Quest Diagnostics Incorporated — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011. Figures are unaudited; dollar amounts below are in millions unless stated otherwise. Quest is a diagnostic testing and information-services provider, with clinical testing generating more than 90% of revenue.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $1,906.4 | $1,864.7 | $5,631.2 | $5,544.9 |
| Operating income | $322.1 | $336.9 | $669.9 | $1,001.3 |
| Operating margin | 16.9% | 18.1% | 11.9% | 18.1% |
| Income from continuing operations attributable to Quest | $172.1 | $198.4 | $282.3 | $555.8 |
| Diluted EPS | $1.07 net income | $1.13 net income | $1.74 net income | $3.09 net income |
| Net cash from operating activities | Not provided quarterly | Not provided quarterly | $557.7 | $778.5 |
Revenue grew 2.2% in Q3 and 1.6% for the nine months. For the nine-month period, net income attributable to Quest was $281.1 million versus $555.1 million. The decline chiefly reflects the $236 million Medi-Cal legal settlement charge, alongside restructuring, acquisition-related costs, and operating pressures. Q3 diluted EPS was $1.07, including a $0.01 discontinued-operations loss; continuing-operations diluted EPS was $1.08.
Cash, debt and liquidity
- Cash and cash equivalents were $110.8 million at September 30, 2011, down from $449.3 million at December 31, 2010. Nine-month capital expenditures were $117.9 million.
- Balance-sheet debt was approximately $4.20 billion, including $835.9 million of short-term borrowings and current debt and $3.37 billion of long-term debt. Debt was approximately $2.99 billion at year-end 2010.
- Operating cash flow fell to $557.7 million from $778.5 million. It included the $241 million Medi-Cal settlement payment and acquisition transaction/integration payments; management said underlying operating cash flow, after those items and related tax effects, increased $2.7 million year over year.
- Quest reported $1.2 billion of borrowing capacity available under its credit facilities and stated that cash, operating cash flow and available credit should cover operating, capital and debt-service needs. It was in compliance with financial covenants at quarter-end.
- Net interest expense was $43.4 million in Q3 and $127.9 million for nine months, up from $36.2 million and $108.5 million, respectively, in 2010.
Material changes and business trends
- Clinical testing revenue increased 0.9% in Q3 and 0.6% for nine months. Requisition volume declined 1.2% in Q3 and was essentially unchanged year to date. Acquisitions contributed to reported revenue growth; revenue per requisition also benefited from greater esoteric and gene-based testing mix.
- Management cited soft healthcare utilization, the 1.75% Medicare fee-schedule reduction, payer and business mix shifts, and pricing on large contract extensions as pressures. Pre-employment drug-testing volume improved.
- Athena Diagnostics was acquired in April for $740 million; Celera was acquired in May. Their results were not material to consolidated results during the reported periods. Acquisitions increased goodwill and intangible assets and contributed to higher amortization and interest costs.
- Repurchases totaled $885 million for nine months, including $835 million of shares bought from a GlaxoSmithKline subsidiary. The company had $115 million remaining under its repurchase authorizations at quarter-end. The board subsequently raised the quarterly dividend from $0.10 to $0.17 per share, payable in January 2012.
Outlook, risks and unusual items
- Management announced a multi-year program targeting $500 million of cost reductions by the end of 2014. Q3 included $26 million of restructuring charges, principally employee separation costs; management expected another $10–$15 million of restructuring and integration costs in Q4.
- Management expected approximately $14 million of CEO-succession charges, about $5 million in Q4 2011 and the remainder principally in Q1 2012. Estimated 2011 capital expenditures, including capital leases, were approximately $190 million.
- The California Medi-Cal settlement was $241 million, with a $236 million pretax charge recorded in Q1. The company denied liability, received a release of the complaint’s allegations, and agreed to limited reporting obligations or a transitional discount through July 2012; the discount was not expected to materially affect results.
- Other lawsuits and government inquiries remain, including billing-practice investigations and subpoenas. Management said losses on these matters were not considered probable at September 30, 2011, but potential losses could not be estimated. Legal reserves were approximately $2 million; professional and general liability reserves were approximately $136 million.
- No specific revenue or earnings guidance for the full year is stated in the provided filing text. Management’s outlook is subject to reimbursement and labor-cost pressures, healthcare utilization, regulation, competition, and legal outcomes.
Important facts for investors to verify
- Whether operating trends, especially requisition volume and revenue per requisition, improve amid utilization and reimbursement pressures.
- Actual realization, timing, and implementation costs of the $500 million cost-reduction program.
- Progress on integrating Athena and Celera, and the final purchase-price allocations and expected acquisition contributions.
- Debt repayment and refinancing needs, cash generation, and liquidity after acquisitions, repurchases, and the dividend increase.
- Developments in government investigations and litigation, including any exposure beyond recorded reserves and the Medi-Cal settlement obligations.