $500.0 and variable interest rates based on three-month LIBOR plus 1.0706%. These instruments are designated as hedges against changes in the fair value of a portion of the Company's long-term debt. The aggregate fair value of $2.9 at December 31, 2021, was included as a component of other long-term assets and added to the reported value of the senior notes.
On April 30, 2021, the Company amended and restated its revolving credit facility. It 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 $500.0, subject to the agreement of one or more new or existing lenders to provide such additional amounts and certain other customary conditions. 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 0.100% to 0.225%, depending on the Company’s debt ratings. Borrowings under the revolving credit facility will accrue interest at a per annum rate equal to, at the Company’s election, either (x) a LIBOR rate plus a margin ranging from 0.775% to 1.275% or (y) a base rate plus a margin ranging from 0% to 0.275%, in each case, depending on the Company’s debt ratings.
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.
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.
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Under the Company's 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 revolving credit facility at December 31, 2021, and expects that it will remain in compliance with its existing debt covenants for the next twelve months.
During 2021, the Company repurchased 5.2 shares of its Common Stock at an average price of $282.05 for a total cost of $1,668.5, which included $1,000.0 paid in respect of an ASR for which the Company received 80% of the shares calculated at the price at the inception of the Agreements. At the end of 2021, the Company had outstanding authorization from the Board to purchase $1,631.5 of Company common stock. The repurchase authorization has no expiration date.
Credit Ratings
The Company’s investment grade debt ratings from Moody’s and Standard & Poor's (S&P) contribute to its ability to access capital markets.
| Contractual Cash Obligations | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| Payments Due by Period | ||||||||||
| Total | Short-term | Long-term | ||||||||
| Operating lease obligations | $ | 829.5 | $ | 187.0 | $ | 642.5 | ||||
| Contingent future licensing and royalty payments (a) | 41.8 | 6.2 | 35.6 | |||||||
| Purchase obligations | 45.2 | 27.4 | 17.8 | |||||||
| Finance lease obligations | 95.1 | 10.5 | 84.6 | |||||||
| Scheduled interest payments on Senior Notes | 1,662.8 | 181.0 | 1,481.8 | |||||||
| Long-term debt (b) | 5,418.0 | 1.5 | 5,416.5 | |||||||
| Total contractual cash obligations (c) (d) (e) (f) | $ | 8,092.4 | $ | 413.6 | $ | 7,678.8 |
(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 15 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 $58.9 reserve for unrecognized tax benefits, including interest and penalties, at December 31, 2021, which is included in Note 12 Income Taxes to Consolidated Financial Statements.
(d)Excludes amount of debt issuance costs included in the long-term debt balance.
(e)The table does not include obligations related to the Company's ASR Agreements which are discussed in Note 11 Preferred Stock and Common Shareholder's Equity to the Consolidated Financial Statements.
(f)This table does not include obligations for venture fund commitments which totaled $13.2 at December 31, 2021, and are subject to calls from the individual venture funds
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, 2021, the Company provided letters of credit aggregating approximately $79.8, primarily in connection with certain insurance programs which are renewed annually.
The contractual value of the noncontrolling interest put in the Company's Ontario subsidiary totaled $16.3 and $16.2 at December 31, 2021, and 2020, 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 Estimates
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;
•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 revenues 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 performed. Under a capitation pool arrangement, the aggregate value of an established rate per member is distributed based on
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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. DD provides these services predominantly to pharmaceutical, biotechnology and medical device companies worldwide. A majority of DD’s revenues are earned under contracts that range in duration from a few months to many years. These contracts generally take the form of fee-for-service or fixed-price arrangements subject to pricing adjustments based on changes in scope. The total contract value is estimated at the beginning of the contract, and is equal to the amount expected to be billed to the customer. Other payments and billing adjustments may also factor into the calculation of total contract value, such as the reimbursement of out-of-pocket costs and volume-based rebates.
The majority of DD's contracts contain a single performance obligation. For contracts that include multiple performance obligations, DD allocates the contract value 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.
Fee-for-service contracts are typically priced based on transaction volume or time and materials. For volume based contracts the contract value is entirely variable and revenue is recognized as the specific product or service is completed. For services billed based on time and materials, revenue is recognized using the right to invoice practical expedient.
Fixed-price contracts are typically recognized as revenue over time based 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. 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. The estimate of total units of input at completion requires significant judgment and estimates are based on various assumptions of events that often span several years. These estimates are reviewed periodically and any adjustments are recognized on a cumulative catch-up basis in the period they become known.
Contracts are often modified to account for changes in contract specifications and requirements. Generally, when contract modifications create new performance obligations, the modification is considered to be a separate contract and revenue is recognized prospectively. When contract modifications change existing performance obligations, the impact on the existing transaction price and measure of progress for the performance obligation to which it relates is generally recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) on a cumulative catch-up basis.
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.
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 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.
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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. The annual impairment test for goodwill includes an option to perform a qualitative assessment of whether it is more likely than not that a reporting unit's fair value is less than its carrying value. Reporting units are businesses with discrete financial information that is available and reviewed by management. If the Company determines that it is more likely than not that the fair value of a reporting unit is less than its carrying value, then the Company performs the quantitative goodwill impairment test. The Company may also choose to bypass the qualitative assessment for any reporting unit in its goodwill assessment and proceed directly to performing the quantitative assessment. The Company recognizes an impairment charge for the amount by which the reporting unit's carrying amount exceeds its fair value.
In the qualitative assessment, the Company considers 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 is compared to forecasts included in prior quantitative valuations. Based on the results of the qualitative assessment, if the Company concludes that it is not more likely than not that the fair value of the reporting unit is less than its carrying values of the reporting unit, then no quantitative assessment is performed.
The quantitative assessment includes the estimation of the fair value of each reporting unit as compared to the carrying value of the reporting unit. The Company estimates the fair value of a reporting unit using both income-based and market-based valuation methods. The income-based approach is based on the reporting unit's forecasted future cash flows that are discounted to the present value using the reporting unit's weighted average cost of capital. For the market-based approach, the Company utilizes a number of factors such as publicly available information regarding the market capitalization of the Company as well as operating results, business plans, market multiples, and present value techniques. Based upon the range of estimated values developed from the income and market-based methods, the Company determines the estimated fair value for the reporting unit. If the estimated fair value of the reporting unit exceeds the carrying value, the goodwill is not impaired and no further review is required.
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.
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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.
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 its 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 2021. The Company elected to perform the qualitative assessment for goodwill and intangible assets for the domestic Dx reporting units and all of the DD reporting units and a quantitative assessment for the Canadian reporting unit and its indefinite-lived assets consisting of acquired Canadian licenses. Based upon the results of the qualitative and quantitative assessments, the Company concluded that the fair values of each of its reporting units, as of October 1, 2021, 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.