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| DGX > SEC Filings for DGX > Form 10-Q on 23-Oct-2008 | All Recent SEC Filings |
23-Oct-2008
Quarterly Report
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions and select accounting policies that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
While many operational aspects of our business are subject to complex federal, state and local regulations, the accounting for our business is generally straightforward with net revenues primarily recognized upon completion of the testing process. Our revenues are primarily comprised of a high volume of relatively low dollar transactions, and about one-half of total operating costs and expenses consist of employee compensation and benefits. Due to the nature of our business, several of our accounting policies involve significant estimates and judgments. These accounting policies have been described in our Annual Report on Form 10-K for the year ended December 31, 2007.
On May 31, 2007, we completed the acquisition of AmeriPath Group Holdings, Inc. ("AmeriPath"), in an all-cash transaction valued at approximately $2 billion, including approximately $780 million of assumed debt and related accrued interest. AmeriPath is a leading provider of anatomic pathology, including dermatopathology, and esoteric testing which generates annual revenues of approximately $800 million.
Through the acquisition, we acquired all of AmeriPath's operations. AmeriPath, with its team of approximately 400 board certified pathologists, operates 40 outpatient anatomic pathology laboratories and provides inpatient anatomic pathology and medical director services for approximately 200 hospitals throughout the country. We financed the all-cash purchase price and related transaction costs, together with the repayment of approximately $780 million of principal and related accrued interest representing substantially all of AmeriPath's debt, as well as the refinancing of the $450 million term loan used to finance the acquisition of HemoCue with $1.6 billion of borrowings under a new five-year term loan facility, $780 million of borrowings under a new one-year bridge loan, and cash on-hand. In June 2007, we completed an $800 million senior notes offering. The net proceeds of the senior notes offering were used to repay the $780 million borrowed under the bridge loan. The acquisition was accounted for under the purchase method of accounting.
On January 31, 2007, we acquired POCT Holding AB ("HemoCue"), a Sweden-based company specializing in point-of-care testing, in an all-cash transaction valued at approximately $450 million, including $113 million of assumed debt of HemoCue. The transaction was financed through an interim credit facility, which was refinanced during the second quarter of 2007 in connection with the financing of the AmeriPath acquisition. In January 2008, we received a payment of approximately $23 million from an escrow fund established at the time of the acquisition.
HemoCue is the leading international provider in point-of-care testing for hemoglobin, with a growing share in professional glucose and microalbumin testing. HemoCue received Food and Drug Administration ("FDA") clearance in October 2007 for a test to determine white blood cell counts and has applied to receive Clinical Laboratories Improvement Amendments of 1988 ("CLIA")-waived status. Additionally, in June 2008, HemoCue was granted a CLIA waiver for its Albumin 201 System, which is used to screen patients for microalbuminuria and allows physicians to begin treatment based on the test's results during a single office visit.
This acquisition complements our point-of-care testing for infectious disease and cancer, including new tests for colorectal cancer screening and Herpes Simplex Type 2. The acquisition increases our presence in the growing point-of-care testing market and we plan to leverage HemoCue's international presence to reach new markets around the world. HemoCue generated annual revenues of approximately $80 million at the time of acquisition.
Our clinical testing business currently represents our one reportable business segment. The clinical testing business accounted for more than 90% of net revenues from continuing operations in both 2008 and 2007. Our other operating segments consist of our risk assessment services business, our clinical trials testing business, our healthcare information technology business, MedPlus, and our diagnostic products business. Our business segment information is disclosed in Note 9 to the interim consolidated financial statements.
Three and Nine Months Ended September 30, 2008 Compared with Three and Nine Months Ended September 30, 2007
Income from continuing operations for the three months ended September 30, 2008 was $160 million, or $0.81 per diluted share, compared to $150 million, or $0.77 per diluted share, in 2007. Income from continuing operations for the nine months ended September 30, 2008 was $463 million, or $2.36 per diluted share, compared to $400 million, or $2.05 per diluted share, in 2007. These increases in income from continuing operations were principally driven by revenue growth and actions we have taken to reduce our cost structure.
