Quest Diagnostics Incorporated — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015; unaudited. Dollar amounts are in millions unless noted. Quest’s diagnostic information services (DIS) business generated more than 90% of revenue; other businesses include clinical trials testing, risk assessment, diagnostic products and healthcare IT.
Financial results and liquidity
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Net revenue | $1,839 | $1,746 | +5.3% |
| Operating income | $228 | $208 | +9.7% |
| Operating margin | 12.4% | 11.9% | +0.5 percentage points |
| Net income attributable to Quest | $61 | $104 | -41.2% |
| Diluted EPS | $0.42 | $0.71 | -40.8% |
| Cash from operations | $52 | $84 | -$32 |
| Capital expenditures | $56 | $68 | -$12 |
- DIS revenue rose 4.9% to $1,692; other-segment revenue increased 11.2% to $147. Excluding the 2014 acquisitions, consolidated revenue grew 0.7%. DIS requisitions rose 5.6%, but excluding acquisitions DIS revenue, volume and revenue per requisition were essentially unchanged. Overall revenue per requisition declined 0.7%, primarily reflecting acquisition effects.
- Operating costs rose 4.8% to $1,611. Cost of services increased 5.7%; SG&A increased 1.0%. Cost reductions from Invigorate and acquisition synergies partly offset acquisition-related operating costs and higher restructuring and integration charges.
- Non-operating expenses were $116 versus $32, including a $79 pre-tax loss on early debt retirement. Interest expense, net, increased to $45 from $39. The effective tax rate was 37.3% versus 36.9%.
- Reported EPS was reduced by $0.36 after tax from early debt retirement and related refinancing charges. Management identified total Q1 items negatively affecting diluted EPS by $0.54, including restructuring/integration/professional fees and other impairment and legal-related charges.
- Operating cash flow was lower partly because of $78 of pre-tax cash charges associated with debt retirement and higher performance-based compensation payments; improved operations and working capital partly offset these factors. Days sales outstanding improved to 45 days from 48 at year-end and 49 a year earlier.
- Cash and cash equivalents were $974 at March 31, up from $192 at December 31, principally due to the notes offering. Current assets were $2,375 and current liabilities $2,089.
- Debt carrying value was $4,731, including $1,043 classified as current. Quest issued $1.2 billion of senior notes in March and used proceeds, with other funding, for debt repayments and redemptions. No borrowings were outstanding under its $525 secured receivables facility or $750 revolving facility; approximately $1.3 billion of capacity was available.
Material changes and management outlook
- Revenue growth included a substantial acquisition contribution: management said 2014 acquisitions contributed nearly 5% to DIS revenue growth. Harsh winter weather was cited despite reported growth.
- Quest reported more than $700 of Invigorate run-rate savings achieved by year-end 2014 and targets an additional $600 by year-end 2017, for $1.3 billion versus 2011. The company estimated approximately $300 of total pre-tax charges for the 2015 course of action, including $95–$115 in 2015; actual charges may differ materially. Q1 charges recorded under the January 2015 course of action were approximately $26.
- Management expects approximately $300 of 2015 capital expenditures. It stated cash, operating cash flow and available borrowing capacity should fund working capital, capital spending, debt service, dividends, repurchases and growth opportunities for the foreseeable future. No specific earnings or revenue guidance was provided.
- In March, Quest agreed to contribute certain clinical trials assets to a Quintiles joint venture for a 40% non-controlling interest. Closing was expected by Q3 2015, subject to customary conditions. A gain on closing may be material; the business was not classified as discontinued operations.
- In April, after quarter-end, Quest redeemed $1.025 billion of notes. It expected approximately $64 of pre-tax debt-retirement charges in Q2. Management expects the refinancing to reduce future interest expense and improve the maturity profile.
- The quarterly dividend increased 15%, from $0.33 to $0.38 per share, and the company repurchased $110 of stock in Q1. $586 remained available under repurchase authorizations.
Risks, contingencies and unusual items
- Quest cited reimbursement pressure, competition, changes in government regulation and customer, payer, supplier or partner relationships among forward-looking risks. Modest reimbursement pressure in Q1 was offset by favorable test and business mix.
- Government investigations and litigation include a Florida Medicaid pricing and billing suit and a False Claims Act case involving subsidiary Berkeley HeartLab, in which the U.S. intervened against the subsidiary but not Quest Diagnostics Inc. The company said losses on the described matters were not believed probable at March 31, but possible losses could not be estimated and could affect results or cash flows when determined or paid.
- General and professional liability reserves were approximately $113; other legal reserves were $12. Management considers the established liability reserves and insurance sufficient for currently estimated exposures, but outcomes remain uncertain.
- Quest was in compliance with its credit-agreement financial covenants. Unrecognized tax-benefit liabilities were approximately $111; up to approximately $46 might decrease within 12 months, but the effective-tax-rate impact was not estimable.
- The company uses interest-rate derivatives to manage exposure and states it does not use derivatives for speculation. Most cash was held in the U.S.; approximately 7% of cash was held outside the U.S. and considered indefinitely reinvested.
Key facts for investors to verify
- How much of subsequent revenue growth is organic, given Q1 organic growth of 0.7% and acquisition-driven reported growth.
- Whether Invigorate delivers the targeted additional $600 of run-rate savings by 2017, and the timing and cash impact of restructuring charges.
- Completion and economics of the Quintiles joint venture, including the potentially material gain and ongoing performance of Quest’s 40% interest.
- Post-redemption debt balances, interest expense, maturity profile and the Q2 debt-retirement charge versus management’s estimate.
- Cash conversion and collection trends, including whether operating cash flow improves after Q1 debt-retirement payments and compensation outflows.
- Developments in government investigations, litigation and tax matters, for which potential losses or outcomes are uncertain.