Quest Diagnostics Incorporated — Q2 2009 Form 10-Q
Reporting period: Three and six months ended June 30, 2009. Financial statements are unaudited. Quest provides diagnostic testing and related services; clinical testing generated more than 90% of continuing-operations revenue.
Financial performance
| Metric | Q2 2009 | Q2 2008 | First half 2009 | First half 2008 |
|---|---|---|---|---|
| Net revenue | $1.902 billion | $1.838 billion | $3.710 billion | $3.623 billion |
| Operating income | $359.4 million | $308.1 million | $680.4 million | $588.4 million |
| Operating margin | 18.9% | 16.8% | 18.3% | 16.2% |
| Net income attributable to Quest | $188.2 million | $161.3 million | $355.3 million | $300.9 million |
| Diluted earnings per share | $1.00 | $0.82 | $1.88 | $1.53 |
- Revenue increased 3.5% in Q2 and 2.4% in the first half. Clinical testing revenue grew 4.0% in Q2 and 3.1% year to date; foreign exchange reduced consolidated growth by 0.7 and 0.8 percentage points, respectively.
- Q2 clinical testing requisitions declined 0.6%, but management estimated underlying volume growth of about 2.5% after adjusting for fewer business days, exiting certain laboratory management agreements, and a 24% decline in pre-employment drug testing. Revenue per requisition rose 4.6%, reflecting test mix and the Medicare fee increase.
- Cost discipline improved operating margins: operating costs were 81% of revenue in Q2 versus 83% a year earlier. Cost of services was 57.9% versus 59.0%; SG&A was 23.6% versus 23.8%.
- Interest expense, net, fell to $36.8 million in Q2 from $45.4 million, primarily due to lower rates and lower average debt. Results also included a $15.5 million insurance settlement gain, a $6.3 million early-debt-extinguishment loss, and a $7.0 million investment impairment charge.
Cash, debt and liquidity
- Cash and equivalents were $119.3 million at June 30, down from $253.9 million at December 31, 2008. Current assets were $1.339 billion and current liabilities $1.024 billion.
- First-half operating cash flow was $263.6 million, versus $371.2 million in 2008; the 2009 figure included $308 million of previously reserved NID settlement payments. Capital expenditures were $76.0 million, versus $94.8 million.
- Total debt carrying value was approximately $3.083 billion, including $205.0 million of short-term borrowings and current maturities. The company reported approximately $1.1 billion of available borrowing capacity, with $200 million drawn on its secured receivables facility and none drawn on its $750 million revolving facility.
- Quest expects 2009 capital expenditures of approximately $200 million and said cash, operating cash flow and available facilities should fund operations, debt service, dividends, repurchases and growth for the foreseeable future. The secured receivables facility matures December 11, 2009; refinancing or extension may be needed.
Material developments, risks and outlook
- Quest finalized the federal NID investigation settlement in April 2009. It paid $268 million to settle civil allegations and NID paid a $40 million fine; approximately $6 million of additional state settlements were expected and fully reserved. Quest also entered a five-year Corporate Integrity Agreement. Failure to comply could lead to federal healthcare program exclusion, penalties and reputational harm.
- Other legal matters include government inquiries and lawsuits concerning billing practices, including California Medi-Cal allegations and a Virginia Medicaid subpoena. Management said reserves for other matters were under $5 million; outcomes may nevertheless materially affect results or cash flows in the period resolved.
- Unrecognized tax-benefit liabilities were approximately $120 million. Credit agreements include financial covenants; Quest reported compliance at June 30, 2009.
- Management cited a slowing economy and reduced employer hiring as operating pressures, but expected continued positive cash flow. No specific earnings or revenue forecast was provided in the filing.
- Disclosure controls were assessed as effective; the filing reported no material second-quarter change in internal control over financial reporting.
Key investor verification points
- Assess how much of the earnings and margin improvement is recurring, excluding the $15.5 million insurance gain and the $13.3 million of investment and debt-tender charges.
- Track underlying test volumes, pre-employment drug testing, revenue per requisition and the sustainability of cost reductions.
- Review cash conversion after the NID settlement, receivables and bad-debt trends, and refinancing or extension of the secured receivables facility before its December 2009 maturity.
- Monitor compliance with the Corporate Integrity Agreement and developments in pending billing-related legal matters and tax contingencies.