Quest Diagnostics Incorporated — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011; interim financial statements are unaudited. Quest provides diagnostic testing, information and related services, with clinical testing accounting for more than 90% of revenue.
Financial results
| Metric | Q1 2011 | Q1 2010 |
|---|---|---|
| Net revenue | $1.822 billion | $1.806 billion |
| Operating income (margin) | $31.0 million (1.7%) | $298.6 million (16.5%) |
| Income from continuing operations attributable to Quest | Loss of $53.5 million | Income of $162.5 million |
| Net income attributable to Quest | Loss of $53.9 million | Income of $162.4 million |
| Diluted EPS | Loss of $0.33 | Income of $0.89 |
| Cash from operating activities | $160.6 million | $239.2 million |
| Capital expenditures | $39.0 million | $39.8 million |
Revenue increased 0.9%. Clinical laboratory testing revenue rose 0.3% to $1.662 billion; other businesses’ revenue rose approximately 7% to $159.4 million. Clinical testing volume, measured by requisitions, rose 2%; management estimated underlying volume growth of 1.3% after adjusting for business days and weather. Revenue per requisition fell 1.7%.
Q1 2011 results included a $236 million pre-tax charge related to the California Medi-Cal litigation, equivalent to $1.19 per share. Management said identified items affected quarterly EPS by $1.33, including workforce-reduction costs, acquisition-related costs and severe weather. The filing does not provide formal earnings guidance.
Balance sheet, debt and liquidity
- At March 31, cash and equivalents were $994.2 million, versus $449.3 million at year-end. Of the quarter-end cash, $750 million was used to fund the Athena acquisition, completed April 4, 2011.
- Total debt carrying value was approximately $4.224 billion, including $629.2 million classified as current, versus $2.990 billion at December 31, 2010. The company issued $1.25 billion of senior notes in March and used proceeds for the Athena purchase and debt repayments.
- Current assets were $2.300 billion and current liabilities $1.767 billion. Available borrowing capacity under credit facilities was approximately $1.3 billion at quarter-end; the company reported compliance with its financial covenants.
- Operating cash flow declined to $160.6 million, principally reflecting higher receivables, interest, tax and restructuring payments and lower net income. Days sales outstanding were 44, compared with 41 a year earlier; management attributed the increase primarily to the temporary Medi-Cal billing suspension.
- Financing activities provided $425.1 million, including substantial borrowing, partly offset by $835 million of share repurchases and $17.1 million of dividends paid. Quarterly dividend was $0.10 per share.
Material changes and management commentary
- Operating results were sharply lower year over year, primarily because of the Medi-Cal charge. Excluding that charge, management also cited weather disruption, lower revenue per requisition, higher compensation and investment in sales and service capabilities, and transaction costs.
- Management estimated severe weather reduced Q1 2011 revenue by $25.7 million and operating income by $18.5 million. It attributed lower revenue per requisition to payer and business mix, contract pricing changes and the 1.75% Medicare fee schedule reduction effective January 1, 2011; growth in gene-based and esoteric testing partly offset these pressures.
- Quest completed its approximately $740 million Athena Diagnostics acquisition on April 4, 2011. It also reported a controlling interest in Celera following a tender offer announced May 4; the transaction was expected to close in Q2 2011, with funding from credit facilities and cash.
- Management estimated 2011 capital expenditures of approximately $220 million and said cash, operating cash flow and available borrowing capacity should support operations, debt service, dividends and growth. No specific full-year revenue or EPS forecast is stated in the provided filing text.
Risks, contingencies and unusual items
- On May 9, 2011, after quarter-end, Quest announced an agreement in principle to resolve California Medi-Cal allegations for $241 million. The company denied liability; final documentation and required approvals remained outstanding. The proposed terms also include limited reporting obligations and a Medi-Cal discount through July 2012. Failure to finalize could lead to materially different losses and additional litigation costs.
- Quest had temporarily suspended Medi-Cal billing while continuing to provide services; the suspension was extended through May 16, 2011. The company expected to resume billing unbilled services under the proposed settlement and be reimbursed consistent with accrued amounts.
- Other government investigations, billing-related subpoenas and private lawsuits remained outstanding. The company said some potential losses were not probable or could not be reasonably estimated. Reserves for the discussed legal matters were approximately $246 million at March 31, 2011, compared with $10 million at year-end; professional-liability reserves were approximately $134 million.
- Interest-rate and foreign-exchange exposures are managed in part with derivatives. The filing identifies variable-rate debt exposure and notes that borrowing costs may fluctuate with rates and credit ratings.
Important facts for investors to verify
- Whether the California settlement was finalized, its final terms and payment timing, and the effect of Medi-Cal billing and reimbursement changes.
- Post-quarter cash, debt and liquidity after the Athena acquisition, the proposed Celera acquisition and the settlement payment.
- Whether clinical testing volumes, revenue per requisition and collections improve; monitor payer mix, Medicare pricing and days sales outstanding.
- Progress toward management’s approximately $220 million 2011 capital expenditure estimate and the cash-flow outlook, given Q1 operating cash flow was lower year over year.
- Subsequent acquisition results and integration costs, and any material developments in the other legal and government matters.