Quest Diagnostics Incorporated — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended September 30, 2014. Unaudited financial statements; dollar amounts are in millions except per-share data. Quest provides diagnostic information services (DIS), which generated more than 90% of continuing-operations revenue.
Financial results and liquidity
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net revenue | $1,904 | $1,788 | $5,552 | $5,390 |
| Operating income | $256 | $689 | $726 | $1,205 |
| Operating margin | 13.4% | 38.6% | 13.1% | 22.4% |
| Income from continuing operations attributable to Quest | $129 | $403 | $366 | $671 |
| Diluted continuing-operations EPS | $0.88 | $2.66 | $2.51 | $4.32 |
| Net cash from operating activities | — | $635 | $442 |
Q3 DIS revenue rose 7.1% to $1,765; DS revenue was $139, essentially flat. Q3 requisition volume increased 7.8%, but acquisitions contributed about 8%; excluding acquisitions, volume declined less than 0.5%. Revenue per requisition fell 0.6%. For the first nine months, DIS revenue grew 3.4%, while revenue per requisition declined 1.9%, reflecting reimbursement pressure and business mix.
The sharp year-over-year decline in operating income and EPS primarily reflects the 2013 $474 pre-tax gain on the sale of ibrutinib royalty rights. Q3 2013 also included a $40 pre-tax Enterix sale loss. 2014 results included identified charges that reduced diluted EPS by $0.22 in Q3 and $0.51 year to date: restructuring, acquisition integration and related professional fees, and legal-related costs.
For the nine months, net cash from operations was $635; investing used $934, chiefly $725 for acquisitions and $219 for capital expenditures; financing provided $282. Cash was $170 at September 30, versus $187 at year-end 2013. Current assets were $1,563 and current liabilities $1,190. Debt comprised $132 of short-term borrowings and current maturities and $3,732 of long-term debt, net of current portion. The $750 revolving credit facility had no borrowings; $110 was outstanding under the $525 secured receivables facility. Available capacity under the two facilities was approximately $1.2 billion.
Material changes and notable items
- Completed the $572 Solstas acquisition, the $151 Summit Health acquisition, and the $34 Steward outreach-laboratory acquisition. Solstas contributed $212 of revenue year to date; acquisition-related operating expenses included restructuring, integration and transaction costs. Purchase-price allocations remain preliminary.
- Issued $600 of senior notes in March 2014 and amended the $750 revolving credit facility, which now matures in April 2019. Long-term debt carrying value increased from $3,332 at December 31, 2013 to $3,754 before current maturities.
- Cost of services rose 8.2% in Q3, faster than revenue, due mainly to acquisitions, higher performance compensation and a change in allocation of certain facility costs. Bad debt expense as a share of revenue increased about 40 basis points in Q3 and 25 basis points year to date.
- Restructuring charges were $16 in Q3 and $35 year to date, compared with $29 and $73 in the respective 2013 periods.
Outlook, management commentary and risks
Management expected the Invigorate cost program to approach $700 of annualized run-rate savings versus 2011 by year-end 2014, with approximately $200 of savings realized in 2014; it continued to seek savings exceeding $1 billion over time. Management estimated $20–$30 of additional pre-tax Invigorate charges in Q4 2014. The company estimated 2014 capital expenditures of approximately $300 and expected to fund operations, debt service, dividends and growth through operating cash flow, cash on hand and credit facilities. No specific earnings or revenue guidance was provided in the supplied filing text.
Management cited continued reimbursement pressure, labor and benefit cost increases, competition, customer and payer relationships, and integration execution as business considerations. Legal matters include government inquiries and litigation concerning billing practices, BRCA patents and other matters. Management said it could not estimate potential losses for the described legal matters; it did not consider losses probable or reasonably estimable at September 30, 2014, while acknowledging outcomes could materially affect results or cash flows in a period. Reserves for general and professional liability claims were approximately $126. Unrecognized tax-benefit liabilities were approximately $174; up to $44 could decrease within twelve months, though timing and tax-rate effects were uncertain.
The company reported compliance with credit-agreement covenants and effective disclosure controls. It expected to replace its secured receivables facility before its December 5, 2014 maturity. Management stated that cash, operating cash flow and available borrowing capacity should provide sufficient financial flexibility, but these are forward-looking expectations.
Key facts for investors to verify
- Separate recurring operating performance from the unusually large 2013 royalty-sale gain and other prior-year disposal items when comparing margins and earnings.
- Assess underlying DIS volume and revenue-per-requisition trends apart from acquisition contributions, including the effects of reimbursement pressure and mix.
- Track integration costs, preliminary acquisition valuations, acquired-business contributions and delivery of Invigorate savings against management’s targets.
- Review debt maturities, facility renewal and borrowing capacity, together with the company’s ability to sustain cash generation, dividends and repurchases.
- Monitor the outcome and financial exposure of legal and government matters, professional-liability claims, tax contingencies and the contingent acquisition consideration.