Quest Diagnostics Incorporated — 2010 Form 10-K
Reporting period: Fiscal year ended December 31, 2010. The filing is an annual report, not a standalone fourth-quarter filing; selected Q4 results are included below. Figures are U.S. dollars.
Business context
Quest is a large diagnostic testing and services provider. It processed approximately 146 million test requisitions in 2010. Clinical testing generated about 91% of revenue; routine testing, anatomic pathology, gene-based and esoteric testing, and employer drug testing were key components. The company’s other activities include clinical trials, life-insurance risk assessment, diagnostic products and healthcare information technology.
Key financial metrics
| Metric | 2010 | 2009 |
|---|---|---|
| Revenue | $7.369 billion | $7.455 billion |
| Operating income | $1.296 billion | $1.359 billion |
| Operating margin | 17.6% | 18.2% |
| Income from continuing operations attributable to Quest stockholders | $722.7 million | $730.3 million |
| Diluted EPS from continuing operations | $4.06 | $3.88 |
| Net cash from operating activities | $1.118 billion | $997.4 million |
| Capital expenditures | $205.4 million | $166.9 million |
| Cash and cash equivalents at year-end | $449.3 million | $534.3 million |
| Total debt at year-end | $2.990 billion | $3.107 billion |
| Current assets / current liabilities | $1.605 billion / $1.214 billion | $1.679 billion / $1.059 billion |
Annual revenue fell 1.2%, operating income fell 4.7%, and continuing income attributable to stockholders fell 1.0%. Diluted EPS nevertheless rose 4.6%, helped by lower shares outstanding following repurchases. Operating cash flow increased year over year, although 2009 included substantial NID settlement payments; management said underlying 2010 cash flow was lower, mainly due to payment timing for variable compensation and accrued expenses. The filing reports no material off-balance-sheet financing other than operating leases.
Fourth quarter: Revenue was $1.824 billion versus $1.848 billion in Q4 2009. Income from continuing operations attributable to stockholders was $166.9 million versus $181.8 million. Diluted EPS from continuing operations was $0.97 in both periods.
Material changes and unusual items
- Clinical testing revenue declined 1.3% for the year. Requisition volume fell 1.0%, attributed by management to fewer physician office visits and severe first-quarter weather; revenue per requisition declined 0.2%.
- Cost actions and lower bad-debt expense partly offset weaker revenue. Bad-debt expense was $291.7 million, or 4.0% of revenue, compared with $321.0 million, or 4.3%, in 2009.
- 2010 included $27.0 million of pretax workforce-reduction charges, a $9.6 million employee-litigation settlement charge, and a $22.1 million income-tax benefit, principally from favorable tax-contingency resolutions. Severe weather was estimated to reduce the year-over-year operating-income comparison by $14.3 million.
- Quest repurchased $750 million of shares in 2010 and paid $71.3 million in dividends. In February 2011, it completed an $835 million repurchase of 15.4 million shares from a GSK affiliate, funded with cash and credit-facility borrowings.
Outlook, risks and contingencies
- Management expects long-term growth in diagnostic testing and considers Quest positioned to benefit, while pursuing international and point-of-care growth. It has a long-term goal of raising international revenue to 10% of consolidated revenue; foreign operations contributed about 3% in 2010. The filing provides no specific earnings or revenue guidance. Planned 2011 capital expenditures were approximately $220 million.
- Healthcare reform expands coverage and removes patient cost-sharing for certain preventive benefits, but also reduces the Medicare clinical laboratory fee schedule by 1.75% annually for five years starting in 2011. Pricing pressure, payer consolidation, lower reimbursement and shifts toward capitated contracts remain risks.
- The FDA announced plans to increase regulatory oversight of laboratory-developed tests; the approach and timetable were not yet established. Additional costs or delays to new tests could result.
- MediCal litigation and billing: California alleges improper MediCal billing. Quest temporarily suspended billing through March 1, 2011 while continuing to provide services. 2010 MediCal revenue was about $66 million and amounts due were about $25 million. A proposed, highly conditioned $241 million settlement understanding had not been finalized; the company said any liability was not determinable. An adverse outcome could reduce reimbursement and materially affect results or cash flows in the period determined or paid.
- Other federal and state billing investigations and False Claims Act matters remain unresolved. The company reported approximately $10 million in reserves for the cited legal matters at year-end and stated that losses were not currently probable or reasonably estimable for several investigations. Separately, professional-liability reserves were approximately $130 million. The 2009 federal NID settlement included a five-year Corporate Integrity Agreement; noncompliance could lead to penalties or exclusion from federal healthcare programs.
- Management reported sufficient liquidity for foreseeable needs and compliance with debt covenants at year-end. However, the post-year-end share repurchase used $575 million of facility borrowings, and the company faces debt-service obligations and refinancing requirements.
Most important facts for investors to verify
- Whether the MediCal dispute was resolved, the final payment or billing terms, and collectibility of the approximately $25 million receivable.
- Developments in federal and state billing investigations, related litigation, reserves, and compliance with the Corporate Integrity Agreement.
- Whether volume, revenue per requisition and operating margin stabilize amid reimbursement reductions and payer pricing pressure.
- Cash generation and debt levels after the $835 million repurchase, including facility utilization, upcoming maturities and covenant headroom.
- Whether planned efficiency savings, new-test launches, international expansion and point-of-care growth offset continued softness in core testing demand.