Quest Diagnostics Incorporated — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 30, 2013. Interim financial statements are unaudited. Quest provides diagnostic information services (DIS), which generated more than 90% of continuing-operations revenue.
Key financial results
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net revenue | $1.787 billion | $1.822 billion | $5.390 billion | $5.609 billion |
| Operating income | $689.5 million | $304.6 million | $1.205 billion | $935.8 million |
| Operating margin | 38.6% | 16.7% | 22.4% | 16.7% |
| Income from continuing operations attributable to Quest | $402.7 million | $158.5 million | $670.9 million | $489.9 million |
| Diluted EPS from continuing operations | $2.66 | $0.98 | $4.32 | $3.04 |
| Net income attributable to Quest | $405.1 million | $163.1 million | $706.4 million | $499.9 million |
Reported operating income and earnings were substantially affected by the $474.1 million pretax gain from selling Ibrutinib royalty rights. Q3 results also included a $39.6 million pretax loss on the Enterix sale and restructuring and integration charges. Accordingly, reported margins and earnings growth do not represent underlying operating trends.
- Revenue and operating trends: Q3 revenue fell 1.9%; nine-month revenue fell 3.9%. DIS revenue declined 2.4% in Q3 and 4.3% year to date. Q3 DIS requisition volume rose 2.0%, including acquisition and business-day benefits; underlying volume was down about 2%. Revenue per requisition fell 4.3% in Q3 and 3.8% year to date. Other operating segments’ Q3 revenue increased 4.1%.
- Cash flow: Nine-month operating cash flow was $441.6 million, down from $806.8 million. Investing activities provided $433.6 million, mainly from the royalty-rights and business-sale proceeds, offset partly by acquisitions and capital spending. Financing activities used $1.030 billion, including $994.1 million of treasury-stock purchases and $141.0 million of dividends. Cash declined to $158.3 million from $295.6 million at year-end 2012.
- Debt and liquidity: September 30 current and long-term debt totaled about $3.367 billion, compared with $3.364 billion at December 31, 2012. Current liabilities were $1.239 billion and current assets $1.426 billion. The company reported $1.2 billion of borrowing capacity across credit facilities, with no borrowings on its $750 million revolving facility; $35 million was outstanding on its secured receivables facility. It stated it was in compliance with debt covenants.
- Other metrics: Q3 and nine-month net interest expense was $40.0 million and $119.8 million, respectively. Nine-month capital expenditures were $155.5 million. Days sales outstanding increased to 48 days from 47 at year-end 2012 and 46 a year earlier.
Material changes and unusual items
- In July, Quest sold future Ibrutinib royalty rights for $485 million cash and recorded a $474.1 million pretax gain. The gain contributed approximately $1.97 per diluted share in Q3 and $1.92 year to date.
- Quest completed the HemoCue sale in April and the Enterix sale in September. Enterix generated a $39.6 million pretax loss and remained in continuing operations because of continuing involvement. Nine-month discontinued-operations income included a $13.5 million HemoCue-sale gain and $19.8 million of discrete tax benefits related to NID.
- Quest acquired businesses from UMass Memorial, Advanced Toxicology Network and Dignity Health during the first half of 2013. It acquired ConVerge Diagnostic Services on October 7, after quarter-end.
- Share repurchases totaled $994.1 million in the first nine months; the company had $871 million remaining under its authorization at September 30. The quarterly dividend was $0.30 per share, up from $0.17 in the comparable 2012 quarter.
Outlook, management commentary and risks
- Management said the market was softer than expected and efforts to restore growth were taking longer than expected. It cited healthcare-utilization headwinds and reimbursement reductions, including Medicare cuts, pathology and molecular-diagnostics changes, sequestration, and commercial payer contract changes.
- Management expected reimbursement pressure to reduce underlying revenue per requisition by about 3% for full-year 2013. It targeted more than $250 million of Invigorate savings in 2013 versus 2012 and $600 million of annual run-rate savings by year-end 2014, with potential savings of as much as $1 billion over time. Estimated Invigorate charges through 2014 were $200 million to $290 million, of which $195 million to $275 million were expected to be cash expenditures. Cumulative charges through September were about $173 million.
- Management expected DSO to decline to 2012 levels by year-end and estimated 2013 capital expenditures of approximately $250 million. It believed cash, operating cash flow and available credit would fund operating needs, debt service, dividends, repurchases and growth opportunities. No specific full-year revenue or EPS guidance is provided in the supplied filing text.
- Legal matters include government inquiries and litigation involving billing and pricing, False Claims Act allegations, employment claims, and securities-related matters. Management said losses on the described matters were not considered probable or estimable as of September 30, although a material effect on results or cash flows in a period remains possible. General and professional liability reserves were approximately $124 million.
- Other exposures include reimbursement and utilization pressure, the labor-intensive and fixed-cost nature of testing operations, debt and interest-rate risks, and execution risks associated with restructuring and acquisitions. Management reported effective disclosure controls and no material third-quarter change in internal control over financial reporting.
Important facts for investors to verify
- Underlying performance excluding the Ibrutinib gain, Enterix loss, restructuring charges and discontinued-operation tax benefits.
- Whether DIS volume stabilizes and whether reimbursement pressure continues to reduce revenue per requisition.
- Delivery, timing and cash costs of Invigorate savings, including remaining restructuring charges.
- Cash conversion, receivables and DSO trends, and the funding implications of dividends and continued share repurchases.
- Developments in legal and government matters, contingent liabilities, and the integration and contribution of acquired businesses.