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Laboratory Corporation of America Holdings (LH - Analyst Report) reported third-quarter 2013 adjusted earnings per share of $1.80. The results were a penny ahead of the Zacks Consensus Estimate and up 2.3% year over year.

On a reported basis, after including amortization (14 cents), restructuring and other special charges (3 cents), LabCorp’s net earnings came in at $148.3 million or $1.63 per share in the third quarter of 2013 against net earnings of $148.0 million or $1.53 per share in the year-ago quarter.

Quarter Under Review

Revenues improved 3.0% year over year to $1,462.2 million in the third quarter, surpassing the Zacks Consensus Estimate of $1,451 million. Although the company witnessed a 5.1% increase in testing volume (measured by requisitions), poor revenue per requisition (down 1.9% year over year) reflects government payment reductions and payment issues related to molecular pathology codes. We note that lower healthcare utilization and Medicare payment reductions also affected LabCorp’s peer Quest Diagnostics’ (DGX - Analyst Report) third-quarter results.

Gross margin declined 173 basis points (bps) to 37.5% in the quarter. Adjusted operating income declined 0.8% year over year to $268.6 million in the reported quarter. This led to an adjusted operating margin of 18.4%, down 72 bps from the year-ago quarter. During the quarter under review, selling, general and administrative expenses dropped 2.1% to $279 million.

LabCorp exited the third quarter with cash and short-term investments of $174.1 million, compared with $466.8 million at the end of 2012. The company had $372 million borrowings outstanding under the $1.0 billion revolving credit facility. Year-to-date operating cash flow was $570.0 million, down from the year-ago level of $587.2 million.

During the quarter, LabCorp repurchased 2.9 million shares for $288 million and was left with $304.1 million of authorization under the approved share repurchase plan. The Board also authorized an additional $1 billion share repurchase program.A consistent share buybackprogram led to a 6.1% decline in the outstanding share count and thereby had a positive effect on earnings per share.

Outlook

LabCorp tightened its revenue guidance for 2013. The company currently expects revenue growth of 3% compared to the earlier range of 2% to 3%. The Zacks Consensus Estimate of $5,792 million remains almost in line with the guidance.

The company trimmed its guidance for adjusted earnings per share to $6.95−$7.05 (including an adverse impact of 35 cents due to Medicare payment reductions) from the earlier range of $6.90−$7.10.The projection does not take into account the positive impact of any share repurchase activity for 2013. The current Zacks Consensus Estimate for earnings per share of $7.04 is at the higher end of the guidance range.

In addition, guidance for operating cash flow and capital expenditure lies in the range of $825 to $850 million (unchanged) and $210 million (from earlier $200−$220 million), respectively. The capital expenditure guidance is higher than the historic levels due to near-term investments in facility consolidation and replacement of a major testing platform. 

Our Take

Although the third-quarter results topped the Zacks Consensus Estimate on both counts, the challenging volume environment for testing laboratories and utilization weaknesses pose as looming headwinds. Moreover, we are concerned about the Medicare payment reductions, recent-introduced molecular pathology codes and implementation of sequestration. Although the share repurchase activity provided some cushion for the company, the bottom-line results failed to boost confidence during the quarter.

Despite near-term challenges from reimbursement issues, the company is working on portfolio expansion to drive its top line. The company is focusing more on the high-margin esoteric testing business, which is expected to contribute 45% of total sales in the next 3–5 years. The company’s long-term alliance with Bristol-Myers Squibb Co. (BMY - Analyst Report) is also anticipated to be another material upside.

In light of these facts and the market overview, we remain on the sidelines for LabCorp. Accordingly, the stock carries a Zacks Rank #3 (Hold).  

Another healthcare stock, ResMed Inc. (RMD - Analyst Report), carrying a Zacks Rank #1 (Strong Buy) is also worth considering.

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