Results for the three and nine months ended September 30, 2008 include a reduction to operating income estimated at approximately $8 million, or $0.02 per diluted share associated with the impact of hurricanes in the third quarter, and a third quarter charge of $8.9 million, or $0.03 per diluted share, associated with the write-down of an equity investment. In addition, the favorable resolution of certain tax contingencies increased diluted earnings per share by $0.01 for the nine months ended September 30, 2008.
During the first quarter of 2007, the Company became a non-contracted provider to United Healthcare Group Inc., ("UNH"). As a result of the change in status, the Company's revenues and earnings were significantly impacted for the first quarter and full year 2007. However, the ongoing profit impact was successfully mitigated by the end of 2007 as a result of actions taken to reduce costs, and higher reimbursement for the testing we continued to perform for UNH members as a non-contracted provider.
Results for the nine months ended September 30, 2007 include first quarter pre-tax charges of $10.7 million, or $0.03 per share, associated with workforce reductions in response to reduced volume levels, and a first quarter pre-tax charge of $4.0 million, or $0.01 per share, related to in-process research and development expense associated with the HemoCue acquisition.
Net revenues for the three months ended September 30, 2008 grew by 3.4% over the prior year level to $1.8 billion. Net revenues for the nine months ended September 30, 2008 were $5.4 billion, 10.4% above the prior year level. The acquisition of AmeriPath, which was completed on May 31, 2007, contributed approximately 6.8% to revenue growth for the nine months ended September 30, 2008. We estimate that the impact of hurricanes in the third quarter of 2008 reduced consolidated revenue growth for the three and nine months ended September 30, 2008 by approximately 0.5% and 0.2%, respectively. While the UNH contract change took effect as of January 1, 2007, much of the loss of volume and change in revenues took place over the course of the first quarter last year. Therefore, there continues to be a carry-over impact in comparing the nine months ended September 30, 2008 volume and revenues to that of the prior year. We estimate that the carry-over impact of our change in status with UNH reduced 2008 revenue growth for the nine months ended September 30, 2008 by less than 1%.
Our clinical testing business, which accounts for over 90% of our net revenues, grew 3.0% above the prior year level for the three months ended September 30, 2008. Volume, measured by the number of requisitions, increased 0.7% for the three months ended September 30, 2008. We estimate that the impact of the hurricanes in the third quarter of 2008 reduced volume growth for the quarter by approximately 0.5% . After adjusting for the impact of the hurricanes, we estimate the underlying volume growth to be about 1.3%. This is despite an almost 10% decline in pre-employment drug testing volume which accounted for
approximately 7% of our total volume. We believe the volume decrease in pre-employment drug testing is principally due to slower hiring by the employers served by this business. Revenue per requisition increased 2.3% for the three months ended September 30, 2008, primarily driven by a positive test mix, partially offset by price reductions on various health plan contracts.
For the nine months ended September 30, 2008, clinical testing revenues grew 10.5% above the prior year level, with AmeriPath contributing 7.3% growth. Volume, measured by the number of requisitions, increased 3.7%, primarily due to the impact of the AmeriPath acquisition, which contributed about 3.2% volume growth. We estimate that the impact of our change in status with UNH and the hurricanes reduced volume growth by approximately 1% and 0.2%, respectively, for the nine months ended September 30, 2008. After adjusting for the impact of the UNH contract change and the hurricanes, results for the nine months ended September 30, 2008 reflect underlying volume growth of between one and two percent. Revenue per requisition increased 6.5% for the nine months ended September 30, 2008 and was impacted by the results of AmeriPath, which contributed 4.0% to the improvement. The balance of the increase was primarily driven by a positive test mix, partially offset by price reductions on various health plan contracts.
