Quest Diagnostics Incorporated — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014. Unaudited results; dollars in millions except per-share data.
Business context and results
Quest is a diagnostic information services provider; this business generated more than 90% of continuing-operations revenue. The company also operates risk assessment, clinical trials, diagnostics products and healthcare IT businesses.
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net revenue | $1,902 | $1,815 | $3,648 | $3,602 |
| Operating income | $262 | $289 | $470 | $516 |
| Operating margin | 13.8% | 15.9% | 12.9% | 14.3% |
| Continuing-operations income attributable to Quest | $133 | $152 | $237 | $268 |
| Diluted EPS from continuing operations | $0.92 | $0.99 | $1.63 | $1.71 |
| Net cash from operating activities | — | — | $364 | $255 |
Financial position, cash flow and capital
- At June 30, cash was $144; current assets were $1,505 and current liabilities $1,258. Accounts receivable was $963, with a $271 allowance for doubtful accounts.
- Debt carrying value was approximately $3,958, including $220 of short-term borrowings and current debt and $3,738 of long-term debt. This compares with approximately $3,332 at December 31, 2013. Estimated debt fair value was $4.3 billion, $342 above carrying value.
- Six-month investing cash outflow was $841, primarily $723 for acquisitions and $117 for capital expenditures. Financing provided $434, including net debt increases of $579; cash declined $43 to $144.
- Capital expenditures are estimated at approximately $300 for 2014. Credit availability was reported as $1.1 billion; the company said it was in compliance with debt covenants. Quarterly dividends increased to $0.33 per share from $0.30. $771 remained under share repurchase authorizations.
Changes versus prior comparable periods
- Q2 revenue rose 4.8%, but operating income fell 9.2% and continuing-operations diluted EPS fell 7.1%. For the first half, revenue rose 1.3%, while operating income declined 8.9% and continuing-operations diluted EPS declined 4.7%.
- Q2 DIS revenue increased 5.3%; requisition volume grew 7.7%. Acquisitions contributed about 7% to DIS revenue growth and 8.5% to volume. Excluding acquisitions, volume declined by less than 1%, partly due to the decision not to renew certain business. Revenue per requisition fell 2.3% in Q2, reflecting reimbursement pressure, mix and acquired businesses.
- Q2 DS revenue declined 1.1%, primarily due to the prior-year Enterix divestiture; excluding that divestiture, DS revenue would have risen about 1%.
- Cost of services rose 7.3% in Q2, outpacing revenue growth; management cited acquisition costs and a $13 facility-cost allocation change. Margin pressure also reflected reimbursement, performance compensation and legal settlement costs. Lower headcount costs and restructuring savings partly offset these factors.
- Reported 2013 net income included discontinued-operations income of $13 in Q2 and $33 in the first half, including a HemoCue sale gain and, for the first half, a $20 tax benefit. These items make reported net-income comparisons less comparable; continuing-operations results provide a more relevant comparison.
Outlook, management commentary and risks
- Management expected Invigorate to deliver $700 of run-rate savings versus 2011 by year-end 2014, with approximately $200 of savings realized in 2014, and continued to seek savings exceeding $1 billion over time. It estimated $40–$55 of pre-tax charges in the second half of 2014; cumulative charges recorded through June 30 were approximately $218.
- Management said acquisition synergies had not yet been fully realized. Solstas contributed $122 of revenue and $122 of operating expenses in the first half; purchase-price allocations remained preliminary. Summit Health included contingent consideration, with possible payments tied to revenue targets.
- Key exposures include reimbursement pressure, uncertain acquisition integration and synergies, and legal, regulatory and billing-related matters. The company cited ongoing government inquiries and litigation, including Medicaid pricing claims and BRCA patent litigation. Management said potential losses on the described legal matters were not estimable; it did not consider an adverse effect on financial condition likely, but results or cash flows could be affected in a period when losses are determined or paid.
- Professional and general liability reserves were approximately $121. Unrecognized tax-benefit liabilities were approximately $172; up to $40 could decrease within twelve months. The company also disclosed $6,936 of contractual obligations, including debt, leases, interest, purchases and merger consideration.
Most important facts for investors to verify
- Whether underlying DIS volume and revenue per requisition stabilize, and whether reimbursement pressure persists.
- Whether acquired businesses deliver expected synergies and whether preliminary purchase accounting or contingent consideration changes.
- Progress toward Invigorate savings targets, remaining restructuring charges and the effect on operating margins.
- Debt, cash generation and liquidity after acquisitions, including refinancing needs and compliance with credit covenants.
- Developments in government investigations, billing-related litigation, patent disputes and other contingencies; disclosed potential losses were not estimable.