Quest Diagnostics Incorporated — Q2 2011 Form 10-Q
Business context and period: Quest Diagnostics provides diagnostic testing and related services, primarily in the United States. This unaudited filing covers the three and six months ended June 30, 2011, compared with the corresponding 2010 periods. Dollar amounts below are in millions unless noted.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net revenue | $1,903.2 | $1,874.7 | $3,724.8 | $3,680.2 |
| Operating income | $316.9 | $365.9 | $347.8 | $664.5 |
| Operating margin | 16.6% | 19.5% | 9.3% | 18.1% |
| Income from continuing operations | $172.0 | $204.1 | $125.7 | $375.3 |
| Net income attributable to Quest | $163.1 | $194.6 | $109.3 | $357.1 |
| Diluted EPS | $1.02 | $1.07 | $0.68 | $1.96 |
- Q2 revenue increased 1.5%; acquisitions contributed 2.5% to overall growth. Clinical testing revenue rose 0.7%, while requisition volume fell 0.9%; revenue per requisition increased 1.6%.
- For the six months, revenue grew 1.2%. Clinical testing requisition volume increased 0.5%, while revenue per requisition was approximately flat.
- Q2 operating costs were 83.4% of revenue versus 80.5% a year earlier. Cost of services rose to 58.0% of revenue from 57.6%, and SG&A to 24.3% from 22.4%.
- Q2 net interest expense was $46.6 million, up from $36.4 million. Six-month net interest expense was $84.5 million, versus $72.3 million.
- Operating cash flow for the first half was $220.1 million, compared with $448.4 million. Investing cash flow was $(1,008.0) million, including acquisitions; financing cash flow was $522.8 million. Capital expenditures were $78.6 million.
- Cash and cash equivalents were $184.2 million at June 30, 2011, down from $449.3 million at year-end 2010. Current assets were $1,478.0 million and current liabilities $1,993.4 million.
- Balance-sheet debt was approximately $4,327.6 million, comprising $994.7 million of short-term borrowings and current maturities and $3,332.9 million of long-term debt, versus approximately $2,990.2 million at year-end. The company reported $1.2 billion of available capacity under its credit facilities and compliance with debt covenants.
Material changes and unusual items
- First-half results included a $236 million pretax charge related to the California Medi-Cal billing settlement. Quest paid $241 million in Q2; the settlement resolved the lawsuit while the company denied liability. The charge reduced disclosed six-month diluted EPS by $1.20.
- Quest acquired Athena Diagnostics for $740 million in April and Celera Corporation for $667 million in cash consideration in May. Athena reported 2010 revenue of approximately $110 million and Celera $128 million. Acquisition results were not material to consolidated results for the periods presented.
- Six-month diluted EPS also reflected disclosed acquisition-related charges of $0.12 per share, workforce-reduction charges of $0.05 per share, and estimated severe-weather impact of $0.07 per share. These items, together with the Medi-Cal charge, materially affected year-over-year comparisons.
- The company issued $1.25 billion of senior notes in March. It repurchased 15.4 million shares for $835 million in the first half, leaving $165 million of authorization at June 30. Quarterly dividends remained $0.10 per share.
Outlook, commentary and risks
- No specific revenue or earnings guidance for the remainder of 2011 is provided in the supplied filing text. Management cited a temporary slowdown in healthcare utilization, continued reimbursement pressure, labor and benefit cost increases, and lower clinical testing volume in Q2.
- In July, the company adopted a restructuring plan expected to generate a pretax charge of approximately $20 million in Q3, principally severance, with the full amount expected to result in future cash expenditures. It also announced a multiyear program targeting $500 million of cost reductions over three years; implementation may generate additional charges.
- The Medi-Cal settlement includes limited-period pricing reporting obligations and an optional transitional discount through July 2012, which management did not expect to materially affect revenue or results.
- Other legal matters include government inquiries and lawsuits involving billing practices, as well as other claims. At June 30, management said losses on these matters were not considered probable, but potential losses could not be estimated. Legal reserves were approximately $2 million; separate reserves for general and professional liability claims were approximately $137 million.
- Management stated that cash, operating cash flow and credit-facility capacity should provide sufficient flexibility for obligations and planned investment. It estimated 2011 capital expenditures of approximately $200 million.
Important facts for investors to verify
- Underlying operating trends after separating acquisition contributions, settlement and integration costs, severe weather, and restructuring charges.
- Whether the announced $500 million cost-reduction program is achieved, and its implementation costs and timing.
- Debt repayment and refinancing needs, interest expense, liquidity, and the effect of acquisition financing and share repurchases.
- Clinical testing volume, reimbursement and payer mix, Medicare fee reductions, and revenue per requisition.
- Developments in remaining billing-related investigations and litigation, and any related financial exposure.