Our businesses other than clinical testing accounted for approximately 9% of our net revenues for the three and nine months ended September 30, 2008. These businesses include our risk assessment services business, our clinical trials testing business, our healthcare information technology business, MedPlus, and our diagnostic products business. The revenues for these businesses as a group grew 7% and 10% for the three and nine months ended September 30, 2008, respectively, with the increase primarily driven by a strong performance of our healthcare information technology and point-of-care businesses during the third quarter of 2008 and our healthcare information technology, point-of-care and clinical trials testing businesses for the nine months ended September 30, 2008.
Total operating costs and expenses for the three and nine months ended September 30, 2008 increased $49 million and $389 million, respectively, from the prior year periods. For the three and nine months ended September 30, 2008, operating costs increased as a result of higher costs associated with annual compensation adjustments. In addition, operating costs for the nine months ended September 30, 2008 increased primarily due to costs associated with the acquired operations of AmeriPath. These increases were partially offset by actions taken to improve our operating efficiency and reduce the size of our workforce as part of our cost reduction program announced in 2007.
Results for the nine months ended September 30, 2007 reflect first quarter costs of $10.7 million associated with workforce reductions ($3.9 million included in cost of services and $6.8 million included in selling, general and administrative), $4 million of in-process research and development costs associated with the acquisition of HemoCue, which was recorded in "other operating (income) expense, net", and costs associated with efforts to retain business and clarify for patients, physicians and employers misinformation regarding the UNH contract change.
Cost of services, which includes the costs of obtaining, transporting and testing specimens, was 58.7% of net revenues for the three months ended September 30, 2008, compared to 58.1% of net revenues in the prior year period. The majority of the increase over the prior year is due to the impact of hurricanes which adversely impacted our operations during the third quarter of 2008. For the nine months ended September 30, 2008, cost of services, as a percentage of net revenues, was 59.0%, compared to 59.3% in the prior year period. The improvement over the prior year for the nine months ended September 30, 2008 reflects actions taken to reduce our cost structure and higher revenue per requisition.
Selling, general and administrative expenses, which include the costs of the sales force, billing operations, bad debt expense, and general management and administrative support, were 23.4% of net revenues for the three months ended September 30, 2008, compared to 24.0% in the prior year period. For the nine months ended September 30, 2008, selling, general and administrative expenses, as a percentage of net revenues, decreased to 23.9% from 24.4% in the prior year period. These improvements were primarily due to actions taken to reduce our cost structure and higher revenue per requisition, and for the nine months ended September 30, 2008, partially offset by the impact of the acquired operations of AmeriPath. In addition, selling, general and administrative expenses for the nine months ended September 30, 2007 included first quarter costs associated with
efforts to retain business and clarify for patients, physicians and employers misinformation regarding the UNH contract change.
For the three months ended September 30, 2008 and 2007, bad debt expense was 4.4% and 4.8% of net revenues, respectively. For the nine months ended September 30, 2008, bad debt expense was 4.6% compared to 4.5% of net revenues in 2007. The inclusion of AmeriPath, which carries a higher bad debt rate than the rest of our business, primarily due to its revenue and customer mix, increased the consolidated bad debt rate by approximately half a percent for the nine months ended September 30, 2008. We continue to make progress in our billing and collection processes, resulting in improvements in bad debt, days sales outstanding and the cost of our billing operation. With our disciplined approach, we expect to see continued strong performance in our billing and collection metrics, despite a slowing economy.
Amortization of intangible assets was $8.8 million for the three months ended September 30, 2008, similar to the prior year period. Amortization of intangible assets for the nine months ended September 30, 2008 increased $9.2 million over the prior year period. This increase was primarily due to the amortization of intangible assets acquired in conjunction with the acquisition of AmeriPath.
Other operating (income) expense, net represents miscellaneous income and expense items related to operating activities, including gains and losses associated with the disposal of operating assets and provisions for restructurings and other special charges. For the nine months ended September 30, 2007, other operating (income) expense, net includes a $4.0 million first quarter charge related to in-process research and development expense recorded in connection with the acquisition of HemoCue.
