Quest Diagnostics Incorporated — Q2 2013 Form 10-Q
Business context and period. Quest provides diagnostic information services, primarily clinical testing; this business generated more than 90% of continuing-operations revenue. This unaudited report covers the quarter and six months ended June 30, 2013, compared with the same 2012 periods.
Financial performance
| Metric | Q2 2013 | Q2 2012 | First half 2013 | First half 2012 |
|---|---|---|---|---|
| Revenue | $1,815.7m | $1,878.4m | $3,602.4m | $3,787.0m |
| Operating income | $288.7m | $333.4m | $515.7m | $631.2m |
| Operating margin | 15.9% | 17.7% | 14.3% | 16.7% |
| Income from continuing operations | $161.8m | $184.0m | $285.1m | $349.5m |
| Diluted EPS from continuing operations | $0.99 | $1.09 | $1.71 | $2.06 |
| Net income attributable to Quest | $165.5m | $177.7m | $301.2m | $336.8m |
- Revenue declined 3.3% in Q2 and 4.9% in the first half. Operating income fell 13.4% and 18.3%, respectively; continuing-operations income fell 12.8% and 19.0%.
- Q2 DIS revenue declined 3.6%. Requisitions rose 0.1%, but acquired volume contribution of about 1.6% was largely offset by an estimated 1.5% decline in underlying volume. Revenue per requisition fell 3.7%. For the first half, DIS requisitions fell 1.6% and revenue per requisition fell 3.6%.
- Management cited lower healthcare utilization and reimbursement reductions, including Medicare and commercial fee schedule changes, as well as a less favorable testing mix. Cost reductions partly offset lower revenue, but restructuring costs and reduced operating leverage contributed to margin contraction.
- Net income includes discontinued operations: $12.8m in Q2 and $33.1m in the first half, versus $2.5m and $5.5m in 2012. The 2013 amounts include a $13.3m after-tax HemoCue sale gain; first-half discontinued income also includes $19.8m of discrete tax benefits related to NID. Continuing-operations results are therefore a useful measure of ongoing performance.
Cash flow, balance sheet and capital allocation
- First-half operating cash flow was $255.3m, down from $412.1m. The company attributed the decline to lower earnings, higher days sales outstanding and about $70m of deferred tax payments related to Hurricane Sandy. DSO was 48 days, versus 47 at year-end 2012 and 44 a year earlier; management expected temporary billing and provider-number delays to resolve by year-end.
- First-half investing cash outflow was $19.4m, including $179.9m for acquisitions and $104.7m of capital expenditures, offset substantially by $266.0m of HemoCue sale proceeds. Financing cash outflow was $400.4m, including $511.6m of treasury-stock purchases and $95.3m of dividends.
- Cash was $148.3m at June 30, down from $295.6m at December 31, 2012. Current assets were $1.470bn and current liabilities $1.291bn. Balance-sheet short- and long-term debt totaled approximately $3.496bn. Debt fair value was estimated at $3.8bn, $262m above carrying value.
- Available borrowing capacity was $1.1bn: $360m under the secured receivables facility and $750m under the revolving credit facility, which had no borrowings outstanding. The company reported compliance with debt covenants and said cash, operating cash flow and credit availability should fund obligations and planned investment.
- The quarterly dividend was $0.30 per share. The company repurchased 8.3m shares for $467m in the first half; $353m remained available under authorizations. It estimated 2013 capital expenditures of about $250m.
Outlook, management commentary and risks
- Invigorate program: Management targeted $600m of annual run-rate savings versus 2011 by exit 2014, with potential over-time savings of as much as $1bn. It expected more than $250m of realized savings in 2013 versus 2012. About 450 management positions had been eliminated through Q2; approximately 500 were expected to be eliminated by year-end. The voluntary retirement program was substantially completed and was expected to generate about $40m in annualized savings.
- Estimated total pre-tax Invigorate charges through 2014 remained $170m–$250m, of which $160m–$230m was expected to require cash. Cumulative program charges were $135.5m through June 30. Actual charges could differ materially.
- Management expected reimbursement pressures to reduce underlying revenue per requisition by about 3% for full-year 2013 versus 2012. The filing does not provide a full-year revenue or EPS forecast.
- Acquisitions included UMass clinical outreach and anatomic pathology operations, ATN toxicology and clinical laboratory operations, and Dignity Health lab-related outreach operations. Management described their combined pro forma impact as not material.
- In July 2013, after quarter-end, Quest sold its ibrutinib royalty rights for $485m cash; the transaction was to be recorded in Q3. It also received $29.2m in July related to HemoCue sale closing adjustments.
- Legal and regulatory matters include pending litigation, government inquiries and subpoenas, and potential claims related to billing and pricing. Management said losses on the described other legal matters were not probable or not reasonably estimable as of June 30; potential losses could nevertheless be material to results or cash flows in the period determined. General and professional liability reserves were approximately $118m.
- Other risks include reimbursement and utilization pressure, collection delays, labor and benefit cost increases, litigation and investigations, and interest-rate exposure. Management reported effective disclosure controls and no material second-quarter change in internal control over financial reporting.
Important facts for investors to verify
- Whether the underlying volume and reimbursement trends improve, and whether the expected roughly 3% full-year revenue-per-requisition pressure proves accurate.
- Progress toward Invigorate savings and associated charges, cash costs and execution timing.
- Whether DSO and collection delays normalize by year-end, and whether operating cash generation recovers.
- Debt maturities, facility availability, and the effect of share repurchases and dividends on liquidity and leverage.
- How the HemoCue and ibrutinib transactions, including the latter’s Q3 accounting, affect reported earnings and cash flow.
- Developments in legal, government-investigation, tax and professional-liability matters, whose ultimate costs remain uncertain.