Quest Diagnostics Incorporated — FY2013 Form 10-K
Reporting period: Fiscal year ended December 31, 2013; the filing also reports unaudited fourth-quarter results. Quest provides clinical diagnostic testing and related services, with Diagnostic Information Services (DIS) generating 92.2% of annual revenue. It processed approximately 147 million test requisitions during 2013.
Financial performance
| Metric | FY2013 | FY2012 |
|---|---|---|
| Net revenue | $7.146 billion | $7.383 billion |
| Operating income | $1.475 billion | $1.201 billion |
| Income from continuing operations attributable to Quest shareholders | $814 million | $630 million |
| Net income attributable to Quest shareholders | $849 million | $556 million |
| Diluted EPS from continuing operations | $5.31 | $3.92 |
| Operating cash flow | $652 million | $1.187 billion |
| Capital expenditures | $231 million | $182 million |
| Cash and cash equivalents at year-end | $187 million | $296 million |
| Total debt at year-end | $3.332 billion | $3.364 billion |
- Revenue fell 3.2%; DIS revenue declined 3.4% to $6.587 billion, while Diagnostic Solutions revenue decreased 0.7% to $559 million.
- DIS requisition volume increased 0.2%, including an approximately 2.0% contribution from acquisitions; excluding acquisitions, volume declined approximately 1.8%. DIS revenue per requisition decreased 3.6%, reflecting reimbursement and test-mix pressures.
- Reported operating margin was 20.6%, versus 16.3% in 2012. The comparison is materially affected by the 2013 $474 million pretax gain on sale of ibrutinib royalty rights. Cost of services rose to 60.5% of revenue from 59.1%; the filing does not provide a directly comparable adjusted operating margin.
- Annual net income and EPS also include unusual items, notably the royalty-rights gain, a $40 million pretax loss on the Enterix sale, and $115 million of restructuring and integration charges.
- Fourth-quarter revenue was $1.756 billion versus $1.774 billion a year earlier. Continuing-operations income attributable to shareholders was $143 million versus $140 million; diluted continuing-operations EPS was $0.97 versus $0.87.
Material changes and capital allocation
- 2013 included acquisitions of UMass laboratory operations, Advanced Toxicology Network, Dignity Health outreach operations, and ConVerge. The company also sold HemoCue, Enterix, and its ibrutinib royalty rights; it had sold OralDNA in 2012.
- Operating cash flow declined by $535 million year over year, affected by tax payments related to the royalty sale, deferred tax payments from 2012, lower earnings excluding the sale gain, and higher restructuring payments. Days sales outstanding remained 47.
- The company repurchased approximately $1.037 billion of stock and paid $185 million in dividends during 2013. It declared quarterly dividends of $0.30 per share during the year and announced an increase to $0.33 in January 2014.
- Available capacity under the revolving credit and secured receivables facilities was approximately $1.3 billion at year-end; neither facility had borrowings outstanding. The company reported compliance with debt covenants.
Outlook, commentary and risks
- Management said weaker-than-expected healthcare utilization hurt 2013 results and expected broad utilization weakness to continue into 2014. It expected the Affordable Care Act to be neutral to slightly positive in 2014, with greater potential benefit over the longer term.
- Management expected reimbursement to decline 1%–2% annually through 2015. It targeted Invigorate run-rate savings approaching $700 million by the end of 2014, compared with 2011, and savings of $1 billion over time. Estimated cumulative Invigorate charges through 2014 were $230 million–$290 million; actual charges could differ.
- The company’s stated debt/EBITDA target was 2–2.25 times; the filing does not provide a clear actual year-end ratio. It planned approximately $300 million of 2014 capital expenditures and announced a definitive agreement to acquire Solstas for $570 million, subject to approval and customary closing conditions.
- Key exposures include ongoing Medicare and commercial reimbursement pressure, patient cost-sharing and collection risk, competition and hospital internalization of testing, evolving regulation of laboratory-developed tests, billing and compliance scrutiny, and successful execution of restructuring, systems conversions and acquisitions.
- Legal matters include Medicaid pricing and billing lawsuits in Michigan and Florida, an ongoing Georgia federal subpoena, and patent litigation involving BRCA testing. Management said losses on the described legal matters were not considered probable at year-end, but possible losses could not be estimated. The five-year Corporate Integrity Agreement was due to expire in April 2014.
Most important facts for investors to verify
- Underlying revenue and volume trends excluding acquired businesses, and whether utilization stabilizes.
- Whether reimbursement declines, test mix and patient cost-sharing continue to pressure revenue per requisition and collections.
- Cash generation excluding the one-time royalty sale, and the company’s capacity to fund dividends, repurchases, acquisitions and debt service.
- Delivery of projected Invigorate savings, related restructuring costs, and progress integrating acquisitions and standardizing systems.
- Updates on Solstas, the BRCA patent dispute, government inquiries, and any change in the company’s assessment of legal or compliance exposures.