Operating income for the three months ended September 30, 2008 was $317 million, or 17.4% of net revenues, compared to $306 million, or 17.3% of net revenues, in the prior year period. For the nine months ended September 30, 2008, operating income was $905 million, or 16.6% of net revenues, compared to $779 million, or 15.8% of net revenues in the prior year period. The increases in operating income, as a percentage of net revenues, were primarily due to actions we have taken to reduce our cost structure, and for the nine months ended September 30, 2008, were partially offset by the impact of the acquired operations of AmeriPath. Results for the three and nine months ended September 30, 2008 include a reduction to operating income estimated at approximately $8 million associated with the impact of hurricanes in the third quarter. In addition, the operating income percentage for the three and nine months ended September 30, 2008, reflects the impact of the various items which impacted cost of services and selling, general and administrative expenses as a percentage of net revenues.
Interest expense, net for the three months ended September 30, 2008 decreased by $15.6 million over the prior year period, reflecting lower outstanding debt levels during the third quarter of 2008, primarily as a result of debt repayments. For the nine months ended September 30, 2008, interest expense, net increased by $11.8 million. This increase was primarily due to additional interest expense associated with borrowings used to fund the acquisition of AmeriPath.
Other income (expense), net represents miscellaneous income and expense items related to non-operating activities such as gains and losses associated with investments and other non-operating assets. For the three and nine months ended September 30, 2008, other income (expense), net includes a third quarter charge of $8.9 million associated with the write-down of an equity investment.
The effective income tax rate for the three and nine months ended September 30, 2008 decreased 0.6% and 0.5%, respectively, compared to the prior year periods. These decreases were primarily due to the favorable resolution of certain tax contingencies.
During the third quarter of 2008, the Company and NID, a former test kit manufacturing subsidiary of the Company, reached an agreement in principle with the United States Attorney's Office to settle the previously disclosed federal government investigation involving NID and the Company regarding NID test kits and tests performed using those test kits.
The agreement in principle provides for a comprehensive settlement of federal claims. As part of the agreement, NID, which was closed in 2006, is expected to enter a guilty plea to a single count of felony misbranding. The terms of the settlement are subject to the final negotiation and execution of definitive agreements, which may include a corporate integrity agreement, and the approval by the United States Department of Justice and the United States Department of Health and Human Services and satisfactory resolution of related state claims. There can be no assurance, however, when or whether a settlement may be finalized, or as to its terms. If a settlement is not finalized, the Company would defend itself and NID and could incur significant costs in doing so.
As a result of the agreement in principle, during the third quarter, the Company recorded a charge of $73 million in discontinued operations to increase its reserve for the settlement and related matters, bringing the total reserve to $314 million as of September 30, 2008. The Company has recorded deferred tax benefits of $57 million on the reserve, including $24 million recorded during the third quarter of 2008, reflecting the Company's current estimate of the portion of the reserve expected to be deductible for tax purposes. The reserve reflects the Company's current estimate of the expected probable loss with respect to these matters, assuming the settlement is finalized. If a settlement is not finalized, the eventual losses related to these matters could be materially different than the amount reserved and could be material to the Company's results of operations, cash flows and financial condition in the period that such matters are determined or paid.
Loss from discontinued operations, net of taxes, for the three months ended September 30, 2008 was $49 million, or $0.25 per diluted share, compared to $52 million, or $0.27 per diluted share in the prior year. Loss from discontinued operations, net of taxes, for the nine months ended September 30, 2008 was $51 million, or $0.26 per diluted share, compared to $55 million, or $0.28 per diluted share in the prior year. Results for the three and nine months ended September 30, 2008 and 2007 reflect charges of $73 million and $51 million, respectively, to reserve for the settlement and related matters in connection with various government claims, which is more fully described in Notes 6 and 8 to the interim consolidated financial statements.
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