Quest Diagnostics Incorporated — Q3 2009 Form 10-Q
Reporting period: Three and nine months ended September 30, 2009. Unaudited interim results; amounts below are USD millions except per-share data. Quest’s clinical testing business generated more than 90% of continuing-operations revenue.
Financial performance
| Metric | Q3 2009 | Q3 2008 | Nine months 2009 | Nine months 2008 |
|---|---|---|---|---|
| Revenue | $1,897 | $1,827 | $5,607 | $5,449 |
| Operating income | $348 | $317 | $1,029 | $905 |
| Operating margin | 18.4% | 17.4% | 18.3% | 16.6% |
| Continuing-operations income attributable to Quest shareholders | $192 | $160 | $549 | $463 |
| Diluted EPS from continuing operations | $1.02 | $0.81 | $2.91 | $2.35 |
Net income attributable to Quest was $192 million for Q3 and $548 million for the first nine months. Q3 diluted EPS including discontinued operations was $1.02, versus $0.56; nine-month diluted EPS was $2.90, versus $2.09. The prior-year comparisons include substantial NID discontinued-operations charges.
For the nine months, operating cash flow was $637 million, down from $700 million; capital expenditures were $117 million, implying approximate operating cash flow less capital expenditures of $520 million. Investing used $140 million and financing used $504 million. Cash ended at $247 million, compared with $254 million at year-end 2008. Days sales outstanding improved to 43 days from 45 a year earlier.
At September 30, total current assets were $1,471 million and current liabilities $991 million. Balance-sheet debt, including current borrowings, was approximately $2,982 million: $104 million current and $2,878 million long-term. Cash was $247 million. The company reported $1.2 billion of available borrowing capacity, including $400 million under its secured receivables facility and $750 million under its revolving facility.
Changes and drivers versus the prior period
- Revenue rose 3.9% in Q3 and 2.9% over nine months. Clinical testing revenue grew 4.3% and 3.5%, respectively; revenue per requisition increased 4.3% in both periods, supported by test mix and the Medicare laboratory fee increase.
- Clinical testing requisition volume was flat in Q3 and down 0.8% year to date. Pre-employment drug-testing volume fell 23% in Q3 and 24% year to date, reflecting reduced employer hiring. Management also cited fewer business days and exits from certain less-profitable laboratory management agreements in the nine-month comparison.
- Operating margin improved as cost-reduction and efficiency actions and higher revenue per requisition offset modest cost increases. Cost of services fell to 57.9% of revenue in Q3 from 58.7%, and to 58.0% year to date from 59.0%.
- Net interest expense declined $10 million in Q3 and $27 million year to date, primarily due to lower rates and lower average debt. Nine-month operating cash flow included $308 million of NID settlement payments; management said underlying operating cash flow exceeded the prior-year level after considering those payments.
- Other businesses, about 8% of revenue, were approximately flat in Q3 but declined 3% year to date; foreign exchange reduced their revenue by approximately 4% and 6%, respectively. Foreign exchange reduced consolidated revenue growth by 0.4% in Q3 and 0.6% year to date.
Outlook, unusual items and risks
- No earnings or revenue guidance is provided in the supplied filing text. Management estimated 2009 capital expenditures of approximately $180 million and said cash, operating cash flow and credit availability should fund operations, debt service, dividends, repurchases and growth. The secured receivables facility was due to mature December 11, 2009; management expected to replace or extend it.
- 2009 nine-month results included a $15.5 million insurance gain for storm-related losses, a $7.0 million investment write-down and $7.6 million of early debt-extinguishment charges. The Q3 2008 comparison included an $8.9 million equity-investment write-down; 2008 hurricane disruption also affected comparisons.
- The NID federal investigation was settled in April 2009: Quest paid $268 million to settle civil allegations, and NID paid a $40 million fine after pleading guilty to felony misbranding. Quest also entered a five-year corporate integrity agreement and paid approximately $6 million under state settlements in Q3; these payments had been reserved. NID was discontinued in 2006.
- Quest disclosed ongoing or potential legal and government matters, including a California Medi-Cal billing case, subpoenas and investigations concerning Medicaid and other billing practices, and a shareholder derivative action related to NID. Legal reserves for the discussed matters were less than $5 million at September 30. Management said some losses were reasonably possible but not then probable or reasonably estimable; outcomes could affect results or cash flows in the period determined or paid.
- Other risks include professional-liability claims, substantial self-insurance exposure, variable-rate debt and refinancing needs. The company reported compliance with its financial covenants. It used $350 million for share repurchases in the first nine months and had $150 million of authorization remaining; quarterly dividends were $0.10 per share.
- Management concluded disclosure controls were effective at quarter-end and reported no material third-quarter change in internal control over financial reporting.
Important facts for investors to verify
- Underlying volume, test mix, pricing and the durability of cost savings, including continued weakness in pre-employment testing.
- Cash generation and working-capital trends, particularly the cash-flow effect of settlement payments and receivables collection.
- Replacement or extension of the secured receivables facility, upcoming debt maturities, interest-rate exposure and covenant headroom.
- Developments in billing-related investigations and litigation, the NID integrity agreement, and whether legal or professional-liability exposures require additional reserves or payments.