Quest Diagnostics Incorporated — Q1 2010 Form 10-Q
Business context and period. The unaudited report covers the three months ended March 31, 2010, compared with Q1 2009; balance-sheet comparisons are to December 31, 2009. Quest provides diagnostic testing and related services. Clinical testing generated over 90% of revenue. Results for the quarter are not necessarily indicative of full-year performance.
Financial results and liquidity
| Metric | Q1 2010 | Q1 2009 / prior balance |
|---|---|---|
| Net revenue | $1.806 billion | $1.808 billion |
| Operating income / margin | $298.6 million / 16.5% | $321.1 million / 17.8% |
| Income from continuing operations | $171.2 million | $177.3 million |
| Net income attributable to Quest | $162.4 million | $167.1 million |
| Diluted EPS | $0.89 | $0.88 net income; $0.89 continuing operations |
| Operating cash flow | $239.2 million | $272.8 million |
| Capital expenditures | $39.8 million | $39.6 million |
| Cash and cash equivalents | $463.2 million | $534.3 million at Dec. 31, 2009 |
| Total debt, carrying value | $3.115 billion | $3.107 billion at Dec. 31, 2009 |
- Revenue was essentially flat year over year. Clinical laboratory revenue declined 0.4%; requisition volume fell 2.6%, while revenue per requisition increased 2.3%.
- Operating costs rose to 83.5% of revenue from 82.2%. Cost of services was 59.1% of revenue versus 58.3%; SG&A was 23.9% versus 23.5%.
- Operating cash flow less capital expenditures was approximately $199.5 million, compared with $233.2 million in Q1 2009. Management attributed lower operating cash flow mainly to timing of variable-compensation payments. Days sales outstanding improved to 41 from 43 a year earlier and at year-end.
- Current assets were $1.645 billion and current liabilities $1.076 billion at March 31. The company reported $1.3 billion of availability under its revolving and receivables credit facilities, with no borrowings under either facility; $742 million was outstanding under its May 2012 term loan.
Material changes and notable items
- Net income attributable to Quest declined 2.8%; diluted EPS increased to $0.89 from $0.88, with continuing-operations diluted EPS unchanged at $0.89. Lower share count supported per-share results.
- Management cited severe weather and workforce-reduction charges as principal factors in weaker operating performance. Weather reduced estimated revenue growth by about 1% and operating income by $14.3 million, or $0.05 per diluted share. Workforce-related pre-tax charges were $17.3 million, or about $0.06 per diluted share.
- Other income included a $4.0 million pre-tax investment gain. Net interest expense decreased $3.5 million, principally due to lower rates on variable-rate debt.
- The company repurchased 4.5 million shares for $250.7 million at an average $56.21 per share; $499 million of authorization remained. The quarterly dividend was $0.10 per share.
Outlook, risks and contingencies
- No specific earnings or revenue guidance was provided. Management estimated approximately $200 million of 2010 capital expenditures and said cash, operating cash flow and available facilities should fund operating needs, debt service, dividends, repurchases and growth opportunities.
- Management viewed federal healthcare reform as a potential long-term industry benefit from expanded coverage, but noted offsets and uncertainty: Medicare clinical laboratory fee reductions of 1.75% annually for five years beginning in 2011, a productivity adjustment to updates, and a medical-device excise tax beginning in 2013. About 12% of consolidated revenue was reimbursed under the Medicare clinical laboratory fee schedule. A potential 21.2% decrease in Medicare Part B pathology and other physician-service fees had been delayed through May 31, 2010; approximately 3% of 2009 revenue was tied to that schedule.
- Legal and government matters include False Claims Act and billing-practice investigations and lawsuits, California MediCal claims, and litigation relating to NID test kits. The company reported approximately $10 million in reserves for the discussed matters, said losses could not currently be estimated or were not probable in several matters, and warned that outcomes could materially affect results or cash flows in the period recognized or paid. Management did not expect a material adverse effect on financial condition.
- A putative class action concerning certain NID test kits was filed in April 2010, after quarter-end. The company also has contingent lease obligations for which no liability was recorded and $134 million of unrecognized tax benefits; it said $26 million might decrease within 12 months.
- Interest-rate exposure includes variable-rate debt and swaps; foreign-exchange exposure was described as not material. The company reported compliance with credit-agreement financial covenants. Disclosure controls were deemed effective, with no material first-quarter change in internal control over financial reporting.
Important facts for investors to verify
- Whether testing volume recovers from weather disruption and physician-office visit weakness, and whether revenue-per-requisition gains persist.
- Progress and realized costs from workforce actions, and whether margins improve after the Q1 expense and volume pressures.
- Effects of Medicare reimbursement changes and evolving healthcare reform on pricing, volumes and device-related costs.
- Status, potential exposure and reserve adequacy for government investigations, billing litigation, NID-related claims, contingent leases and tax matters.
- Debt maturities, variable-rate exposure, covenant compliance, cash generation and the pace of share repurchases against planned capital spending and dividends.