Quest Diagnostics Incorporated — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Quest provides diagnostic testing and related services; clinical testing generated more than 90% of revenue. Interim statements are unaudited.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Revenue | $1.851B | $1.906B | $5.695B | $5.631B |
| Operating income | $308.7M | $322.1M | $943.1M | $669.9M |
| Operating margin | 16.7% | 16.9% | 16.6% | 11.9% |
| Net income attributable to Quest | $163.1M | $171.8M | $499.9M | $281.1M |
| Diluted EPS | $1.01 | $1.07 | $3.11 | $1.74 |
| Operating cash flow | Not separately reported by quarter | $806.8M | $557.7M |
Q3 revenue declined 2.9% year over year; nine-month revenue increased 1.1%. Nine-month diluted EPS growth reflects, in significant part, the prior-year $236M Medi-Cal settlement charge. Q3 diluted EPS was down 6.5%.
Nine-month cash flow from operations included $71.8M of proceeds from terminating interest-rate swaps. Investing cash outflow was $175.0M, including $122.3M of capital expenditures and $50.6M for the S.E.D. acquisition. Financing cash outflow was $604.9M, including $507M of net debt repayments, $150.0M of share repurchases and $81.0M of dividends.
Balance sheet and liquidity
- Cash and cash equivalents were $191.8M at September 30, 2012, versus $164.9M at December 31, 2011.
- Current assets were $1.472B and current liabilities were $1.071B. Accounts receivable, net, was $930.7M.
- Short-term borrowings and current portion of long-term debt were $154.6M; long-term debt was $3.376B. The filing estimates debt fair value at $4.1B, $521M above carrying value.
- Available borrowing capacity under credit facilities was approximately $1.1B; no borrowings were outstanding under the $750M revolving credit facility. The company reported compliance with its credit covenants.
- Days sales outstanding increased to 46 from 45 at year-end 2011 and 44 in the prior-year quarter.
Material changes and management commentary
- Clinical testing revenue fell 2.1% in Q3; requisitions declined 1.1%, partly because of fewer business days, and revenue per requisition declined 1.0%. For the first nine months, underlying volume growth was described as essentially flat after adjusting for weather and acquisitions.
- Quest’s multi-year Invigorate program targets $500M of annualized run-rate cost savings by exit 2014. Management estimated approximately $150M of run-rate savings by exit 2012, versus a prior estimate of about 20% of the target.
- An October 2012 management restructuring will create two business groups and eliminate three management layers and approximately 400–600 management positions by the end of 2013. Management expects about $65M in annualized savings from this restructuring.
- Estimated Invigorate pre-tax charges through 2014 are $115M–$195M, of which $105M–$175M are expected to be cash expenditures. The estimate includes separation, facility, asset impairment, and systems/integration costs. No specific revenue or EPS guidance is provided.
- Q3 results included $44.6M of restructuring and integration charges. Nine-month results included $70.2M of those charges and $10.1M of costs associated with the prior CEO succession. Comparable 2011 results included the $236M Medi-Cal charge and other restructuring and acquisition costs.
- On October 16, 2012, Quest signed an agreement to acquire UMass Memorial Medical Center’s clinical outreach laboratory business; financial terms are not stated in the provided filing text.
Risks and contingencies
The filing describes pending litigation, government investigations and subpoenas involving billing and pricing practices, including a federal False Claims Act appeal and Michigan Medicaid litigation. Management said it could not estimate potential losses for certain legal matters; legal reserves were less than $5M, and no loss was considered probable for the matters described. Separately, reserves for general and professional liability claims were approximately $115M. Management cautioned that outcomes could affect results or cash flows in the period determined or paid.
Other risks include reimbursement pressure, labor and benefit cost increases, competition, customer and payer relationships, regulatory changes, and execution of the restructuring and savings program. Management stated that cash, operating cash flow and available credit were expected to fund operations, debt service, capital spending, dividends, repurchases and growth opportunities.
Important facts for investors to verify
- Progress and realized savings from Invigorate, compared with the $500M target, and actual restructuring charges versus the $115M–$195M estimate.
- Underlying test volume and revenue-per-requisition trends, excluding acquisition, weather, business-day and payer-mix effects.
- Debt balances, interest-rate exposure and refinancing needs; the filing reports both balance-sheet debt and a higher estimated fair value.
- Developments in legal proceedings and government inquiries, for which potential losses may not be estimable.
- Terms, completion conditions and expected financial contribution of the UMass Memorial transaction.