Quest Diagnostics Incorporated — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014. Unaudited results; financial figures below are in millions of dollars except per-share data. Quest provides diagnostic information services (DIS), which generated more than 90% of continuing-operations revenue.
Financial performance and liquidity
- Revenue: $1,746, down 2.3% from $1,787. DIS revenue was $1,614, down 2.1%; Diagnostic Solutions revenue was $132, down 4.3%.
- Earnings: Operating income was $208, down 8.4%, and operating margin was 11.9% versus 12.7%. Income from continuing operations attributable to Quest was $104 versus $116. Diluted continuing-operations EPS was $0.71 versus $0.72. Net income attributable to Quest was $104 versus $136; Q1 2013 included $20 of discontinued-operations income, principally a tax benefit.
- Cash flow: Operating cash flow was $84 versus $47. Investing used $636, including $567 for acquisitions and $68 for capital expenditures. Financing provided $509. Cash declined $43 during the quarter to $144.
- Balance sheet and debt: Total assets were $9,550 and stockholders’ equity was $4,020. Current assets were $1,488 against current liabilities of $1,192. Debt carrying amounts were approximately $3,947, including $223 of short-term borrowings and current debt and $3,724 of long-term debt. Debt fair value was estimated at $4.2 billion, $293 above carrying value.
- Funding access: $1.1 billion of capacity was available under credit facilities; $195 was drawn on the secured receivables facility and none on the $750 revolving facility. The company reported compliance with financial covenants.
- Other metrics: Bad-debt expense was 4.3% of revenue, up 30 basis points. Days sales outstanding were 49, compared with 47 at year-end 2013. The quarterly dividend rose 10% to $0.33 per share.
Changes and notable items
- Management estimated harsh winter weather reduced DIS revenue and volume by about 2%. Acquisitions since Q1 2013 added approximately 2.5% to DIS revenue growth and 3.5% to volume; excluding those effects and weather, DIS volume was less than 1% below the prior year.
- Revenue per requisition declined 2.8%, attributed primarily to reimbursement changes and a greater mix of lower-priced drug-testing services. The sale of Enterix contributed about 2 percentage points to the decline in Diagnostic Solutions revenue.
- Solstas was acquired on March 7 for $572 ($563 net of cash acquired). It contributed $25 of revenue and $27 of operating expenses in the quarter, including $3 of integration and transaction costs. Preliminary purchase accounting included $269 of goodwill and $203 of customer-related intangible assets.
- Quarter results included $24 of pre-tax charges, or $0.13 per diluted share: $0.11 per share for restructuring, integration and professional fees (including acquisition costs) and $0.02 for a legal settlement. Comparable 2013 charges were $45, or $0.17 per diluted share. Separately, reported Invigorate restructuring charges were $9 in Q1 2014 versus $35 in Q1 2013.
- Debt increased during acquisition financing and refinancing activity. In March, Quest issued $600 of senior notes in two tranches, due 2019 and 2024, and repaid borrowings and notes.
Outlook, risks and contingencies
- No specific full-year revenue or EPS guidance is provided in the filing. Management expected approximately $200 of Invigorate savings in 2014 and a $700 annualized savings run rate by year-end 2014, measured against 2011; it said savings could reach as much as $1 billion over time. Estimated remaining 2014 pre-tax program charges were $72–$105, of which $70–$100 were expected to be cash expenditures. Actual charges could differ materially.
- Management estimated 2014 capital expenditures of approximately $300 and said cash, operating cash flow and available borrowing capacity should support operations, debt service, dividends, repurchases and growth. It expected to refinance part of debt maturing in 2015.
- Management characterized the expected 2014 impact of the Affordable Care Act as neutral to slightly positive. Legislation delayed potential Clinical Laboratory Fee Schedule reductions until 2017 and initiated a market-based rate-setting process.
- Risks include reimbursement pressure, labor and benefit costs, high-deductible plans and patient collection risk, competition, and the operating leverage of a labor- and infrastructure-intensive business. Legal matters include government inquiries and litigation concerning Medicaid pricing and billing, other billing practices, and BRCA testing patents. Management said potential losses on the described legal matters could not be estimated; it did not anticipate a material adverse effect on financial condition, but results or cash flows in a period could be materially affected.
- After quarter-end, Quest completed acquisitions of Steward Health Care’s outreach laboratory operations (April 16) and Summit Health (April 18); Summit consideration included approximately $113 cash and up to $25 contingent consideration.
Most important facts for investors to verify
- Whether underlying DIS demand and revenue per requisition stabilize after adjusting for weather, acquisitions and reimbursement or test-mix effects.
- Whether the company achieves its stated Invigorate savings targets and whether restructuring and integration costs remain within estimates.
- Solstas integration, final purchase-price allocation, realized synergies and the effects of subsequent acquisitions on debt and cash flow.
- Trends in bad debt, DSO and operating margin, particularly as patient cost-sharing increases.
- Developments in legal and government matters, for which potential losses were not estimable, and the company’s ability to manage debt maturities and refinancing.