Quest Diagnostics Incorporated — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; unaudited. Quest provides diagnostic information services, which generated more than 90% of continuing-operations revenue.
Financial results and liquidity
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Net revenue | $1.787 billion | $1.909 billion | Down 6.4% |
| Operating income | $227.0 million | $297.8 million | Down $70.8 million |
| Operating margin | 12.7% | 15.6% | Down 2.9 percentage points |
| Continuing-operations income attributable to Quest | $115.5 million | $156.1 million | Down 26.0% |
| Diluted EPS from continuing operations | $0.72 | $0.97 | Down 25.8% |
| Net income attributable to Quest, including discontinued operations | $135.8 million | $159.1 million | Down 14.7% |
| Diluted EPS, including discontinued operations | $0.85 | $0.99 | Down 14.1% |
| Operating cash flow | $47.2 million | $161.3 million | Down $114.0 million |
Cost of services was $1.092 billion, or 61.1% of revenue, versus $1.109 billion, or 58.1%, a higher cost ratio despite lower expense dollars. SG&A was $447.9 million, or 25.1% of revenue, versus $483.3 million, or 25.3%. Q1 2013 included $44.5 million of pre-tax restructuring and integration charges, equivalent to $0.17 per diluted share.
Cash and cash equivalents were $133.6 million at March 31, down from $295.6 million at year-end. Investing used $140.1 million, including $90.4 million for acquisitions and $49.1 million for capital expenditures; financing used $59.7 million, including $61.6 million for share repurchases and $47.7 million in dividends. Management attributed much of the operating-cash-flow decline to reduced earnings and approximately $70 million of deferred tax payments made in Q1 under Hurricane Sandy relief provisions. Days sales outstanding were 46, versus 47 at year-end and 44 a year earlier.
Balance-sheet debt consisted of $254.4 million of short-term borrowings and current maturities and $3.147 billion of long-term debt. The filing’s contractual-obligations table reports $3.347 billion of outstanding debt. The company reported $1.2 billion of available borrowing capacity, was in compliance with credit covenants, and said cash, operating cash flow and credit facilities should provide sufficient funding flexibility. Current assets were $1.457 billion and current liabilities $1.208 billion.
Material changes and business drivers
- Diagnostic information services revenue fell 6.7%; requisition volume declined 3.4%, with fewer business days and weather reducing volume by about 2.5%, partly offset by roughly 1% from the UMass acquisition. Management estimated underlying volume was about 2% lower.
- Revenue per requisition decreased 3.4%, mainly due to Medicare and commercial fee schedule reductions. Management expected reimbursement pressure to reduce revenue per requisition by about 3% for full-year 2013. Mix effects were roughly offsetting.
- Cost-reduction savings from the Invigorate program partly offset revenue pressure, but restructuring charges and lower volume weighed on operating results. Net interest expense declined by $2.2 million, mainly due to lower average debt; the effective tax rate fell to 37.3% from 38.3%.
- Q1 2013 discontinued-operations income included a $19.8 million discrete tax benefit related to revised estimates of NID tax contingencies. Consequently, reported net income and EPS include a significant item not representative of continuing operations.
- Quest acquired UMass Memorial’s clinical outreach and anatomic pathology businesses on January 2, 2013. It completed the HemoCue sale on April 9 for approximately $300 million plus customary cash adjustments, and on April 17 agreed to acquire certain Dignity Health clinical outreach operations.
Outlook, risks and unusual items
- Invigorate targets $600 million of annual run-rate savings versus 2011 by exit 2014, with potential savings of up to $1 billion over time. Quest reported approximately $200 million of run-rate savings exiting 2012 and expected the remaining $400 million in 2013–2014. Estimated pre-tax program charges remain $170–$250 million, of which $160–$230 million are expected to be cash expenditures; cumulative charges through March 31 were $118.1 million.
- The voluntary retirement program was essentially completed in Q1 and is expected to deliver about $40 million in annualized savings. Management expected to eliminate three management layers and approximately 400–600 management positions by the end of 2013.
- Management estimated 2013 capital expenditures of approximately $250 million and expected to fund debt maturities and the $0.30 quarterly dividend from cash and available facilities. On April 19, after quarter-end, Quest entered a $450 million accelerated share repurchase agreement, funded with cash and secured receivables facility borrowings.
- Legal matters include government inquiries and litigation involving laboratory pricing and billing, False Claims Act allegations, employment claims, and other matters. Management said no loss was probable and estimable for the described “Other Legal Matters,” while acknowledging a reasonable possibility of losses that could not be estimated; outcomes could affect results or cash flows in the period recognized or paid. General and professional liability reserves were approximately $113 million.
- Other exposures include reimbursement and regulatory changes, competition, customer and payer relationships, variable-rate debt, and uncertain litigation outcomes. The filing says foreign-exchange exposure is not material and derivatives are not held for speculation.
- Management stated disclosure controls were effective at quarter-end and there were no material changes to internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether the volume and reimbursement trends, including the expected roughly 3% full-year pressure on revenue per requisition, persist or worsen.
- Whether Invigorate delivers the targeted savings on schedule and within the estimated charge range, and whether savings offset ongoing revenue and margin pressure.
- The sustainability of operating cash flow after the deferred tax payment effect, and the company’s capacity to fund debt, capital spending, dividends, acquisitions and the post-quarter $450 million repurchase.
- The final HemoCue sale proceeds and adjustments, and the financial and strategic terms and performance of the UMass and Dignity Health transactions.
- Developments in government investigations, litigation and tax contingencies, including matters for which potential losses were not estimable.
- The distinction between continuing results and reported net income: Q1 discontinued-operations income included a $19.8 million tax benefit.